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Fiat-backed stablecoins: Proposed UK regulatory regime

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6 mins read

Updated on 22 May 2024

Our subject expert
Charles Rogers

Senior Solicitor - Financial Services (Scottish Qualified)

Fiat-backed stablecoins regulation is set to transform the way you issue and use crypto assets in the UK, following HM Treasury’s late 2023 proposals and Financial Conduct Authority (FCA) consultations in 2024.

In this rapidly evolving landscape, you need clear guidance on how the draft rules on backing assets, client asset segregation and prudential requirements will affect your stablecoin operations. Our financial services solicitors draw on deep sector expertise to help you interpret the proposed regime, assess compliance gaps and implement robust governance, ensuring you’re ready for implementation.

How are stablecoins and fiat-backed stablecoins defined?
What distinguishes fiat-backed stablecoins from other crypto currencies?
How are fiat-backed stablecoins currently regulated?
What changes to FCA regulation are proposed in the UK?
How might the proposed UK regulations impact the crypto currency market?

How are stablecoins and fiat-backed stablecoins defined?

Stablecoins are a category of crypto assets that aim to maintain a stable value relative to a specified asset or basket of assets, offering perceived stability compared to the high volatility of unbacked crypto assets. Fiat-backed stablecoins are a specific type of stablecoin that seeks to maintain a stabilised value by reference to, and potentially holding one or more specified fiat currencies.

The Financial Conduct Authority (FCA) distinguishes between regulated stablecoins, which are issued by firms authorised by the FCA within the UK, and approved stablecoins, which are issued from outside the UK (overseas stablecoins). Stablecoins have various use cases, primarily for purchasing or selling other crypto assets or facilitating cross-border payments such as remittances.

What distinguishes fiat-backed stablecoins from other crypto currencies?

Although not defined in the consultation paper, fiat money can be understood as currency issued by government decree that is not backed by a precious metal such as gold or silver.

Crypto assets are digital assets implemented using blockchain or distributed ledger technology (DLT). While Bitcoin was the first crypto currency, its value is not pegged to the value of another asset.

Leading examples of fiat-backed crypto currencies are Tether and USD Coin, which are each pegged to the US dollar. The key advantage of pegging a crypto asset to a government-issued currency in this way is its perceived stability compared to the volatility in the value of crypto assets that are not pegged.

How are fiat-backed stablecoins currently regulated?

The existing UK regulatory framework for stablecoins is still in its early stages of development. The UK does not yet have a fully developed regulatory regime for crypto assets, compared to competing jurisdictions such as Switzerland or Singapore. The government’s phased approach is intended to allow firms to innovate.

Currently, the FCA’s remit for stablecoins is limited to anti-money laundering and counter-terrorist financing, as well as the financial promotion of crypto assets. The relevant regulations are:

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (MLRs), as amended, under which 42 FCA firms were registered in September 2023. Several other firms withdrew their applications and/or ceased to undertake crypto asset business in the UK.

The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (SI 2023/612), under which new FCA rules and guidance came into effect from October 2023. See our article Marketing crypto assets to UK consumers: what you need to know about the new standards for further details.

Fiat-backed stablecoins are currently regulated in the UK under both of these statutory instruments, which represents a fairly light-touch approach.

What changes to FCA regulation are proposed in the UK?

The FCA discussion paper sets out several proposals for regulating fiat-backed stablecoins, including:

Backing assets and redemption
Assets backing stablecoins would need to be government treasury debt instruments with maturities of one year or less. Remuneration or interest payments to consumers would not be permissible. Holders would need to be able to convert their stablecoin into fiat currency at par value at all times and by the end of the next business day. The terms and conditions of a regulated stablecoin would need to be reasonable and proportionate, in compliance with other laws, such as the Consumer Rights Act 2015. Information about the stablecoins would need to be communicated clearly in line with the Consumer Duty and financial promotions rules.
CASS and Custody
The FCA Client Assets regime (CASS) would apply, with a statutory trust to safeguard and segregate client assets from a firm’s assets. Accurate books and records would be required, with daily reconciliations. A CASS oversight officer would need to be accountable for overseeing the backing assets, with monthly reports to the FCA. Crypto asset custodians may be prohibited from using clients’ crypto assets for other purposes, such as rehypothecation, which is the re-use of assets held as collateral. Custodians may need to explicitly disclose their safeguarding controls and liability in client agreements in the event of loss. There could be new diligence requirements for the use of sub-custodians.
Organisational requirements
The FCA’s Senior Management Arrangements, Systems and Controls (SYSC) sourcebook would apply to regulated stablecoin issuers and custodians. FCA rules on operational resilience could also apply, as well as requirements for effective cyber resilience practices. Firms would need to have systems and controls to counter financial crime. A Money Laundering Reporting Officer (MLRO) would be required, providing both annual and ad hoc financial crime reports. The Senior Managers Regime and Certification Regime (SM&CR), as well as other FCA conduct rules, would apply.
Conduct of business and consumer redress
The FCA Principles for Businesses apply to every regulated firm, including Principle 12 on the Consumer Duty. For example, firms would be expected to offer fair prices and value to consumers. Firms would be subject to the Conduct of Business Sourcebook (COBS). For example, COBS restricts the inducements firms can accept, such as commissions. Conflicts of interest rules would also apply. Complaint-handling rules would apply. Customers would have access to the Ombudsman Service; however, the Financial Services Compensation Scheme would not apply.
Prudential requirements
A dedicated new prudential sourcebook for regulated stablecoin issuers and custodians is proposed: CRYPTOPRU. New capital requirements would be established, together with new minimum liquidity requirements.
Resolution on failure
CASS rules on the safeguarding of regulated stablecoin backing assets would apply on the failure of a firm, with some adaptations. However, off-chain post-failure secondary trading would not be prohibited.
Payments
HM Treasury has proposed extending the Payment Services Regulations 2017 (SI 2017/752) (PSRs) to capture stablecoins used for payment. Existing conduct rules for payment service providers in the PSRs would apply to certain stablecoin payment activities and ancillary service activities. The Money Laundering Regulations also apply to payment services regulated under the PSRs.

How might the proposed UK regulations impact the crypto currency market?

Many in the industry have long been calling for increased regulation, as it gives a product a stamp of some authority. Regulation is generally thought to mitigate the risk of contagion in financial markets, such as was evident in the so-called “crypto winter” of 2022-23. Many think regulation will increase consumer confidence in investing in crypto assets.

Clearly, the scope of the proposed regulatory changes will have a significant impact on the crypto currency market. It will take firms issuing and safeguarding stablecoins considerable time to review their business models for compliance with the new regime and enhance governance and risk management.

For example, if fiat-backed stablecoins are limited to government treasury debt instruments, this will impact those stablecoins that are currently backed by other assets such as commercial paper, certificates of deposit or money market funds. Similarly, the shift to same-day reconciliations and next-day redemptions will pose challenges to some stablecoin firms.

Timing these changes is essential, though, as these regulatory proposals are at an early stage, awaiting a further round of consultation by the FCA before any legal instruments are drafted. Now is the time to plan the approach, but not necessarily to make wholesale changes to the business.

Our financial Services solicitors are on hand to assist with tailored advice on any new requirements and how they might impact your business.

About our expert

Charles Rogers

Senior Solicitor - Financial Services (Scottish Qualified)

Charles is a financial services regulation specialist who advises financial institutions, fintech businesses and service providers on regulated and unregulated financial services. Qualified as a solicitor in Scotland in 2014, he brings experience from private practice, in-house roles and as a legal adviser at the Financial Conduct Authority (FCA), with particular expertise in consumer credit, payments, e-money, retail financial services and consumer protection.

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