The U.K. Financial Conduct Authority has published a discussion paper regarding potential future proposals for regulating fiat-backed stablecoins, including when used as a means of payment. The FCA's paper follows the government's recent Policy Paper on Plans for the Regulation of Fiat-backed Stablecoins, which confirmed that changes to legislation would bring these types of stablecoins into the U.K. regulatory perimeter. This is part of HM Treasury's plan to regulate cryptoassets, focusing first on fiat-backed stablecoins.

The FCA will supervise non-systemic fiat-backed stablecoins for prudential and conduct of business purposes, and systemic fiat-backed stablecoins for conduct purposes only. The Bank of England is responsible for the financial stability of systemic payment systems using fiat-backed stablecoins and has published a discussion paper alongside the FCA's discussion paper. Responses to both discussion papers may be submitted until February 6, 2024. The Prudential Regulation Authority will supervise banks' activities in tokenized deposits. The PRA has written to banks stating that any business in fiat-backed stablecoins will, among other things, need to be conducted from a separate legal entity under branding that is different to the banks' branding. The Payment Systems Regulator will supervise the competition aspects relating to systemic payment systems that use fiat-backed stablecoins.

Under the government's new regime, firms will need to be authorized by the FCA to issue fiat-backed stablecoins, regardless of whether the stablecoin is marketed to retail consumers, and to provide custody services of the stablecoins. Authorized stablecoin issuers will need to ensure that their regulated stablecoins maintain a stable value. In its discussion paper, the FCA sets out its current thinking about its rules for this new regime that will govern fiat-backed stablecoins—namely, the issuance of stablecoins in or from the U.K., custody services from the U.K. or to U.K.-based consumers of fiat-backed stablecoins, the use of fiat-backed stablecoins as a means of payment, and managing the failure of non-systemic payment systems using fiat-backed stablecoins.

Authorized Issuer Requirements

The FCA is proposing two main requirements related to ensuring that regulated stablecoins maintain a stable value:

1.   An authorized issuer will need to ensure that their stablecoins maintain their value relative to their reference currency or currencies.

The FCA is, among other things, proposing that an issuer would be required, at all times, to hold backing assets that are: (i) sufficient to back all of its issued stablecoins; (ii) stable in value; and (iii) sufficiently liquid to reinforce consumers' right to redeem the stablecoin promptly. The FCA proposes that backing assets should constitute government treasury debt instruments with a maturity of one year or less and short-term cash deposits. Backing assets would need to be adequately identified, recorded, segregated and protected in the event of the issuer's insolvency. The FCA proposes that backing assets for regulated stablecoins should be held on statutory trust, with the terms of the trust set out in FCA rules, including when backing assets would be distributed if an authorized issuer failed. Also under consideration is requiring an issuer that owns its own stablecoins to hold backing assets for those stablecoins too.

In terms of safeguarding of the backing assets, the FCA confirms that where an issuer appoints a third-party entity to hold the assets, the issuer would remain legally responsible for ensuring the assets are safeguarded appropriately. The FCA is seeking feedback on whether it should instead require issuers to partner with an independent custodian, appointing it to take on the safeguarding responsibility. This would be similar to the existing independent depositary model for regulated funds.

2.   An authorized issuer will need to ensure that their stablecoins can be promptly redeemed at par value by any holder of the stablecoin.

The FCA is proposing that where a regulated stablecoin issuer is a going concern, it will need to ensure redemption at par to all holders of the regulated stablecoin, by the end of the next U.K. business day, after receiving their redemption request. This requirement would apply for wholesale and retail holders of the issuer's stablecoin. If by then an issuer had not had dealings with a customer (which is currently the usual case for retail customers) that time would only start once the requisite anti-money laundering checks had been done.

Custody Requirements

In its discussion paper, the FCA discusses the custody regime that should apply for regulated stablecoins as well as cryptoassets that are currently categorized as security tokens. Subject to feedback, the FCA indicates that it will adopt a similar regime for other cryptoassets that are being brought under regulation. The FCA is proposing to base the regulatory requirements for custody of stablecoins on the existing regime that operates in traditional finance for custody of assets, which are set out in the FCA's Client Assets Sourcebook, known as CASS. The CASS requirements would be adapted to create a bespoke regime for stablecoins covering:

  • Arrangements to protect clients' rights to their cryptoassets, including requiring custodians to segregate clients' cryptoassets from their own by recording of ownership and wallet labelling. Contrary to the general traditional finance position which bans the use of assets, the FCA is considering allowing custodians to use clients' cryptoassets held under custody, for example, to provide staking services, hold cryptoassets as collateral or lend them to other clients.
  • Organizational arrangements to minimize risk of loss or diminution of clients' custody assets, as a result of misuse, fraud, poor administration, inadequate record-keeping, money laundering, illicit activities or negligence.
  • Accurate books and records of clients' custody assets holdings. The FCA is considering requiring a stablecoin custodian to maintain a client-specific cryptoasset record and to keep records that would ensure that, at any time, it would be able to differentiate between cryptoassets held for its clients and its own cryptoassets.
  • Controls and governance to protect clients' custody asset holdings. The FCA believes that the risks that could arise from the use of third parties could be mitigated by strict rules on due diligence and oversight but seeks views from stakeholders on the proposed approach.

The FCA also intends to apply and adapt its existing client assets regime to regulated stablecoin backing assets (discussed above), including requiring stablecoin issuers to appoint a CASS oversight officer.

For exchanges that offer a range of services other than trading, the FCA is proposing to require the establishment of separate legal entities for all custody-like activities to ensure a separate governance structure for the cryptoasset custodian and to ensure that an exchange does not take possession of clients' cryptoassets to prefund trading activities.

The FCA is also contemplating other requirements that would be appropriate for issuers of stablecoins and custodians of cryptoassets, such as organizational requirements, conduct of business and consumer redress requirements, prudential requirements and managing the failure of a regulated issuer or custodian of non-systemic stablecoins.

Stablecoins Used in Payments

HM Treasury intends to amend the Payment Services Regulations 2017 to allow fiat backed stablecoins to be used as a means of payment in the U.K., covering both "mixed" stablecoin payments (i.e., where the on-ramp to the payment chain is from a stablecoin, which then converts to fiat within the payment chain and the off-ramp is in fiat), or "pure" stablecoin payments (i.e., both the on- and off-ramp in the payment chain are in stablecoin and the transfer of value occurs in stablecoin). The FCA sets out how the existing requirements might apply to payment service providers under these two models, noting that the PSRs are due to be repealed and restated with many of the requirements moving to the FCA's Handbook. The FCA considers that the existing conduct of business requirements that apply to payment service providers would apply to payment service providers in stablecoin payments. The existing safeguarding requirements would apply for mixed stablecoin payments; however, the FCA's proposed new custody rules for stablecoins (discussed above) would apply to pure stablecoin arrangements. The FCA notes that the U.K. Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 are likely to apply to stablecoin payments under either model, as would operational resilience requirements. In addition, the FCA is proposing that payment service providers facilitating stablecoin arrangements would be required to comply with the FCA's dispute resolution rules and that clients of payment arrangers would have access to the Ombudsman Service. However, the FCA notes that unless legislation is amended, the Financial Services Compensation Scheme would not apply to payments using stablecoins.

Finally, the FCA discusses the requirements that would apply to U.K. payment arrangers for overseas stablecoins to be used for retail payments.