On 30 October 2023, HM Treasury (HMT) published three documents setting out how the UK government plans to regulate cryptoassets going forward:

  • a response to its February 2023 consultation and call for evidence on the future financial services regulatory regime for cryptoassets;
  • an update on its plans for the regulation of fiat-backed stablecoins; and
  • a response to its May 2022 consultation on managing the failure of systemic digital settlement asset (DSA) (including stablecoin) firms

A week later, the UK’s Financial Conduct Authority (FCA), the Bank of England (BoE) and the UK’s Prudential Regulation Authority (PRA) published a package of related documents flowing out of HMT’s update on its plans for the regulation of fiat-backed stablecoins:

  • an FCA discussion paper on its approach to regulating fiat-backed stablecoins;
  • a BoE discussion paper on its proposed regulatory framework for systemic payment systems using stablecoins and related service providers;
  • a PRA Dear CEO letter on banks’ innovative use of deposits, e-money and regulated stablecoins; and
  • a cross-authority roadmap on innovation in payments, which explains how the UK authorities’ current and proposed regulatory regimes will interact

As explained in our previous blog post, when it launched its consultation and call for evidence in February 2023, HMT proposed a phased approach for the implementation of the future cryptoassets regime. Since then, the Financial Services and Markets Act 2023 (FSMA 2023), which received Royal Assent in June 2023, has given HMT the powers to bring cryptoassets into the regulatory perimeter. It also empowered HMT to establish a regime in which the BoE and the Payment Systems Regulator (PSR) will regulate systemic payment systems using DSAs and related service providers, subject to designation or recognition by HMT.

In its February 2023 consultation, HMT set out the general principles underpinning its future approach to the regulation of cryptoassets, which remain broadly unchanged. These latest documents confirm and clarify how aspects of the proposed regime will be implemented in practice.

Phase 1: fiat-backed stablecoins

In the first phase of HMT’s iterative approach, stablecoins backed by a single fiat currency or a basket of fiat currencies will be brought in scope of the UK’s payment services regime or a FSMA-based authorisation regime, depending on how the fiat-backed stablecoin is used. The use of fiat-backed stablecoins in payment chains will be regulated through amendments to the Payment Services Regulations 2017 (PSRs 2017), while the issuance and custody of UK-issued fiat-backed stablecoins will be included in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). HMT says it plans to lay legislation before Parliament as soon as possible, and by early 2024 at the latest.

Issuers of stablecoins that are non-systemic will be regulated by the FCA for conduct and prudential purposes. Stablecoin entities recognised by HMT as systemically important, on the other hand, will be dual-regulated by the PRA for prudential purposes and by the FCA for conduct purposes. They will also be regulated by the PSR for competition purposes.

While HMT’s recent update confirms the general concepts which it had previously proposed with respect to Phase 1, the FCA’s related discussion paper sets out more granular proposals regarding the implementation of its regime for fiat-backed stablecoins. For example, the FCA’s discussion paper builds on HMT’s framework by proposing conduct of business and consumer redress rules and custody, organisational and prudential requirements for firms in scope of Phase 1, as well as plans for managing the failure of stablecoin issuers and custodians.

The FCA also sets out its plans to regulate payments using stablecoins. HMT is proposing to extend the scope of the PSRs 2017 to capture two types of stablecoins used for payment. The first is a pure stablecoin model, where both the payer and payee transact in stablecoin, and the second is a hybrid model, where a stablecoin is used in combination with a traditional payment in fiat.

HMT has also floated the possibility of introducing an approach to regulate payments that use fiat-backed stablecoins issued from outside the UK. Under that approach, UK firms in the payment chain that “arrange” payment services would (i) require FCA authorisation and (ii) be responsible for ensuring overseas fiat-backed stablecoins comply with the FCA’s standards. This proposal would create additional obligations for any UK firm that acts as arranger in such payment chains. The arranging firm would be whichever UK entity facilitates a UK individual or merchant to pay or be paid using an overseas fiat-backed stablecoin.

The BoE’s discussion paper deals with the specific issue of how systemic payment systems using stablecoins and related service providers should be regulated. It focuses on sterling-denominated stablecoins, as the BoE expects these to be the most widely used for retail payments. In line with its “same risk, same regulation” approach, the BoE proposes to rely on its existing framework to regulate systemic payment systems using stablecoins, to the extent that the risks are similar to other systemic payment systems. The BoE will regulate the recognised payment system operator as the central entity responsible for the transfer function in any systemic stablecoin payment chain.

At the same time, the BoE recognises that requirements for systemic payment systems using stablecoins need to account for innovative features such as the use of external and distributed ledgers. Among other things, the BoE proposes detailed requirements on the backing assets that must be maintained by in-scope payment systems. The BoE also proposes that issuers of stablecoins should not receive interest on central bank deposits or pay interest to coinholders. In addition, the BoE proposes requirements for wallet providers and other service providers.

If an issuer or other recognised service provider involved in a systemic payment chain fails or is likely to fail, the BoE may apply to the courts to place the firm into special administration. In HMT’s response to its May 2022 consultation, HMT has confirmed that it will manage the failure of systemic DSA firms under a modified version of the existing Financial Market Infrastructure Special Administration Regime. DSA firms that are not systemic will continue to rely on the standard corporate insolvency procedures under the Insolvency Act 1986, though the government says it may consider developing a new special administration regime for such firms in future.

The deadline for comments on the FCA and BoE discussion papers is 6 February 2024. The regulators intend to finalise rules for consultation in H2 2024, with implementation of the new regime planned for 2025.

The PRA’s Dear CEO letter to deposit-takers also addresses important aspects of the future Phase 1 regime, although it applies more broadly than both the FCA and BoE discussion papers (i.e. it also addresses other innovations in digital money and money-like instruments). In particular, the Dear CEO letter clarifies that if a bank wishes to issue regulated stablecoins to retail customers, it must do so from a separate non-deposit-taking and insolvency remote entity. Furthermore, where a stablecoin issuer seeks a deposit-taking permission, it should move its UK customers to deposits at the new deposit-taking entity as soon as possible.

HMT has separated the regulation of tokenised deposits from the regulation of fiat-backed stablecoins. The government has indicated that it does not intend to include tokenised deposits within the scope of regulated activity, because tokenised deposits are already covered by the regulated activity of accepting deposits. In its Dear CEO letter, the PRA says that banks taking tokenised deposits should ensure they meet the PRA’s rules for eligibility for depositor protection under the Financial Services Compensation Scheme.

Phase 2: other cryptoassets

The next phase of HMT’s iterative approach will bring regulated activities conducted with respect to other cryptoassets in scope of the existing FSMA regime, as proposed in HMT’s February 2023 consultation paper (Phase 2). Phase 2 will include cryptoassets such as algorithmic stablecoins and commodity-linked tokens, which do not fall within the scope of Phase 1. The regulatory framework for custody of regulated stablecoins established in Phase 1 will be expanded in Phase 2 to include these other types of cryptoassets. HMT expects Phase 2 legislation to be laid before Parliament at some point in 2024.

Firms that are already registered with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs 2017) should note that they will not be automatically authorised to conduct Phase 2 regulated activities. According to HMT, the new regime will include aspects of compliance that may not have been previously assessed. The FCA will provide more detail in due course.

The UK government has confirmed that non-fungible tokens (NFTs) and utility tokens could also fall within scope of its future cryptoasset regime in certain circumstances. The proposals regarding NFTs are complicated and serve to illustrate some of the challenges that regulators face when seeking to regulate in the space.

NFTs that are akin to “digital collectibles or artwork” will be outside of Phase 2’s scope. An in-game purchase could be structured as an NFT but would not necessarily be subject to the financial services regulatory regime if the NFT is not sold within financial markets or as a financial instrument. However, NFTs used as an exchange token will be in scope. This could be the case, for example, where a large class of technically unique but largely indistinguishable NFTs are purchased on an exchange as financial instruments or products by UK consumers with no preference of one NFT over another. Exchanges trading in such tokens would be subject to the applicable financial services regulatory regime, even if the tokens are marketed as NFTs.

HMT has confirmed that it will implement the territorial scope of the wider cryptoassets regime as consulted upon, meaning that it will capture cryptoasset activities provided by overseas firms to UK persons. The Overseas Persons Exclusion will not apply. The government says it intends to work with its international partners to develop a framework in which equivalence and/or deference arrangements may apply. In the meantime, HMT says it may implement transitional arrangements that could facilitate access to global liquidity pools being operated in jurisdictions meeting international recommendations and standards. For example, the FCA could allow UK firms operating a regulated cryptoassets trading venue in an overseas jurisdiction to apply for a UK branch to be authorised to carry out trade matching and execution activity.