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UK regulators have set their sights on 2024 to introduce new regulation for fiat-backed stablecoins. Although the rules have yet to be confirmed, they could have serious implications for stablecoin issuers.
On November 6, the Bank of England (BoE) and the Financial Conduct Authority (FCA) each published discussion papers detailing how they intend to develop new regulations for fiat-backed stablecoins.
The BoE’s paper sets out a proposed regulatory framework for systemic payment systems that may handle stablecoins, while the FCA’s paper sets out a proposed regulatory framework for stablecoin issuers, custodians and payment "arrangers".
Both papers seek feedback from firms by February 6, 2024.
In addition, the Prudential Regulation Authority (PRA) has written to UK bank CEOs setting out its expectations on the issuance of stablecoins, tokenised deposits and other forms of private digital money.
The three publications are designed to be read alongside a policy statement from HM Treasury, published last month, on its plans to define fiat-backed stablecoins in legislation.
According to the Treasury, bringing stablecoins into existing financial services regulation will be the first step in a two-phase journey towards regulating all crypto-assets as financial services.
First, the issuance and custody of UK-issued, fiat-backed stablecoins will be designated under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO).
This will enable the FCA to make rules for firms conducting these activities, and will require that firms wishing to act as issuers or custodians apply for FCA authorisation.
In addition, the government wishes to accommodate fiat-backed stablecoins that are issued overseas.
The government and the FCA will engage industry ahead of legislation on options for achieving both of these aims and the plans will be laid before parliament as secondary legislation in 2024.
Until the wider regime for crypto-assets comes into place in phase 2, the scope of the regulation will not cover stablecoins used in the buying and selling of crypto-assets on exchanges.
A big step for a small market
David Rodriguez, associate director at Cosegic,a UK-based consultancy, said the proposals are a “step in the right direction” for regulatory clarity on stablecoins.
However, he questioned whether they are a case of too much too soon, considering the current size and influence of the UK’s stablecoin market.
“The proposed requirements papers are certainly above and beyond those that currently apply to e-money issuers,” he told Vixio.
“If the proposed approach is confirmed, I guess we could genuinely ask whether we are over-regulating stablecoin issuers or under-regulating e-money.”
Rodriguez said regulators should take a “hard stance” on stablecoins that have “systemic” implications, but he also said there are no stablecoins — either in the UK or elsewhere — that currently fit that description.
“Nonetheless, it is a good sign that the potential regulatory treatment of stablecoins is being subject to public discussion,” he said.
“Obviously, it's important to ensure that regulation does not hinder the potential advantages of using stablecoins in cross-border payments or as on-ramps and off-ramps to the crypto space.”
Nisha Sanghani, partner at Ashurst Risk Advisory, also welcomed the clarity of the FCA’s proposals.
“While stablecoins have the potential to revolutionise payment flows, these rules will be important in ensuring safeguards for consumers and market stability,” she told Vixio.
“Of course, successful outcomes will ultimately impact both public confidence and long-term benefits."
User protection in focus
In formulating the proposed rules, the FCA said that protecting stablecoin users from the failure of issuers and custodians was a top priority.
Looking back at 2022, the regulator said that repeats of the Celsius and FTX sagas must be avoided.
With both platforms now having filed for bankruptcy, customers whose funds were lost to these custodians now find themselves as unsecured creditors in bankruptcy proceedings.
Instead, under the FCA and BoE’s proposed rules, the aim is for the “overall level of protection” for stablecoin users to be “equivalent” to that of depositors at a bank.
Difficulties for incumbent stablecoin issuers
At present, there are few, if any, stablecoin issuers that would meet the requirements proposed by the FCA.
As noted by the FCA, the total market cap of all stablecoins worldwide is currently about $123bn, and 87 percent of that market is made up of Tether’s USDT and Circle’s USDC.
Moreover, neither of these two stablecoin issuers would meet the demands proposed by the FCA in their current form.
For example, the FCA has proposed that only two assets would be acceptable as reserves for regulated stablecoins: short-term government bonds; and short-term cash deposits.
All other assets considered by the FCA were deemed inappropriate due to counterparty and liquidity risk.
This includes certificates of deposit (CDs), commercial paper (CP), corporate bonds, repurchase (repo) agreements and money market funds.
In September, Tether said in its latest attestation that it currently holds almost $9bn in repo agreements and more than $8bn in money market funds as reserves.
Circle, likewise, holds almost $14bn in repo agreements as reserves.
Transparency matters
In addition to changes in the composition of stablecoin reserves, the proposed rules would also require a significantly higher standard of transparency from stablecoin issuers.
For example, the FCA has proposed that stablecoin issuers should provide information on the “stability, sufficiency and constitution” of reserves and information on “how and where” they are held.
Such practices would be much different than those that can currently be seen at Tether, for example, which is well-known for its opaque handling of reserve assets.
Not only has Tether never been audited, but questions have continually been raised about certain items in its reserve attestations.
With holdings totalling $56bn, Tether’s largest reserve asset is said to be US Treasury bills.
However, in contrast to Circle, Tether does not publish the CUSIP Numbers of the US Treasuries it holds.
In other words, there is no way for customers to independently verify that Tether’s purported holdings of US Treasuries actually exist.
If the proposed rules are adopted in their current form, Tether is likely to be placed on the FCA’s Warning List, as noted by crypto and financial crime researcher Bitfinex'ed.
