DP23/4: Regulating cryptoassets Phase 1: Stablecoins

In view of the increased use of stablecoins – whose values are pegged to another currency, asset, or cryptoasset – particularly by cryptoasset exchanges as a means of payments for cryptoassets, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) have issued various discussion papers, a roadmap, and a „Dear CEO Letter“ relating to stablecoins. In this particular discussion paper (DP23/4), the FCA presents its first views on a new regulatory regime for stablecoins, including requirements on stablecoin issuers and custodians. The new framework thereby mainly aims to ensure market integrity by imposing clear obligations on stablecoin issuers as to the backing and maintenance of the value of issued stablecoins and redemption against the pegged asset and on custodians as to their safeguarding obligations. The key pillars of the proposed new regime are briefly discussed below; for more detailed, comprehensive information, please refer to the enclosed legal document. It shall be noted that the PRA concurrently consults on various related rules to enable payments via stablecoins (modifications to the payments services regulations).
#### The proposed new regulatory regime
(1) Authorization requirements: The FCA proposes to require stablecoin issuers seeking to issue fiat-backed stablecoins (those tied to one or more fiat currencies such as the US$ – see the comment box below) in or from the UK to be authorized by the regulator. This authorization would be irrespective the fact whether or not the fiat-backed stablecoins would be offered to UK customers. Also, firms providing custody service for such stablecoins which the FCA calls „regular stablecoins“ would have to be authorized by the Authority. As far as third-country issuers are concerned, the PRA and the FCA are contemplating an „approval“ regime for such issuers. Thereafter, entities seeking to assess third-country fiat-backed stable coins against UK rules would have to be authorized as so-called „payment arrangers“. It would be up to payment arrangers to verify compliance by the foreign entity with UK regulations. Once found to be suitable, the third-country issuer would be able to „offer“ its stablecoins in the UK.
(2) Maintenance of value and facilitation of redemptions: The FCA proposes to require fiat-backed stablecoin issuers to maintain a stable value relative to their reference currency / currencies. Specifically, to ensure stability and consumer protection, the proposed regulatory regime would mandate that stablecoin issuers must consistently hold backing assets that are
– adequate to cover ALL issued stablecoins;
– possess a stable value; and
– maintain sufficient liquidity to facilitate prompt redemption by consumers.
Furthermore, the regulator proposes to require that fiat-backed stablecoin issuers MUST ensure redemption at par value to ALL holders of regulated stablecoins by the end of the next UK business day after they have received a redemption request from a customer. This requirement would be irrespective the type of customer involved (retail versus institutional). Moreover, the issuer would have to disclose corresponding redemption policies to their clients.
(3) Qualifications for backing assets to facilitate prompt redemption and asset segregation Issuers of fiat-backed stablecoins would be obliged to back their stablecoins with government treasury debt instruments maturing in one year or less along with short-term cash deposits. The proposed framework would prohibit the use of Money Market Funds (MMFs) when investing in treasury bills to back stablecoins. Furthermore, the FCA proposes to apply the current „Client Assets regime (CASS)“ which provides for the safeguarding of client assets. Specifically, the FCA seeks to require the backing assets of regulated stablecoins to be segregated from the issuer’s own assets and held in a statutory trust for the benefit of consumers. The trust’s terms, including conditions for payouts (e.g. for redemptions) and asset distribution in case of an issuer’s failure would also be part of the regulatory framework. Additionally, the FCA and PRA are considerating requiring the segregation for backing assets for each regulated stablecoin individually to prevent cross-contamination risks.
(4) Requirements pertaining to recordkeeping and reconciliation of backing asset: The FCA proposes to require issuers of fiat-backed stablecoins to maintain records that enable them to identify the total backing assets required for each consumer. Furthermore, issuers would be required to maintain detailed records of any activities related to the backing assets, including regular updates on the daily valuations of these assets.
In addition, the FCA would require both internal and external reconciliations as checks to ensure the accuracy of backed assets. External reconciliations would thereby have to be performed daily and involve comparing a firm’s internal records with those of third parties holding the backing assets for custody purposes (e.g., credit institutions).
(5) Requirements of custodians: Similar to custodians of „traditional“ financial assets, the FCA would require custodians of backing assets to fiat-backed stablecoins to meet a number of requirements, including the following, among others:
– custodians would be required to keep custodized assets separate from their own assets;
– custodians would be required to have adequate policies and procedures in place to minimize the risk of loss or „diminution of clients’ custody assets“;
– custodians would be required to maintain accurate and up-to-date records of client holdings; and
– custodians would be required to monthly report on their clients’ holdings.
(6) Prudential requirements: The FCA proposes to introduce a new prudential sourcebook for stablecoin issuers and custodians which would include capital requirements based upon firms‘ permanent minimum requirement (PMR), which is not yet defined in the discussion paper, the fixed overhead requirement (FOR), which includes firms‘ fixed overhead costs in the previous year, and a variable K-factor capital requirement based upon firms‘ individual risks. The FCA proposes to select the highest of the three, the PMR, the FOR, and the variable K-factor requirement as the capital requirement to be imposed on a firm. Furthermore, issuers and custodians would have to meet some basic liquid asset requirements which would have to be met by holding any of the following – as quoted:
– coins and banknotes;
– short-term deposits at a UK bank;
– assets representing claims on or guaranteed by the UK Government or the Bank of England (for example UK gilts and Treasury bonds); or
– units or shares in a short-term regulated money market fund, or in a comparable third country fund.
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The discussion paper further includes proposals as to conduct of business and consumer redress requirements, as well as new rules on the use of stablecoins for payment purposes.