Letter from David Bailey, Nathanaël Benjamin and Vicky Saporta on ‘Innovations in the use by deposit-takers of deposits, e-money and regulated stablecoins’

In view of and concurrently to the publication of two discussion papers, one by the Financial Conduct Authority (FCA) and one by the Prudential Regulation Authority (PRA), about a new supervisory regime for issuers, distributors, and custodians of stablecoins (EventID 23724 and EventID 23817), the PRA has published a Dear CEO Letter addressed at deposit taking institutions. In this letter, the PRA formulates its expectations as regards deposit taking institutions that engage in or plan to engage in digital money-related services. According to the PRA, in such circumstances, customers may be confused about their protection for such services – which vary to traditional deposit taking – , potentially leading to loss of customer money, trust in (traditional) deposits, or confidence in the entire financial market. Therefore, it is necessary to point out concrete expectations of deposit taking expectations in this context.
Expectation 1: Separation of services: Deposit-taking entities should only offer digital money in form of deposits for retail customers. The issuance of such digital money necessitates the operation and licensing of a separate, non-deposit-taking entities. These entities must have distinct branding, be insulated from insolvency impacts on the deposit-taking group, and ensure continuity of deposit services. Deposit-takers already issuing e-money need to promptly discuss with regulatory authorities any plans to restructure their operations accordingly to mitigate any of the beforementioned risks.
Expectation 2: Transition for firms without deposit permissions: Firms without deposit-taking permission but issuing e-money or stablecoins to retail customers, when seeking deposit-taking permission, should transition customers to deposits at the new entity swiftly. They should collaborate with regulatory bodies regarding their transition plans.
Expectation 3: Innovations in Deposit-Taking: Deposit-taking institutions that plan to engage in innovative ways to collect deposits (for instance, via ‚tokenized‘ deposits) must comply with the PRA’s rules for depositor protection under the Financial Services Compensation Scheme (FSCS). Additionally, these deposit-takers must ensure they follow the requirements for maintaining a single customer view which mandates that an institution has systems and processes in place to aggregate and manage all the information related to a customer’s deposits, ensuring that the institution can accurately track and understand the customer’s overall relationship with the firm. Also, institutions need to comply with the exclusion view requirements that oblige institutions to disclose information, adopt specific risk management practices, and ensure compliance monitoring as to deposits that do not qualify for protection or might have limitations in terms of coverage from the FSCS.
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For international deposit-takers operating in or entering the UK market, it’s crucial to align with these PRA’s expectations, especially when seeking to engage in retail activities. Regardless of their operation’s scale, these entities MUST adhere to the same standards as domestic deposit-takers.
Furthermore, the PRA warns institutions of potentially increased liquidity risks and other risks that come along with the reliance on new payment systems (safety, stability). Before engaging in any new (digital) deposit-taking activities, deposit-takers are therefore expected to fully comprehend potential impacts on operational resilience and meet the supervisory standards outlined in the PRA’s supervisory statement SS1/21 and SS2/21.
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To conclude, the PRA notes that it expects institutions engaging in innovative digital money services to keep the regulator informed about any such engagements and their alignment with the outlined expectations. Also, the regulator has enclosed three annexes to
– provide definitions of the forms of digital money and money-like instruments discussed in the letter (Annex 1, page 6);
– further explain the contagion risk arising from multiple forms of digital money or money-like instruments with different protections (Annex 2, page 7); and
– summarize broader expectations for deposit-takers for innovations in the use of digital money or money-like instruments such as AML risk controls or liquidity risk mitigation measures (Annex 3, page 10)