FCA plans new UK regulatory regime for fiat-backed stablecoin

The FCA’s proposals are included in a recent discussion paper (DP) (101 pages/ 1,466 KB). Fiat-backed stablecoins are a type of cryptoasset that aim to maintain their stabilised value by reference to a fiat currency or currencies ‘peg’ – such as the pound sterling or US dollar– and are increasingly used for payments and other purposes in the crypotasset market. According to the DP, stablecoins “play an important role” in crypto markets to enable smooth trading, lending, and borrowing of crypoassets as well as to allow investors to earn yields on their cryptoasset holdings in lending arrangements. 

The proposed regime will regulate the issuance and custody of fiat-backed stablecoins under the Financial Services and Markets Act 2000 (FSMA), and the use of these stablecoins as a means of payment under the Payment Services Regulations 2017 (PSRs). “The DP focusses on arrangements to protect consumers and the market in the event of the failure of a regulated stablecoin issuer, custodian or other entity providing them with services,” said David Heffron, partner, financial regulation and digital assets expert of Pinsent Masons.

The stablecoin market has been growing rapidly across the world. However, according to the DP, there have been various high-profile failures related to stablecoins that have resulted in significant consumer harm. An example it provides is “deviations” of value resulting in losses for consumers, if the stablecoin becomes ‘de-pegged’ from its currency. De-pegged stablecoin usually trade at a discount on the secondary market, risking potential losses for consumers from lower returns, with the DP noting that redemption may currently only be available to wholesale users or high redemption fees, or minimum redepemtion thresholds may prevent or deter consumers from doing so. 

David Heffron said: “Crucial parts of the FCA’s proposed regulatory regime focus on consumers having the right to redeem promptly at par value while the issuer is a going concern, including when the coin has de-pegged on the secondary market; and on issuers having the right assets in place to back a stablecoin, thereby seeking to ensure it both maintains its value relative to its peg and holders can redeem at par.”

Under the proposals, firms will need to be authorised by the FCA and comply with the relevant rules in the FCA’s Handbook to carry on the activities of issuing a UK-based fiat-backed stablecoin and custody of regulated stablecoins. The FCA’s proposed regime would differentiate between “regulated stablecoins” and “approved stablecoins”. Regulated stablecoins would be fiat-backed stablecoins, issued in the UK by FCA authorised firms, that meet the FCA’s rules, which can be used as a means for payment for buying and selling goods and services in the UK. Approved stablecoins would be fiat-backed stablecoins issued from outside the UK (overseas stablecoin) that seek to maintain a stabilised value of the cryptoasset by reference to, and which may include the holding of, one or more specified fiat currencies.

Regulated stablecoin issuers will be required to maintain a reserve of backing assets equivalent in value to the issued stablecoins. Backing assets must be stable in value and sufficiently liquid to enable prompt redemption of the stablecoin at par on demand by any holder. Issuers must manage the backing assets prudently, ensuring changes in the stablecoins’ supply is always reflected by a mirroring increase or decrease in backing assets. The proposed framework requires backing assets to be low risk, secure, and sufficiently liquid, with a focus on low credit risk and low-price volatility – meaning corporate bonds and equities are inappropriate due to higher risks and volatility. 

Under the proposals, issuers would be required to redeem regulated stablecoins at par, even if the backing assets fall in value. Prompt resolution of any identified shortfalls in backing assets is crucial to mitigate risks such as market instability, consumer losses, and potential insolvency if there is a “run” on the stablecoin due to loss of confidence in it. So, under the proposals, issuers must “top up” any shortfall promptly and at most within one business day, using their own liquid resources.

The FCA is proposing that regulated stablecoin issuers should designate a person, a CASS oversight officer, to be responsible for ensuring compliance with the rules on backing assets, as well as overseeing the processes and controls related to them. 

In future, wider use of stablecoin "may hold promise for revolutionising global payments for businesses and consumers", added Heffron. Due to their global reach and interoperability stablecoin potentially could "streamline payments, offering faster, cheaper, and frictionless retail transactions. Additionally, if used for wholesale purposes in on-chain settlement systems, stablecoin might also reshape traditional post-trade financial processes, significantly reducing settlement times and counterparty risks."

The FCA is seeking feedback from interested parties on its proposals and questions by 6 February 2024.