Stablecoin Regulation in the UK

The UK is making targeted amendments to its existing financial reguhlations so that they can apply to cryptoasset-related activities accordingly.

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I. Introduction

In the ever-evolving world of global finance, the increasing popularity of cryptoassets and distributed ledger technology (DLT) has presented both unprecedented opportunities for the industry players and unique challenges for the regulators around the globe. With the City of London, the United Kingdom (UK) has managed to remain a global financial hub for more than a century by successfully navigating turbulent seas of the global financial system as well as by proactively adopting all developments that have been reshaping the industry throughout this period.

Ever since the departure of the UK from the European Union (EU), the UK Government has been promising to take all necessary measures to maintain and further improve the UK legal and regulatory framework with the aim of fostering innovation in the financial services industry and maintaining the City of London’s position as the global hub of international finance.

This has prompted a reevaluation of the national legal and regulatory framework, demanding the UK Government to find a right balance between fostering innovation on the one side and safeguarding financial stability and the country’s reputation in international finance on the other. By no surprise, a part of this process was also for the Government to find an adequate approach to the regulation of the rapidly evolving industry that was catching everyone’s attention – the crypto industry.

II. The beginning of UK crypto-industry regulation

In 2019, the UK Government made the very first step towards »regulation of« the crypto-industry by making targeted amendments of Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the MLR) that effectively transposed the Fifth EU Money Laundering Directive into UK national law.¹ These amendments introduced the very first national definition of a »cryptoasset« that went beyond the definition of virtual assets under 5AMLD² and imposed a registration obligation on crypto-exchanges and custodian wallet providers that started to apply as of 20 Jan. 2020.

This was for a long time the only piece of the UK regulation that was directly and explicitly regulating the crypto-industry. Nonetheless, throughout this period, the UK Financial Conduct Authority (FCA) has been constantly remindingcrypto-businesses that in relation to cryptoassets that qualify as specified investments under the Financial Services and Markets Act 2000 (FSMA) Regulated Activities Order 2003(RAO), existing authorisation and conduct requirements are to be duly observed and complied with.³

Conscious of the risks that massive and unregulated advertising of cryptoassets may pose for UK investors, in the second step the HM Treasury saw as suitable to focus its attention on bringing crypto-advertisements within the existing regulatory perimeter.⁴ Based on the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (»FPO«), the financial promotions regime is a very important part of the UK financial regulatory puzzle that effectively ensures that regulated instruments and services are being promoted to UK investors only in compliance with strict regulatory requirements. With this in mind, in July 2020, HM Treasury launched a consultation aimed at gathering views from the industry on the potential extension of the scope of application of the existing financial promotions regime to certain »qualifying cryptoassets« through targeted amendments of FPO.⁵

Earlier that month, based on the mandate given to him by, at the time, Chancellor of the Exchequer Rishi Sunak, Ron Kalifa OEB started an independent review of the UK Fintech sector with the aim of identifying priority areas to support further development of the fintech ecosystem in the UK and maintain the country’s global reputation in the industry. In early 2021, a long awaited »Kalifa Report«⁶ was published which set the roadmap for further improvement of the fintech ecosystem in the UK concluding that the UK shall come up with a similar plan to the EU’s Digital Finance Strategy⁷ published in Sep. 2020. More specifically, the report outlined some examples of specific policy initiatives that would represent UK’s answers to EU’s digital finance package,⁸ including supporting digitization of financial market infrastructures, creating a new regulatory framework for cryptoassets and developing a central bank digital currency.

While still expecting the Kalifa Report to be published, HM Treasury has published in Jan. 2021 a consultation and call for evidence on the UK regulatory approach to cryptoassets⁹ with the aim of gathering industry views on the approach that the UK shall take in order to develop a regulatory framework on cryptoassets by harnessing the benefits of innovation while maintaining resilience to consumer related, market integrity and financial stability related risks.

III. Phased approach

In Apr. 2022, HM Treasury published its response¹⁰ to its consultation in which it outlined for the first time some details about the planned UK approach to regulation of cryptoassets and stablecoins. It laid out the plan for the creation of the regulatory framework in different phases by firstly regulating the areas of the crypto-industry where risks and opportunities are most acute, starting with the finalization of the proposed extension of the financial promotions regime. The remaining elements of the UK regulatory framework on cryptoassets are planned to be created in two phases as described in more detail below.

1. Phase 1
In the first phase, the Government would focus on the creation of a regulatory framework for fiat-backed stablecoins used as a means of payment in the UK. This would be achieved through targeted amendments of the existing Electronic Money Regulations (2011) and Payment Services Regulations (2017) that would bring the use of fiat-backed stablecoins as a means of payment within the regulatory perimeter. In addition, amendments to the FSMA RAO definition of specified investments would be made that would make the activity of issuance and custody of fiat-backed stablecoins regulated activities that are subject to FCA authorization.¹¹

2. Phase 2
In the second phase, the UK Government plans to create a broader regulatory framework on cryptoassets for cryptoassets other than fiat-backed stablecoins and standard activities related to them such as issuance, custody, operation of a crypto-exchange etc.

This would likewise be achieved through amendment of the definition of specified investments under the FSMA RAO leading to imposition of Part 4A FSMA authorization requirement on all entities providing services in relation to cryptoassets. This framework would capture entities providing cryptoasset-related services including issuers, cryptocustodians, entities engaging in the provision of various types of intermediary services (e.g. buying/selling cryptoassets or making arrangements for deals in cryptoassets as an agent or principal) as well as entities operating crypto-exchanges.¹²

Unlike the EU regime on crypoassets based on MiCAR, the UK framework is not intended to capture services consisting of advising on cryptoassets and portfolio management of cryptoassets.¹³

It is noteworthy that the Government has clarified that this future regulatory framework would apply to all entities providing regulated cryptoasset-related services in the UK or from outside the UK to UK customers, irrespective of their primary place of establishment, pretty much by mirroring the territorial scope of application of MiCAR. However, unlike MiCAR, the UK framework is at least for now not planned to have an equivalent reverse solicitation option that would allow non-UK entities to provide UK residents with regulated services at their exclusive initiative.

Almost 18 months after providing some details on its planned comprehensive regulatory framework on cryptoassets, on 30 Oct. 2023 HM Treasury issued three interlinked policy documents that have provided some further details on the proposed framework: Policy paper on the plans for the regulation of fiat-backed stablecoins,¹⁴ response to the consultation on the future financial services regulatory regime for cryptoassets¹⁵ and response to the consultation on the new framework on the management of the failure of systemic digital settlement asset (including stablecoin) firms.¹⁶

These documents, focusing on the Phase 1 and Phase 2 measures, were followed by a discussion paper from the FCA on stablecoin regulation¹⁷ and a discussion paper from the Bank of England (BoE) on the regulation of systemic payment systems using stablecoins¹⁸ that also provided helpful details on how the regulators intent to approach this process and how their supervisory practice may look like along the way.+

IV. Scope of UK stablecoin regulatory framework

The proposed UK stablecoin regulatory framework will target fiat-backed stablecoins exclusively. The definition of this category of cryptoassets is planned to be set out in legislation, with HM Treasury aiming to encompass cryptoassets that seek or purport to maintain a stable value by reference to a fiat currency (one or a basket of multiple currencies) and by holding a fiat currency, in whole or in part, as backing (i.e. in the form of reserve assets).

Notably, unlike the EU framework based on MiCAR, this part of the UK regulatory framework will not include algorithmic, crypto-backed, or commodity-backed tokens, given that these will be regulated as part of the planned Phase 2.¹⁹

1. Payment activities
Concerning payment activities, payment systems involving fiat-backed stablecoins will be brought under the Payment Services Regulations 2017 (PSR 2017) when they are structured in any of the following ways:

– »mixed stablecoin payment transaction« (on-ramp stablecoin off-ramp fiat currency and vice-versa);

– »pure stablecoin payment transactions«: (on-ramp stablecoin off-ramp stablecoin).²⁰

To fall within the scope of PSR 2017, the payment transactions must include UK customers, with at least one end of the transaction occurring in the UK.²¹ Nonetheless, when UK firms facilitate payment transactions, the rules will be applicable, irrespective of whether the payment has a UK endpoint or not.²²

On the other hand, transactions involving peer-to-peer payments with cryptoassets, conducted on a non-commercial basis, will not be subject to these regulations.²³

Under the proposed framework, service providers providing payment services in relation to fiat-backed stablecoins would become subject to existing conduct, authorization and operational rules applicable to payment service providers under PSR 2017.²⁴

2. Regime for stablecoin issuers and custodians
Under the new framework, issuance and custody of fiatbacked stablecoins would become regulated activities through amendments of the RAO, that would require entities engaging in these activities to comply with FCA requirements.²⁵ When it comes to issuance activity, its scope would cover issuers located in the UK including those that are issuing fiatbacked stablecoins not marketed to UK customers.²⁶

In its latest policy document on fiat-backed stablecoin framework, the FCA sets out various requirements that it will expect regulated stablecoin issuers to comply with.²⁷ These include first and foremost compliance with strict requirements around the maintenance of stable value of the tokens so that they can properly serve as money-like instruments.²⁸ To that end, issuers will be required to hold assets backing the value of the stablecoin (»backing assets«) that are equivalent in value to the circulating supply of the stablecoin.²⁹ For this purpose, issuers shall be allowed to use only assets that are stable in value and sufficiently liquid so that they can be easily disposed of to support customers’ redemption rights.³⁰ With the aim of ensuring proper safe-keeping of backing assets, issuers would need to comply with strict record keeping requirements as well as to ensure proper asset segregation effectively ensuring that backing assets are not being mixed with their own, with a particular focus on the protection of backing assets in the case of the issuer’s insolvency.³¹

Stablecoin holders will benefit from quite broad redemption rights, enabling them to convert their stablecoins into fiat currency at par value at all times.³² For this purpose, issuers will be required to be in position to convert stablecoins in fiat currency by the end of the next business day following receipt of customers’ request.³³ With the aim of ensuring high level of transparency and ensuring that customers can make informed decisions before acquiring regulated stablecoins, issuers will be required to publish key information on their stablecoins on their website and main communication channels (e.g. social media profiles).³⁴

In addition to issuance activity, a new regulated activity focused on custody of fiat-backed stablecoins will be created under the RAO. This activity can comprise of safeguarding or safeguarding and administering of stablecoins as well as the mere arranging of safeguarding and administering of regulated stablecoins.³⁵ Entities engaging in the provision of custody service in any of the above forms would be required to have adequate arrangements in place to ensure proper safeguarding of customers’ assets by using dedicated omnibus or individual accounts that keep customers’ assets separated from their own.³⁶ Further, they will need to keep their customers properly informed about safeguarding arrangements they have in place, comply with strict record keeping requirements ensuring they can track all assets in custody accordingly (both on and offchain) as well as to ensure technical resilience of their systems used for safeguarding of client assets.³⁷

3. Regulation of DSA payment systems
Alongside the creation of the FCA regime for fiat-backed stablecoins, the Government confirmed its previous plan to create a supervisory framework for payment system operators and service providers providing services in relation to the so-called digital settlement assets (DSA) defined under the FSMA 2023.³⁸

For this purpose, targeted amendments to Part 5 of the Banking Act 2009 and Part 5 of the Financial Services (Banking Reform) Act 2013 were introduced as part the FSMA 2023, aiming to bring operators of payment systems and service providers providing services in relation to DSAs that are deemed as systemic (based on HM Treasury’s decision) into the supervisory remit of the Bank of England (BoE) and the Payment Systems Regulator (PSR).³⁹

As part of this framework, based on the FSMA 2023, BoE would have power to publish principles and codes of practice that systemic DSA service providers would need to comply with.⁴⁰ In addition, based on its powers steaming from the amended Part 5 of the Financial Services (Banking Reform) Act 2013, PSR would be empowered to regulate DSA payment systems and their participants aiming to ensure proper functionality of DSA payment systems and fair access to them for the participants.⁴¹

The FCA authorized firms that provide services in relation to fiat-backed stablecoins that are recognized as systemic by HM Treasury would be dual-regulated and supervised by both BoE, that would have the lead role of a prudential regulator, while the FCA would remain responsible for the supervision of compliance with conduct requirements.⁴²

V. Conclusion

From a number of policy papers and legislative measures already taken, it is clear that the UK is taking significant steps towards creating a very comprehensive regulatory framework on cryptoassets. In this process, the UK Government has decided to take a slightly different approach to its counterparts on the continent: instead of creating a designated piece of legislation that would exclusively regulate the crypto-industry, the UK is making targeted amendments to its existing financial regulations so that they can apply to cryptoasset-related activities accordingly.

The measures that the UK Government is taking in this process are a piece of a broader policy reform puzzle in the UK that is being performed as part of the so-called Edinburgh reforms, a package of a number of legislative measures aimed at making »smarter, agile and home-grown regulatory framework for the UK«.⁴³ As part of this future UK regulatory framework based on the FSMA 2023, the FCA shall be granted more rulemaking powers enabling it to define detailed rules more efficiently while overarching high level rules will be anchored in the legislation. The future UK regulatory framework on cryptoassets will likewise be created in the same way having the regulators (the FCA, BoE and PSR where relevant) in position to define detailed rules that operators in the cryptoindustry need to comply with.

As we move into 2024, the UK regulatory framework on cryptoassets is slowly but surely getting its form and shape. First, the regime on financial promotions cryptoassets has become operational as of 8 Oct. 2023, effectively banning unregulated advertising of cryptoassets in the UK. Second, when it comes to Phase 1, HM Treasury intends to bring forward secondary legislation that would define the framework on fiat-backed stablecoins by early 2024, subject to available parliamentary time. Once the consultation periods related to their discussion papers end, the BoE and the FCA are expected to consult on more detailed policy proposals in their respective areas of responsibility most likely in the second half of 2024. In their discussion papers BoE and the FCA have left indication that this wider regime is expected to become operational sometime in 2025. HM Treasury has also given indication that the same timeline is expected for the secondary legislation aimed at creating wider regulatory framework on cryptoa sets other than fiat-backed stablecoins that is planned to be done as part of the Phase 2.

And while the legislation and regulatory guidance are finding their way through the UK legislative and administrative procedure, the crypto-industry is already feeling the impact: entities operating both in the EU and the UK are having a hard time maneuvering two regulatory frameworks on both sides of the Channel requiring them to usually have two separate entities dedicated to their EU and UK arms of business. It remains to be seen whether the UK will achieve its goal to become the global hub of a crypto-industry especially bearing in mind developments in other key jurisdictions: on the one hand its closest neighbor, the EU, that with its new regulatory framework and position in the global economy is becoming an ever more attractive destination for crypto-businesses and, on the other hand, some smaller jurisdictions such as the United Arab Emirates (UAE), Hong Kong, and Singapore, that are also trying to attract crypto-businesses from across the globe by offering regulatory certainty combined with tax and operational flexibility.

~The author is Associate at Taylor Wessing, Solicitor (England & Wales), Solicitor (Ireland), Registered European Lawyer (Germany). He is a member of the Financial Regulatory Practice at Taylor Wessing where he advises financial institutions and non-financial entities across a wide range of topics in the areas of banking, capital markets and payment services law including legal questions related to the application of new technological solutions in finance (crypto-assets, DeFi, Artificial Intelligence, Cloud computing etc.).

1 The Money Laundering and Terrorist Financing (Amendment) Regulations 2019, Link: https://www.legislation.gov.uk/uksi/2019/1511/made [30.01.2024].

2 Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/ EU (»5AMLD«).

3 FCA Guidance on Cryptoassets Feedback and Final Guidance to CP 19/3, July 2019, Link: https://www.fca.org.uk/publication/policy/ps19-22.pdf [30.01.2024].

4 FCA, Cryptoasset promotions Consultation, July 2020 Link: https://assets.publishing.service.gov.uk/media/5f18174f3a6f40727f97b765/ Cryptoasset_promotions_consultation.pdf [30.01.2024]

5 HM Treasury Consultation: Cryptoasset promotions, July 2020. Link: https://assets.publishing.service.gov.uk/media/5f18174f3a6f40727 f97b765/Cryptoasset_promotions_consultation.pdf [30.01.2024]

6 Policy paper, The Kalifa Review of UK FinTech, 26 Feb. 2021. Link: https: //www.gov.uk/government/publications/the-kalifa-review-of-uk-fintech [30.01.2024].

7 European Commission, Digital finance strategy published as part of the Digital Finance Package, 24 Sep. 2020, Link: https://eur-lex.europa.eu/legalcontent/EN/TXT/HTML/?uri=CELEX:52020DC0591 [30.01.2024].

8 European Commission, Digital finance package, 24 Sep. 2020. Link: https://finance.ec.europa.eu/publications/digital-finance-package_en [30.01.2024]; see also Siadat RdF 2021, 12 ss. and Ritz ZdiW 2021, 144 ss. with an overview to the digital finance package and the Markets in Crypto-assets Regulation (»MiCAR«).

9 HM Treasury, Call for evidence outcome UK regulatory approach to cryptoassets and stablecoins: consultation and call for evidence, 7 Jan. 2021. Link: https://www.gov.uk/government/calls-for-evidence/uk-reg ulatory-approach-to-cryptoassets-and-stablecoins-consultation-and-call for-evidence [30.01.2024].

10 HM Treasury, UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: in title heading: Response to the consultation and call for evidence. Link: https://assets.publishing.service.gov.uk/media/62c595318fa8f54e8aadc753/O-S_Stablecoin s_consultation_response.pdf [30.01.2024].

11 HM Treasury, UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: in title heading: Response to the consultation and call for evidence. Link: https://assets.publishing.service.gov.uk/media/62c595318fa8f54e8aadc753/O-S_Stablecoin_s_consultation_response.pdf [30.01.2024].

12 HM Treasury, Consultation outcome Future financial services regulatory regime for cryptoassets, 1 Feb. 2023. Link: https://www.gov.uk/governm ent/consultations/future-financial-services-regulatory-regime-for-crypt oassets [30.01.2024].

13 HM Treasury, Consultation outcome Future financial services regulatory regime for cryptoassets, 1 Feb. 2023. Link: https://www.gov.uk/governm ent/consultations/future-financial-services-regulatory-regime-for-crypt oassets [30.01.2024]; see also Siadat RdF 2021, 172 ss. and Ritz ZdiW 2021, 144 ss. with an overview to the digital finance package and the Markets in Crypto-assets Regulation.

14 HM Treasury, Policy Paper, Policy paper Update on plans for the regulation of fiat-backed stablecoins, 30 Oct. 2023. Link: https://www.gov.uk/government/publications/update-on-plans-for-the-regulation-of-fiat-backedstablecoins [30.01.2024].

15 HM Treasury, Consultation outcome Future financial services regulatory regime for cryptoassets, 1 Feb. 2023. Link: https://www.gov.uk/government/consultations/future-financial-services-regulatory-regime-for-crypt oassets [30.01.2024].

16 HM Treasury, Consultation outcome Managing the failure of systemic Digital Settlement Asset (including stablecoin) firms, 31 May 2022. Link: https://www.gov.uk/government/ consultations/managingthe-failure-of-systemic-digital-settlement-asset-including-stablecoin-firms [30.01.2024].

14 HM Treasury, Policy Paper, Policy paper Update on plans for the regulation of fiat-backed stablecoins, 30 Oct. 2023. Link: https://www.gov.uk/government/publications/update-on-plans-for-the-regulation-of-fiat-backedstablecoins [30.01.2024].

15 HM Treasury, Consultation outcome Future financial services regulatory regime for cryptoassets, 1 Feb. 2023. Link: https://www.gov.uk/government/consultations/future-financial-services-regulatory-regime-for-crypt oassets [30.01.2024].

16 HM Treasury, Consultation outcome Managing the failure of systemic Digital Settlement Asset (including stablecoin) firms, 31 May 2022. Link: https://www.gov.uk/government/ consultations/managingthe-failure-of-systemic-digital-settlement-asset-including-stablecoin-firms [30.01.2024].

17 FCA Discussion Paper DP23/4 Regulating cryptoassets Phase 1: Stablecoins, 6 Nov. 2023. Link: https://www.fca.org.uk/publication/discussion/dp23-4.pdf [30.01.2024].

18 Bank of England, Regulatory regime for systemic payment systems using stablecoins and related service providers: discussion paper, 6 Nov. 2023. Link: https://www.bankofengland.co.uk/paper/2023/dp/regulatory-reg ime-for-systemic-payment-systems-using-stablecoins-and-related-serviceproviders [30.01.2024].

19 HM Treasury, Consultation outcome Future financial services regulatory regime for cryptoassets, 1 Feb. 2023. Link: https://www.gov.uk/government/consultations/future-financial-services-regulatory-regime-for-cryptoassets [30.01.2024].

20 HM Treasury, Policy Paper, Policy paper Update on plans for the regulation of fiat-backed stablecoins, 30 Oct. 2023. Link: https://www.gov.uk/government/consultations/future-financial-services-regulatory-regime-for-cryptoassets stablecoins [30.01.2024].

21 Ibid. 22 Ibid. 23 HM Treasury, Policy Paper, Policy paper Update on plans for the regulation of fiat-backed stablecoins, 30 Oct. 2023. Link: https://www.gov.uk/government/publications/update-on-plans-for-the-regulation-of-fiat-backed stablecoins [30.01.2024].

24 Ibid.
25 Ibid.
26 Ibid.

27 FCA Discussion Paper DP23/4 Regulating cryptoassets Phase 1: Stablecoins, 6 Nov. 2023. Link: https://www.fca.org.uk/publication/discussion/dp23-4.pdf [30.01.2024].

28 Ibid.
29 Ibid.
30 Ibid.
31 Ibid.

32 FCA Discussion Paper DP23/4 Regulating cryptoassets Phase 1: Stablecoins, 6 Nov. 2023. Link: https://www.fca.org.uk/publication/discussion/dp23-4.pdf [30.01.2024].

33 Ibid.
34 Ibid.
35 Ibid.
36 Ibid.
37 Ibid.
33 Ibid.
34 Ibid.
35 Ibid.
36 Ibid.
37 Ibid.

38 Digital settlement assets are defined under Section 23(2) of FSMA 2023 as a digital representation of value or rights, whether or not cryptographically secured, which: (i) Can be used for settlement of payment obligations, (ii) can be transferred, stored or traded electronically, and (iii) uses technology supporting the recording or storage of data. The explanatory notes to FSMA 2023 clarify that this definition of digital settlement assets is intended to encompass a range of digital assets and is broader than the definition (that is still to be developed) of fiat-backed stablecoins that will be regulated under amended Payment Service Regulations (2017).

39 HM Treasury, Government response to consultation, Managing the failure of systemic digital settlement asset (including stablecoin) firms Government response to consultation, 3 Oct. 2023, Link: https://assets.publishing.service.gov.uk/media/653a6d5fd10f3500139a69f7/CR_Managing_ the_failure_of_systemic_dsa__ including_stable coin__firms.pdf [30.01.2024].

40 Ibid.
41 Ibid.
42 Ibid.

43 HM Treasury press release, 9 Dec. 2022. Link: https://www.gov.uk/gov ernment/news/edinburgh-reforms-hail-next-chapter-for-uk-financial-servi ces [30.01.2024].

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