In this edition of Payments:Unpacked we take a look at the topic of stablecoins which features within the Financial Services and Markets Bill which is currently at its Second Reading in the House of Commons.
This email provides all you need to know about the Government’s work to bring stablecoins, a type of cryptoasset, into the scope of regulation when used as a form of payment, paving their way for use in the UK as a recognised form of payment.
A précis for the layperson
At almost 330 pages the Financial Services and Markets Bill makes heavy and, to the layman, confusing reading but helpfully the accompanying Explanatory Notes (234 pages) unwraps the detail of the Bill in a more manageable form.
For some delving into the 550+ pages will be a necessity but, for the rest of us, here is a précis of the aspects of the Bill relating to stablecoins.
Background: Financial Services and Markets Bill
The Financial Services and Markets Bill was introduced to Parliament on 20 July 2022.
The Chancellor’s speech at the Financial and Professional Services Dinner at Mansion House on 19 July 2022 set out the importance of the financial services sector to the UK economy, and the central role of the Financial Services and Markets Bill in delivering the government’s vision for an open, green, and technologically advanced financial services sector that is globally competitive.
The UK Government states that:
The Bill seizes the opportunities of EU Exit, tailoring financial services regulation to UK markets to bolster the competitiveness of the UK as a global financial centre and deliver better outcomes for consumers and businesses.
The Bill seeks to:
- Implement the outcomes of the Future Regulatory Framework (FRF) Review
- Maintain the UK’s position as an open and global financial hub
- Harness the opportunities of innovative technologies in financial services
- Bolster the competitiveness of UK markets and promote the effective use of capital
- Support the levelling up agenda, promote financial inclusion and consumer protection.
At almost 330 pages the Financial Services and Markets Bill makes heavy and confusing reading but helpfully the accompanying Explanatory Notes (234 pages) unwraps the detail of the Bill in a more manageable form.
The Government states that:
…the Bill introduces measures that support financial inclusion by ensuring people across the UK can continue to access cash with ease; enabling credit unions to offer more products; introducing a regulatory gateway designed to improve the quality of financial promotions; and enhancing protection for victims of authorised push payment scams.
This briefing focuses on how the Bill considers the topic of Stablecoins and is the third in our series of briefings on the Bill ahead of its 2nd Reading in the House of Commons on the 7 September 2022:
Bringing stablecoins into the scope of regulation when used as a form of payment
The explanatory notes explain the government’s position on bringing stablecoins, a type of cryptoasset, into the scope of regulation when used as a form of payment, paving their way for use in the UK as a recognised form of payment via the Financial Services and Markets Bill – here’s a quick summary:
Cryptoassets are a digital representation of value or contractual rights that can be transferred, stored or traded electronically, which may (though do not necessarily) utilise cryptography or distributed ledger technology. No internationally agreed definition, taxonomy or classification currently exists.
Call for evidence
In January 2021, HM Treasury launched a consultation and call for evidence on the UK’s regulatory approach to cryptoassets. This sought views on how the government and regulators can ensure that the UK’s regulatory framework is equipped to harness the benefits of new technologies, supporting innovation and competition, whilst mitigating risks to consumers, market integrity and financial stability.
Staged and proportionate approach to regulation
This consultation proposed a staged and proportionate approach to regulation, which is sensitive to risks posed and responsive to new developments in the market. In particular, it highlighted that certain forms of cryptoassets, known as “stablecoins” had the potential to develop into a widespread means of payment, and potentially deliver improvements for payment transactions.
Bringing stablecoins into the regulatory perimeter
HM Treasury’s response to the consultation, published in April 2022, outlined the government’s intention to bring stablecoins, where used as a means of payment, into the regulatory perimeter.
A new category
A new category of “digital settlement asset”, which includes stablecoins and other cryptoassets which meet the definition, will be created to bring all such instruments within the regulatory reach of the existing payment and electronic money system landscape. Initially, digital settlement assets will be defined (in clause 22(2) of this Bill and new section 182(4A) of the Banking Act 2009, which will be inserted by Schedule 6 to this Bill) as a digital representation of value or rights, whether or not cryptographically secured, that:
- can be used for the settlement of payment obligations,
- can be transferred, stored or traded electronically, and
- uses technology supporting the recording or storage of data (which may include distributed ledger technology).
Stablecoins are a form of cryptoasset which aim to maintain a stable value relative to other assets. Design features vary, including how the stablecoin is backed or stabilised (for example, with financial assets or using an algorithm to increase or decrease the supply as needed to maintain a stable price).
More akin to traditional payment instruments
Stablecoins which reference their value in relation to fiat currencies can be seen as more akin to traditional payment instruments, than other types of cryptoassets such as those used primarily as a means of investment (for example, Bitcoin). Depending on the specific way that they are designed, stablecoins may already be subject to UK financial services regulation, though many currently are not in scope.
When used as a means of payment
This Bill brings activities facilitating the use of certain stablecoins, where used as a means of payment, into the UK regulatory perimeter primarily by amending the existing electronic- money and payment system regulatory frameworks. Through this approach, the government has sought to reflect the Financial Stability Board’s recommendations on the regulation, supervision and oversight of global stablecoin arrangements, and the CPMI-IOSCO consultation report on the application of the Principles for Financial Market Infrastructures to stablecoin arrangements, and will leave room to update the regulatory framework as international standards are developed.
Regulatory approach to wider cryptoassets to follow?
Separately, the government intends to launch a consultation on its regulatory approach to wider cryptoassets beyond stablecoins used for payments, including those primarily used as a means of investment (such as Bitcoin) later in 2022.
Similar (but different) characteristics
Electronic money is, broadly, monetary value as represented by a claim on the issuer which is: stored electronically, including magnetically; issued on receipt of funds; and used for the purposes of making payment transactions. Although stablecoins have similar characteristics to electronic money, they often, due to their characteristics, fall outside of scope of the payments regulatory regime. This is out of step with the government’s stated objective of ensuring that activities that involve the same risk have the same regulatory outcome.
Bringing digital settlement assets into the regulatory perimeter
This Bill gives HM Treasury a power to bring digital settlement assets used for payments into the UK regulatory perimeter. It introduces a definition of “digital settlement asset”, a new concept which has not been previously defined in legislation. Given the nascent nature of the cryptoasset market, the Bill gives HM Treasury a power to amend this definition in the event that there are changes in the features, underlying technology or usage of these assets, so that the regulation can continue to have effect as intended.
Subject to the same requirements and protections
As mentioned above, the government’s staged and proportionate approach will begin by focusing on stablecoins which reference their value from fiat currency (such as Pound Sterling), where used as a means of payment, because the government believes that such tokens share characteristics with existing forms of electronic money. This will ensure that fiat- linked stablecoins, where used for payments, are subject to the same requirements and protections as other similar payment methods.
Clear identification of the applicable regulatory requirements
A feature of the current design of the UK payments and electronic money legislation is a degree of regulatory overlap between the authorities, where responsibilities are distributed across the regulators and they set requirements and oversee firms pursuant to their differing statutory objectives. By extending the existing frameworks to cover fiat-referenced stablecoins used as a means of payment, further regulatory overlaps will apply between the Bank of England and the FCA for a small number of systemic firms. The Bill therefore puts in place a regime that allows for the clear identification of the applicable regulatory requirements (for example, in relation to prudential rules) where a payment system using digital settlement assets or digital settlement asset service provider is recognised as being systemic by HM Treasury.
The Bill will:
- Provide the power for HM Treasury to establish an FCA authorisation and supervision regime, drawing broadly on existing electronic money and payments regulation, to mitigate conduct, prudential and market integrity risks for issuers of, and payment service providers using, stablecoins.
- Enable HM Treasury to recognise the operators of systemic payment systems and systemic service providers using digital settlement assets for regulation by the Bank, subject to meeting relevant thresholds and following HM Treasury’s publication of a recognition order. This will enable the Bank of England to regulate and supervise systemically important stablecoin payment systems and related service providers to mitigate financial stability risk.
- Enable the PSR to regulate payment systems using digital settlement assets, following HM Treasury’s publication of a designation order, to address issues relating to competition innovation, user interests and access.
- Enable HM Treasury to apply the Financial Markets Infrastructure Special Administration Regime (FMI SAR), which is a bespoke administration regime for recognised payment and settlement systems and recognised service providers, to stablecoin firms that have been recognised by HM Treasury, with appropriate modifications. This will ensure appropriate tools are in place to mitigate the risks to financial stability associated with a systemic stablecoin firm’s failure.
- Amend or disapply existing FCA or PRA rules in areas relating to financial stability to avoid relevant systemic stablecoin firms being subject to conflicting requirements. HM Treasury intends to establish this mechanism through secondary legislation.
Passage through the Commons and the Lords
This is a public bill presented to Parliament by the Government.
The Bill was introduced to the House of Commons and given its First Reading on 20 July – this stage is formal and takes place without any debate.
MPs will next consider the Bill at Second Reading on Wednesday 7 September 2022.
The most relevant Government sources of information are: