Clifford Chance

The Financial Services and Markets Bill introduces powers for HM Treasury (HMT) to bring stablecoins used as means of payment and similar "digital settlement assets" within scope of regulation. Most details of the new regime are left to be fleshed out by HMT, who confirmed their intention to regulate stablecoins used as a means of payment earlier in 2022 and plans to consult on its approach to regulating other types of cryptoassets later in 2022.

Therefore, whilst the broad shape of the UK regulatory regime for cryptoassets is emerging, attention will turn to HMT and the regulators for further clarity on the precise scope and structure of the regime. This staged approach to UK cryptoasset regulation is in contrast to the more comprehensive approach taken in the EU under MiCA.

A staged approach to UK cryptoasset regulation

In the explanatory notes accompanying the Financial Services and Markets Bill (FSMB), the UK government explains that it plans to take a staged approach to cryptoasset regulation, beginning with stablecoins used for payments. Perhaps surprisingly then, the term "stablecoins" is not referred to in the Bill itself. Instead, it introduces a new defined term, "digital settlement assets" (DSAs).

DSAs are defined as a digital representation of value or rights, whether or not cryptographically secured, that:

(a)   can be used for the settlement of payment obligations,

(b)   can be transferred, stored or traded electronically, and

(c)   uses technology supporting the recording or storage of data (which may include distributed ledger technology).

This is potentially a wide definition. As drafted and depending on how broadly the requirement that the digital asset can be used for the settlement of payment obligations is interpreted, it could capture types of digital assets or cryptoassets other than stablecoins (potentially even including Bitcoin, even though the government indicates this is not its intention) if they are accepted as a means of payment.

The FSMB also gives HMT powers to amend the definition of DSAs set out in the Bill, meaning that HMT could clarify or narrow the current definition if it is considered too broad. For example, the explanatory memorandum accompanying the FMSB indicates that the UK government "will begin by focusing on stablecoins which reference their value from fiat currency (such as Pound Sterling), where used as a means of payment". Therefore, HMT could exercise its powers to amend the DSA definition to limit initial regulation of DSAs to fiat-backed stablecoins used for payments.

Conversely, this also means that HMT could seek to broaden the DSA definition in future to capture other types of cryptoassets, without further primary legislation. In particular, HMT intends to consult later in 2022 on the UK's approach to regulating other types of cryptoassets including those used for investment purposes. It could therefore seek to expand the scope of the UK regulatory perimeter following the outcome of that consultation to include other types of cryptoassets by updating the DSA definition. Overall, this means the power to determine the scope of the future UK regulatory regime for cryptoassets will rest with HMT.

Whilst the UK regulators have been gathering industry input on their potential approaches to broader cryptoasset regulation (for example through the FCA's Crypto Sprint earlier in 2022) they will only be empowered to make relevant rules once the new DSA regime has been introduced.  

Stablecoin regulation and its interaction with e-money and payments regulation

HMT is granted a range of powers to regulate services and activities relating to DSAs under the FSMB. In particular, HMT will:

• be empowered to establish an FCA authorisation and supervision regime for issuers of DSAs and payment service providers using DSAs, drawing broadly on existing electronic money and payments regulation to mitigate conduct, prudential and market integrity risks.
• have powers to recognise operators of systemic payment systems using DSAs and service providers to those payment systems, bringing them within scope of Bank of England (BoE) supervision, via amendments to its existing powers to recognise systemic payment systems under the Banking Act 2009. Similarly, Payment Systems Regulator (PSR) will have powers to regulate payment systems using DSAs, including powers to give directions relating to direct and indirect access to such systems.
• be empowered to extend the FMI special administration regime (SAR) to systemic DSA firms, with appropriate modifications. The FMI SAR is a bespoke administration regime for recognised payment and settlement systems and service providers to mitigate the risks to financial stability associated with their failure. HMT has already consulted in May 2022 on how it intends to extend the FMI SAR to systemic DSA firms, including how the FMI SAR would take precedence over the payment and e-money special administration regime (PESAR) in cases of overlap.

An important distinction between the two special administration regimes is that the FMI SAR would impose an objective on administrators to pursue the continuity of a failed payment system's services ahead of the interests of its creditors, whereas the focus of the PESAR is on the prompt return of customer funds. As both objectives may be important in the case of a failed systemic DSA firm, HMT's consultation proposes that the FMI SAR for systemic DSA firms would impose an additional objective on administrators covering the return or transfer of funds and custody assets. The BoE would also be required to consult with the FCA before exercising its powers under the FMI SAR with respect to a systemic DSA firm.

Expanded FCA rulemaking powers for payment services and e-money

In its July 2022 consultation on Payments Regulation and the Systemic Perimeter, HMT indicated that it also intends to exercise its powers under the FSMB to grant the FCA a general rulemaking power appropriate to payment services and e-money. This forms part of the Future Regulatory Framework Review, and aims to create a "comprehensive FSMA model" in relation to payments regulation when retained EU law is repealed and replaced. Empowering the FCA to make rules covering payment services and e-money in this way will be important to enable appropriate alignment between the payment services and e-money regimes on the one hand, and any new DSA regulatory regime on the other hand.

Comprehensive approach to EU cryptoasset regulation under MiCA

In contrast to the UK's staged approach to cryptoasset regulation, the EU Markets in Cryptoassets Regulation (MiCA) will introduce a comprehensive EU regulatory framework applicable to a broad range of cryptoassets. MiCA will introduce authorisation and conduct of business requirements for firms issuing, intermediating and dealing in cryptoassets, as well as a market abuse regime with respect to cryptoassets. (See our article: MiCA – EU reaches agreement on the crypto-assets regulation)

Titles III and IV MiCA set out rules applicable specifically to stablecoins in the form of "asset-referenced tokens" or "e-money tokens", respectively, including authorisation and conduct of business requirements for issuers, disclosure requirements via white papers, redemption requirements and obligations on custodians holding reserve assets for an issuer of asset-referenced token.

However, rules applicable to cryptoasset service providers under Title V MiCA relate to broader range of cryptoassets, including but not limited to stablecoins. The types of activities that are regulated under Title V MiCA and the associated conduct of business requirements are more akin to existing EU securities regulation under the EU Markets in Financial Instruments Directive (MiFID 2) than payments regulation.

The EU Commission is separately reviewing the second Payment Services Directive (PSD 2) and specifically asked stakeholders for feedback on whether and how PSD 2 may need to be revised to take into account services associated with the transfer of e-money tokens and stablecoins. The Commission is also required to report on this topic as part of its report on the functioning of MiCA 18 months after it enters into force, if not already addressed as part of the PSD 2 review.

Finally, MiCA imposes additional rules for regulation of "significant" asset referenced tokens and e-money tokens, including in relation to liquidity maintenance, recovery and redemption planning. Competent authorities will also be granted MiFID-like product intervention powers and a separate empowerment to require an issuer of an asset-referenced token widely used as a medium of exchange or of an e-money token denominated in a non-EU currency to introduce a minimum denomination or to limit the amount issued in order to decrease usage of such tokens. The way in which these restrictions and powers are interpreted and exercised in practice could significantly impact the development and eventual scale of stablecoin markets in the EU.

The limits on use of USD-pegged stablecoins under MiCA have been subject to debate amongst EU co-legislators and appear to be driven by a desire to avoid USD-pegged stablecoins becoming a global reference currency for cryptoassets. The thresholds set for the daily number and value of transactions (2,500,000 and EUR 500 million respectively) are relatively low in the context of USD denominated stablecoins currently used in the market, so could limit the ability of EU market participants to use USD-pegged stablecoins.

The provisions of Titles III and IV on issuance of asset-referenced tokens and e-money tokens will apply from 12 months after entry into force of MiCA with requirements for cryptoasset service providers applying from 18 months after entry into force – subject to transitional provisions for existing issuers and service providers.