Background

I) Regulate the following activities under FSMA 2023 through the RAO (amendment expected H1 2024): 

a) the issuance of fiat-backed stablecoins in or from the UK (will be referred to as “UK-regulated stablecoins”); and
b) custody activities from the UK or to UK-based consumers for UK-regulated stablecoins.

II) Bring the following activity into PSRs: using fiat-backed stablecoins as a means of payment in the UK.

This blog will focus on Chapter 5 of the Discussion Paper: Custody Requirements, specifically how the regulatory perimeter is drawn. Read my earlier blog for An overview of Regulating Crptoassets Phase 1.

Fiat-backed stablecoins custody – Mind the gap

The UK’s phased approach to bringing cryptoassets into the regulatory regime is pragmatic and sensible. However, in Phase 1, there appears to be a regulatory gap in its proposed approach to regulating the custody of fiat-backed stablecoins. 

UK-issued fiat-backed stablecoins will be in-scope of the proposed UK custody regime when a UK-authorised stablecoin custodian holds it. However, all other fiat-backed stablecoins will not be in-scope if held by that UK-authorised custodian – this is attributed to the definition used in the Discussion Paper for “Regulated Stablecoins” and the proposed RAO regulated activity of fiat-backed stablecoins custody (Footnote 1). The proposed regulatory perimeter is based on the issuer’s jurisdiction, which is not the case in the existing RAO for specified activities and investments and the existing CASS regime. For example, transferable securities, regardless of whether an Amazon share (US) or Vodafone share (UK) is held on behalf of its customer, both are captured under the existing CASS regime when a UK-authorised custodian is responsible for these assets, i.e. in-scope of protection regardless of issuer jurisdiction of the transferable security.

The proposed approach does not support the FCA’s Principle 10 nor its proposed regulatory approach as described in 5.11: “Our overarching objective is to ensure adequate protection of clients’ cryptoassets while a cryptoasset custodian is responsible for them and that those assets are returned as quickly and as wholly as possible to clients if a custodian enters an insolvency process.”

Principle 10: firms must arrange adequate protection for client assets (in this case, fiat-backed stablecoins) when they are responsible for them (in this case, a UK-authorised stablecoin custodian).

Recommendation: 

The Treasury and the FCA should, in Phase 1, cover both Regulated Stablecoins and Overseas Stablecoins when regulating custody activities from the UK or to UK-based consumers. This will be consistent with the RAO for traditional investment firms when holding transferable securities, such as shares and bonds, in custody. This will also be consitent with existing CASS 6 Custody requirements where the securities issuer’s jurisdiction is not a determinant factor for protection. This will also be in line with the FCA’s stated objective to ensure adequate protection of clients’ assets.

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Footnote 1:

Regulated Activities Order (‘RAO’) for fiat-backed stablecoins custody: “…bring two new activities into the Financial Services and Markets Act 2000 through the Regulated Activities Order (the RAO) relating to fiat-backed stablecoins, covering both issuance in or from the UK and custody activities carried out from the UK or to UK based consumers for UK-issued fiat-backed stablecoins.“ – DP23/4 Paragraph 1.2

Custody of fiat-backed stablecoins: “This [Custody Requirements] chapter [5] is relevant to custody of both regulated stablecoins and those cryptoassets that already meet the definition of a specified investment (i.e. security tokens).” – DP23/4 Paragraph 5.2

Regulated Stablecoins: “For the purposes of this DP, we will refer to fiat-backed stablecoins that are issued in the UK and meet FCA rules as ‘regulated stablecoins’.” – DP23/4 Paragraph 1.2

Overseas Stablecoins: “…fiat-backed stablecoins issued outside of the UK.” – DP23/4 Paragraph 1.3