Shearman & Sterling LLP | FinReg | UK To Bring Stablecoins Used for Payments Under Regulation
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  • UK To Bring Stablecoins Used for Payments Under Regulation

    Following the call for evidence issued in January 2021, the U.K. government has confirmed that it will bring the issuing or facilitating the use of stablecoins used as a means of payment into the U.K. regulatory perimeter, in an announcement by John Glen, MP, at U.K. Fintech Week. The details were published in a response to the consultation.

    Consistent with the proposals under the Future Regulatory Framework Review, the government will set the regulatory perimeter, objectives and principles and the regulators - the Financial Conduct Authority, the Bank of England and the Payment Systems Regulator - will set out the detailed requirements in rulebooks. The government also confirms that it intends to consult later in 2022 on regulating a wider set of crypto activities, including trading of cryptocurrencies such as Bitcoin and Ether.

    All stablecoins used for payment that reference fiat currencies, including a single currency stablecoin or stablecoin based on a basket of currencies, will be subject to financial regulation. Stablecoins that reference commodities will thus be excluded from the new rules, although activities concerning such stablecoins may well already be regulated (whether these structures fall within the regulatory perimeter is determined on a case-by-case basis). The extension of the regulatory perimeter to stablecoins that are predominantly used to facilitate trading and investment activities in unbacked crypto-assets will be further considered.

    To bring stablecoins used as payment within the regulatory perimeter, changes to several pieces of legislation will be made. These are the Electronic Money Regulations 2011, the Payment Services Regulations 2017, the Banking Act 2009, and the Financial Services (Banking Reform) Act 2013. The FCA will have powers to regulate issuers of stablecoins for payments as well as other entities providing related services, including wallet providers and firms providing custody services. The requirements will ensure convertibility into fiat currency, at par and on demand. As with other entities providing payment services and e-money issuance, stablecoin-based payment service entities will need to be established in the U.K. to provide these services in the U.K.

    Notably, consumers will have a legal claim to redeem the value of the token against either the stablecoin issuer or, where appropriate, the third party facing the consumer. The government appreciates that often a stablecoin issuer may not offer holders a legal claim, leaving a customer with no redemption rights or with rights against a third party. However, for consumer protection, the government will not permit no legal claim to be available.

    Firms undertaking activities in relation to stablecoins for payment would become subject to numerous regulatory requirements, including authorization, prudential requirements, rules for ensuring the quality and safekeeping of reserve assets, orderly failure and insolvency requirements for issuers and service providers, systems and controls, risk management and governance, conduct requirements, financial crime requirements, outsourcing, operational resilience and security requirements.

    Entities that are in scope and that are deemed systemically important would also be subject to supervision by the Bank of England. This will come about by extending the scope of Part 5 of the Banking Act 2009 to stablecoin activities posing potentially systemic risks. These entities will be authorized by the FCA and recognized by the Bank of England, and the Bank will be the lead prudential regulator. The requirement to be established in the U.K. will still apply. The government intends to consider the location issue in its consultation on the systemic perimeter for payments later in 2022.

    Relevant stablecoin payment systems will also become subject to competition regulation by the PSR and the scope of the Financial Services (Banking Reform) Act 2013 will be extended to provide for this.

    The government has also announced its response to the call for evidence on the use of distributed ledger technology in the financial services sector. The government acknowledges that legislative changes will be required to accommodate DLT. However, where the changes are needed is not yet known. The government has stated that the FMI sandbox, announced in April 2021, will be available in 2023. Legislation will be brought forward when Parliamentary time allows to give HM Treasury powers to establish the FMI sandbox. HM Treasury will work with the regulators and industry to design the FMI sandbox, taking into account the legislation that will need to be disapplied or modified, the types of entities that will have access to the FMI sandbox, the standards that will need to be met to preserve the existing high standards met by current FMIs and the nature and scale of activities to be permissible in the FMI sandbox.

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