On 29th June 2023 the Financial Services & Markets Act 2023 (the Act) received Royal Assent and became law in the UK. Specifically, as it relates to crypto, the Act introduces new frameworks for cryptoasset financial promotions and stablecoins (which this blog will focus on).
The UK is taking a phased approach to the regulation of cryptoassets. The focus will firstly be on stablecoins, with a more generalised framework for cryptoassets to be developed based on the recently closed consultation and call for evidence Future Financial Services Regulatory Regime for Cryptoassets.
Stablecoins, defined as “Digital Settlement Assets” in the Act, will be recognised as a form of payment.
The Bank of England’s (BoE) proposals for regulating systemic stablecoins under the Act are expected to be published shortly. In the meantime, what can we read from the tea leaves of BoE publications and speeches?
Stablecoins will likely be authorised in the UK before a digital pound or UK Central Bank Digital Currency (CBDC) is launched. A decision on whether or not to go ahead with a retail UK CBDC will be taken at the end of the design phase — in 2025 or 2026 — for possible launch before the end of the decade.
Also, it is possible, that both the UK and EU could be ready to authorise the first stablecoins around the same time. Around mid-2024.
2. Equivalent Standards to TradFi
The Financial Policy Committee (FPC) in its March 2022 Financial Policy Summary and Record said “stablecoins used in systemic payments systems should meet equivalent standards to those that apply for commercial bank money.”
The assumption is that the BoE can design and apply a regulatory framework which mitigates the risks to financial stability. In particular, the FPC was concerned at how a stablecoin could compensate depositors in the event of failure. For banks, backstops include a resolution regime and the Financial Services Compensation Scheme deposit guarantee scheme, but such arrangements are generally not available for stablecoins.
3. What Assets could back a Stablecoin?
The March 2022 FPC paper went on to say that stablecoins should be “fully backed with high quality and liquid assets, alongside loss absorbing capital as necessary, to compensate coinholders in the event that the stablecoin fails”. We can therefore reasonably assume:
· An algorithmic stablecoin is unlikely to be approved in the UK in the near future;
· Bitcoin, as the BoE regards this as an unbacked cryptoasset, will unlikely be permitted; and
· There will be investment guidelines on the types of permitted commercial paper. My guess is that Chinese commercial paper will not be permitted.
InApril 2023 Sir Jon Cunliffe (Deputy Governor Financial Stabilty) gave a speech saying “These could include either deposits at the Bank of England or very highly liquid securities, or some combination of the two”.
4. International Standards
The BoE likely closely follow international guidance (where Sir Cunliffe is the Chair of the Bank for International Settlements’ Committee on Payments and Market Infrastructures). For instance, a requirement to match the requirements imposed on commercial bank money, and a requirement to be able to redeem from the stablecoin issuer, in fiat money, at par value and on demand.
We now await further guidance from the BoE so that we can understand more fully what is expected from stablecoin issuers in the UK. In particular, the application of regulatory capital requirements? The possible models of safekeeping, bank deposit versus custody models, for the assets backing the stablecoin? Whether there will be any limits imposed to allow the BoE to monitor the impact on financial stability?
The BoE is likely to move in a deliberate and cautious manner, balancing the public policy perspective of encouraging competition and innovation in payments, while guarding against “rapid, disruptive change that does not allow the financial system time to adjust and could therefore threaten financial stability”.