The UK government has taken further steps towards regulating a variety of cryptoassets and other digital assets through powers granted to it under FSMA 2023. Following recent consultations, HM Treasury has now confirmed a number of key policy positions intended to underpin the future regimes. These seek to address industry concerns, for example around allowing UK consumers access to global liquidity pools and stablecoins issued overseas. Secondary legislation has been promised next year.

HM Treasury papers

On 30 October 2023 HM Treasury published the following papers relating to cryptoassets:

1. An update on plans for the regulation of fiat-backed stablecoins
2. A response to its consultation on managing the failure of systemic digital settlement asset (including stablecoin) firms
3. A response to its consultation and call for evidence on the future financial services regulatory regime for cryptoassets

These papers modify, clarify and confirm a number of policy positions the government has previously consulted and commented on. The final positions appear to have been closely informed by industry feedback. Notwithstanding significant turmoil and misbehaviour in the sector, the government claims to remain steadfast in its ambition to make the UK a global hub for “cryptoasset technologies”. It sees these latest measures as an important step towards achieving that aim. 

Update on fiat-backed stablecoins

Regulating fiat-backed stablecoins forms Phase 1 of the government’s regulatory strategy. In its update, HM Treasury provides more detail on the scope and plans for this phase.

In relation to scope, broadly speaking HM Treasury expects Phase 1 to capture cryptoassets whose value is intended to be stabilised by reference to one or more fiat currency, where fiat currency is held as backing. It does not plan to cover algorithmic stablecoins or tokens backed by assets other than fiat currency in this phase. (By contrast, these structures are expected to be caught under the EU’s “e-money token” and/or “asset-referenced token” regimes under MiCAR, rather than under MiCAR’s general catch-all regime.) Tokenised deposits are not intended to be caught either on the basis that they fall under existing rules on deposit-taking activities. The same goes for other instruments that fall within the scope of existing regulation.

The government will extend payment services legislation so that it applies to the use of these fiat-backed stablecoins in UK payments chains (i.e. where they are used in a payment transaction involving a UK consumer where one leg of the transaction takes place in the UK or where a UK firm is facilitating the transaction). This will mean that firms involved in these payments would have to seek authorisation as a payment service provider in the UK and be subject to supervision by the Financial Conduct Authority.

The issuance and custody of fiat-backed stablecoins (whether or not used in payments) will also be brought into the scope of regulation. UK issuers of fiat-backed stablecoins will need to be regulated by the FCA. The FCA will set rules on, for example, how these stablecoins should be backed, redemption rights for holders and custody of backing assets. The FCA will be given the power to require backing assets to be held on trust. Custodians of these stablecoins will also be regulated by the FCA.

The government recognises the importance of accommodating fiat-backed stablecoins that are not issued in the UK, although it is still considering the optimal regulatory approach for achieving this. It has suggested, for example, placing additional obligations on UK regulated entities in the payment chain (such as acquirers or wallet providers).

Response on managing the failure of systemic digital settlement asset firms

As well as regulating the issuance, custody and use of fiat-backed stablecoins, the government has been keen to address the potential systemic risks posed by novel means of payment. Among other things, it is concerned about the knock-on effects if a system or service provider in relation to a novel payment asset becomes systemically important and then fails.

The Financial Services and Markets Act 2023 provides the Bank of England and the Payment Systems Regulator with powers to supervise certain digital settlement asset (DSA) firms that pose such risks, subject to recognition or designation (as applicable) of the firm by HM Treasury. The term “digital settlement asset” is defined more broadly than the concept of fiat-backed stablecoins discussed above (for example, there is no similar requirement for backing assets). The Bank of England is expected to publish a discussion paper on its proposed regime in the coming months.

In addition to this, last year the government proposed applying a special administration regime to DSA firms that have been recognised for Bank of England supervision as well as related service providers. HM Treasury’s response document relates to that consultation. In it, HM Treasury now confirms that:

• The special administration regime for financial market infrastructure will be extended to apply to these firms (other than banks), subject to certain modifications.
• An additional objective for this regime will focus on the return of customer funds and custody assets, similar to the special administration regime for payments firms. In this regard, HM Treasury has acknowledged the complexities arising from the fact that the value of customer “funds” may be intrinsically linked to the health of the DSA firm.
• The Bank of England will receive new rule-making powers so that it can respond to the failure of a systemic DSA firm.

Response on future regulatory framework for cryptoassets

As noted above, the UK is prioritising regulating fiat-backed stablecoins in its first phase of regulating cryptoassets. Phase 2 involves regulating a wider range of cryptoassets and related activities.

Earlier this year, HM Treasury sought views on its plans for a future financial services regulatory regime for cryptoassets. Now in a response to that consultation HM Treasury summarises the feedback it received from the consultation and confirms its intention to bring several cryptoasset activities into the scope of regulation for the first time.

Overall, the response indicates that the general direction of travel is unchanged from HM Treasury’s original proposals. When it starts to apply, the regime will mark a significant step up in what some crypto businesses are expected to do. Broadly speaking, they will need to meet similar standards to those that apply to traditional financial services.

There are a few notable modifications and clarifications, however. For example, HM Treasury is now expecting to introduce a new tailored regime for the custody of security tokens (including cryptoassets that meet the definition of a specified investment or collective investment scheme). It has also acknowledged the importance of allowing UK consumers access to global liquidity pools in respect of cryptoassets, which may be based outside the UK. Its comments suggest that this would depend on international regulatory cooperation, however, which may be difficult to achieve in practice.

The paper is an important stepping-stone towards a comprehensive regulatory regime for cryptoassets in the UK. However, some aspects remain outstanding. For example:

• Timing: The government promises to lay legislation in 2024. However, it does not indicate when the regime would start to apply. By way of comparison, MiCAR will be generally in force by the end of 2024, subject to transitional measures.
• Exemptions: The government has tried to clarify where it wants to draw the line between regulated and unregulated cryptoasset activities. However, the picture will only be fully clear once the legislation arrives.
• Homework: The government explains that it is continuing to develop policy in key areas, including rules around staking and DeFi (as well as other matters mentioned above).
• Supervision: The government’s work is focused on creating the framework of the future regime. This is important for determining what activities will and will not be regulated in future. However, what day-to-day life will look like as a regulated cryptoasset firm will largely be determined by the FCA which will have to decide how to apply its rulebook to cryptoasset businesses.

What happens next?

• HM Treasury says that it will lay “Phase 1” legislation – the regime for fiat-backed stablecoins – as soon as possible and by early 2024.
• The Bank of England plans to open a discussion paper on the proposed regulatory regime for systemic DSA firms.
• Legislation for “Phase 2” – the wider regulatory regime – is due in 2024.