Insights – John Glen and Stablecoins

On 4 April John Glen, the Economic Secretary to the Treasury and City Minister, delivered his keynote speech at the Innovate Finance Global Summit (IFGS), where, among other things, he announced that HM Treasury had published its long-awaited response to the consultation on stablecoins (the Response). We provide here some takeaways from the speech, as well as 10 key points you should know from the Response.

John Glen's IFGS Speech

In his keynote speech, John Glen emphasised the focus that the UK government has on prioritising the FinTech industry and that it aims to position itself as crypto-friendly. He set out three key factors that the government sees as being in the UK’s favour in this regard.

1. A detailed plan. Mr. Glen outlined the government’s approach to cryptoasset and DLT legislation, suggesting that it understands the need to be both tailored and proportionate, but also nimble and tech-neutral. He confirmed that, following the consultation on stablecoins, government would be legislating to bring certain stablecoins into the UK payments framework (more below). Following this, government is now looking at regulating a broader set of crypto-activities, including Bitcoin, which it will consult on later this year. There was also a suggestion that there will be a review of the tax code (though it is not expected to require a lot of changes), to look at DeFi loans and staking, as well as confirmation that the government will amend the Investment Manager Exemption to remove disincentives to UK fund managers including cryptoassets in their portfolios.

2. Determined to learn quickly. As part of ensuring that the government and relevant regulators develop their understanding, Mr. Glen outlined a number of strategies that have been announced. Firstly, the FCA are organising a series of ‘crypto-sprints’, which will involve working with industry experts to inform its policy thinking. Further, The Sandbox, run by the Bank of England and the FCA aims to allow firms to develop new products and test new technologies in a controlled regulatory environment. Finally, Mr Glen announced the Cryptoasset Engagement Group, which looks to be a group, chaired at ministerial level, and will include senior representatives from the FCA, the Bank of England and business to discuss and propose actions that could benefit the industry.

3. Leading role of government. Mr. Glen suggested that with the UK only having a small number of regulators, in contrast with the EU and US, and with central government setting the overall framework, it is in a better position to take decisive action. He stressed that the government is going to prioritise the FinTech and crypto industries, including assessing whether it is possible to apply DLT to the debt issuance process, using crypto-technologies to make government more efficient, and developing opportunities to use DLT for Customs and International Trade. He also announced that the Royal Mint will be creating an NFT (non-fungible token) by the Summer.

UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: Response to the consultation

As noted above, the long-awaited response to HMT’s consultation on stablecoins has been released. The consultation was launched in January 2021, and the Response sets out the government’s intention to introduce legislation to bring certain activities in relation to stablecoins within the UK’s regulatory perimeter. The 10 key points from the Response are outlined below:

1. The government proposes to introduce a new class of cryptoasset, defined as a ‘payment cryptoasset’. This will cover any cryptographically secured digital representation of monetary value which is, among other things stabilised by reference to one or more fiat currencies and/or is issued and used as a means of making payment transactions. The intention is that this will cover all fiat currency backed stablecoins, while excluding those that stabilise their value by referencing other assets (e.g. commodities). The aim is to capture those that can be used as a means of payment specifically, the regulation will cover both single currency stablecoins, as well as those based on a basket of fiat currencies. Further, HMT confirmed that in terms of nomenclature, it will adopt the terminology of ‘stablecoin’, rather than “stable token” that has been used in other consultations.

2. Wallet providers and stablecoin payment service providers to be authorised by the FCA, and if systemic, also by the Bank of England. The response has sought to confirm the territorial scope of the future legislation, suggesting that wallet providers and other entities providing stablecoin activities for payments in the UK must be authorised by the FCA and would, if deemed systemic, also be subject to Bank of England supervision. However, there is little detail as to how cross-border services are intended to be covered, if at all.

3. There will be a further consultation on the regulation of other cryptoassets, including Bitcoin. The Response states that the government is of the view that the development in legislation relating to stablecoins is just a first step, and it considers that additional regulation of a broader set of cryptoasset activities, particularly as a means of investment, should form a second legislative phase. It announces a further consultation to follow later this year.

4. The Electronic Money Regulations 2011, the Payment Services Regulations 2017 and Parts 5 of the Banking Act 2009, and the Financial Services (Banking Reform) Act 2013 will be amended to cover the changes proposed. The Response confirmed that in order to implement the government’s proposed changes, it intends to amend and extend the existing payments regulatory regime across several pieces of legislation. The government believes that many stablecoins that reference fiat currencies share characteristics with existing e-money, and so it makes sense to base amendments on this legislation. The changes will introduce a regulatory mandate in relation to stablecoins for each of the FCA, Bank of England, and Payment Systems Regulator.

5. The FCA will be the regulator for stablecoin issuers and wallet providers. Changes to the e-money and payment services regimes will provide the FCA with powers to regulate these entities. The legislation will ensure that such stablecoins can be converted into fiat currency, at par and on demand (much like e-money currently is). There will be a new regulated activity introduced of “stablecoin custody”. The Response notes that the role of the wallet provider is a key feature of cryptoassets, unlike traditional e-money, and highlights the key difference which is that stablecoins are able to be exchanged without redemption of the underlying funds via the issuer. The issuer instead holds the assets or funds backing the stablecoin, whereas the wallet provider or exchange provides access to the token.

6. The stablecoin regime will ensure that customers have a claim against either the issuer of the stablecoin or the consumer facing entity. To ensure equivalence between traditional e-money and stablecoins used as a means of payment, the Response confirms that there must be a legal claim for the customer. While in traditional e-money this would be against the issuer, for stablecoins it may be appropriate to also include a claim against the customer-facing entity. The legal requirement would continue to sit with the issuer, just not the obligation to fulfil directly unless the issuer is systemic. In cases of systemic risk, and where judged necessary, the Bank of England may seek to require a direct legal claim on the issuer to address financial stability risks. The Response also confirms that the statutory redemption rights set out in the Electronic Money Regulations 2011 (EMRs) would also apply.

7. Safeguarding requirements which exist under the EMRs will apply to customer funds received in exchange for issuing a stablecoin. The key obligation for firms issuing stablecoins will be the requirement to safeguard the funds that they receive in exchange. Firms will be required to hold funds in a separate account from the institution’s working capital, invested in high quality liquid assets, or alternatively ensure they are covered by an appropriate insurance policy or comparable guarantee. Importantly, those funds cannot be used for any purpose (e.g. lending).

8. The Bank of England and the Payment Systems Regulator will regulate certain stablecoin-based systems. As well as the FCA regulating aspects of stablecoins, the government also intends to extend the scope of the Financial Services (Banking Reform) Act, to capture relevant stablecoin-based systems within the purview of the Payment Systems Regulator. Clarification will be provided so that the legislation operates appropriately for ‘digital settlement assets’. In particular, HMT have confirmed that arrangements will be needed to manage risks related to systemic stablecoin failure.

9. A new Financial Market Infrastructure (FMI) Sandbox is to be introduced. As well as setting out a number of proposed legislative changes, the Response also looked at the call for evidence in relation to the use of cryptoassets and DLT in financial markets. It confirms that while legislative changes are likely to be required in this regard, the government is not yet clear how and where these changes should be made. As a result, the Response has proposed a new FMI Sandbox, facilitating the testing of DLT in FMIs and enabling the UK authorities to gain a better understanding around the legislative changes necessary to accommodate DLT.

10. The government will continue to engage with industry on a Central Bank Digital Currency. There was also a passing mention of the government’s continued interest in a CBDC, though the Response confirms that the government and the Bank of England have not yet made a decision on whether to introduce a CBDC in the UK. It will continue to engage with industry.