Date: 03 October, 2023
The government initiated a consultation in response to the growth of digital settlement assets (DSAs), particularly stablecoins, and their potential systemic risks. The consultation addressed failures within systemic DSA firms and proposed amendments to regulatory frameworks to manage such occurrences.
In their previous consultations 2021 and subsequent responses in April 2022, the government affirmed the need to regulate stablecoins used for payments within the UK regulatory perimeter. The proposed Financial Services Markets (FSM) Act outlined vital strategies:
- Bringing DSAs into Regulatory Perimeter: The Act aimed to incorporate digital settlement assets (DSAs) within the regulatory scope of the Bank and Payment Systems Regulator (PSR) under specific circumstances, emphasizing supervision for systemically important payment systems and service providers.
- Regulation of Fiat-Backed Stablecoins: HM Treasury was empowered to regulate the use, issuance, and custody of fiat-backed stablecoins, proposing inclusion within the Financial Conduct Authority’s (FCA) remit.
- Facilitating Dual Regulation: The Act aimed to establish mechanisms enabling joint regulation by the FCA and the Bank for certain activities.
The consultation recognised the potential wide-ranging implications of a systemic DSA firm’s failure, including impacts on financial stability and consumer protection. Consequently, the government proposed appointing the FMI SAR as the primary regime for managing systemic DSA firms, excluding banks. The proposals aimed to grant the bank authority over these firms’ administration, focusing on the transfer or return of assets held under custody and customer payments.
The critical policy proposals highlighted in the consultation included:
appointing the FMI SAR as the primary regime for systemic DSA firms not classified as banks.
Establishing an additional objective for the FMI SAR focused on safeguarding customer funds and custody assets
Granting the bank powers to direct administrators and implement rules for effective management
Mandating consultation between the Bank and FCA before any administration orders for systemic DSA firms subject to regulatory requirements from both entities
The government clarified that these proposals were tailored for systemic DSA firms and excluded non-systemic DSA firms, which would continue to be governed by standard corporate insolvency procedures. However, the government expressed potential consideration for future bespoke insolvency arrangements for non-systemic stablecoin firms.
The consultation regarding the appointment of the Financial Market Infrastructure Special Administration Regime (FMI SAR) for systemic Digital Settlement Asset (DSA) firms and the government’s responses involved detailed considerations:
1. Appointing FMI SAR as the Primary Regime:
Feedback was divided; some supported using FMI SAR for systemic DSA firm failures, while others proposed a bespoke framework.
The government acknowledged this feedback but stressed the need for immediate application of existing legal frameworks while considering bespoke frameworks for the future.
Proposals included amendments and additional provisions to align FMI SAR with systemic DSA systems’ unique features.
2. Establishing an Additional Objective for FMI SAR:
The majority supported introducing an objective focused on the transfer or refund of client money and custody assets for systemic DSA payment systems.
Queries arose regarding execution difficulties due to diverse stablecoin structures and fund separations.
The government noted the interdependency between managing failure and ongoing regulatory regimes, intending to address these concerns in forthcoming regulations.
3. Providing Bank Power to Direct Administrators:
A broad agreement existed for empowering the bank to direct administrators, but queries arose regarding the FCA’s role and practical implementation.
- The government justified the Bank’s role in directing administrators and assured consultation with the FCA for dual-regulated systemic DSA firms.
4. Introducing Further Regulations for FMI SAR:
Overall support existed for additional regulations to support FMI SAR’s objectives, with queries regarding liability and decision-making factors.
The government aims to draw upon existing provisions and frameworks while addressing concerns through forthcoming regulations.
5. Requiring Consultation Between Bank and FCA:
A broad welcome was given for the bank’s requirement to consult the FCA before seeking administration orders for dual-regulated systemic DSA firms.
Requests for clarity on the consultation process and regulatory responsibilities between the bank and FCA were raised.
6. Other Comments:
Queries included defining systemic DSA firms, insolvency funding, and administrator payments.
The government plans to mirror existing SAR rules, clarify systemic designations, and explore public funding while finalising regulations for systemic DSA firms.
The government intends to address these concerns through ongoing consultations and publications detailing regulations for systemic DSA firms’ administration.
Next Steps:
Regulatory Framework Implementation: The government plans to lay down initial regulations appointing FMI SAR as the primary regime for systemic DSA firms (non-banks). This includes establishing an additional objective focused on customer funds and custody assets. They aim to work with devolved administrations to cover Scotland and Northern Ireland.
Insolvency Rules Development: Further detailed rules will be formulated to outline how the FMI SAR will function. This involves specifics about fund transfers, administrator procedures, and similar issues in existing SARs.
Guidance and Updates: The Bank will consider providing additional guidance within its final going concern regime, keeping stakeholders informed.
Regulation of Cryptoassets: The government is working on establishing a regulatory regime for stablecoins and other cryptoassets in phases. Phase 1 focuses on fiat-backed stablecoins, already legislated through the FSM Act; phase 2 concerns unbacked cryptoassets, with a consultation closed in April 2023.
Annex: Definitions from the FSM Act: Provides specific definitions related to digital settlement assets and DSA service providers.
These steps aim to establish a robust regulatory framework for systemic DSA firms, considering their unique characteristics and potential failure scenarios. The government is also focusing on regulating crypto assets in phases, starting with stablecoins and gradually addressing other forms of digital assets.
References:
https://assets.publishing.service.gov.uk/media/653a6d5fd10f3500139a69f7/CR_Managing_the_failure_of_systemic_dsa__including_stablecoin__firms.pdf