Regulating payments activities that use fiat-backed stablecoins.

Posted on: 20 December 2023

Written by: David Rodriguez

Some key considerations from the FCA Discussion Paper (DP23/4)

As part of its recently published discussion paper (DP23/4) on stablecoin regulation, the Financial Conduct Authority (FCA) has clarified, in alignment with the initial HM Treasury (HMT), proposals on regulating stablecoins used to carry out payment services activities and its position regarding the regulation of the use of fiat-backed stablecoins to make payments in the UK.

The proposed framework is aimed to achieve the following standards for payments made with stablecoins:

  • Securing good outcomes for consumers under the Consumer Duty with regard to payment services that use stablecoins, which are equivalent to current requirements for regulated payment services providers (PSPs)
  • Providing regulatory clarity to incentivise innovation and competition in the best interest of consumers.

In this, our second article on DP 23/4 we examine the proposed regulatory approach discussed in the paper regarding payment services activities that involve fiat-backed stablecoins and the permitted use of overseas stablecoins.

1. Proposed regulatory approach

The Payment Services Regulations 2017 (PSRs) currently regulate the transfer of ‘funds’, including transfers of non-cash and electronic money. However, the regulations do not capture transfers of value made via other assets, including cryptoassets such as fiat-backed stablecoins.

In line with the HMT’s views, it is proposed to extend the scope of the PSRs to cover two potential models of stablecoins used for payment services:

  1. The hybrid model, where a stablecoin would be used at the entrance or exit of an existing fiat payment chain, but the actual transfer of value would be in fiat, by way of a traditional payment service. A typical case of this model is where a consumer uses a stablecoin to make a payment for goods or services, and the PSP then performs a conversion from stablecoin to fiat to enable the payment to be made to the merchant.
  2. The pure stablecoin model, in which both the payer and payee transact in stablecoin, and the transfer of stablecoins between them occurs on-chain.

In both models, depending on the specific arrangement in each case, some parts of these activities would fall within the existing scope of the PSRs if carried out in the UK. For example, a stablecoin ‘payment interface’ would be likely to fall within the current definition of ‘payment instrument’ under the PSRs and would require authorisation from the FCA.

However, under this approach, the full payment transaction in stablecoins will not be regulated end-to-end, as some elements of the service will remain unregulated, such as the exchange of stablecoins to fiat and vice versa. In this sense, it has been proposed to bring ancillary crypto-related activities, such as the exchange of stablecoin to fiat, into scope of the PSRs as payment services under a new classification of ‘ancillary stablecoin payment services’.

Conduct requirements

The FCA considers that the existing conduct rules for regulated PSPs should apply for both the pure stablecoin payments activities and the ancillary stablecoin payments activities. Accordingly, the information requirements set out in Part 6 of the PSRs, and the rights and obligations for the provision of payment services set out in Part 7 of the PSRs, will apply to stablecoin payments activities.

Custody and safeguarding

Custody arrangements will likely arise in stablecoin payment services where payment firms intermediate payments in stablecoins. Where this occurs, it is expected that the same requirements to safeguard funds under the PSRs will also apply to regulated stablecoin payment services.

Money Laundering

Similar to regulated PSPs, both pure and hybrid stablecoin payment services will be in scope of the relevant requirements in the Money Laundering Regulations (MLRs).

Operational Resilience

Considering the important role of payment services for consumers, it is vital that stablecoin payment arrangers maintain operational and prudential resilience. Here, the FCA has indicated that it expects to impose similar organisational and prudential requirements that would apply to both stablecoin issuers and custodians to payment arrangers. The FCA’s objective is pretty much to ensure that all new stablecoin payment services firms have robust resilience frameworks in place to ensure they have a greater ability to withstand operational and economic disruption, deliver critical operations and minimise consumer harm.

Redress and dispute resolution

The FCA is proposing that all PSPs coming into scope of the new ancillary and pure stablecoin payment service activities, will need to comply with its dispute resolution sourcebook (DISP) which currently applies to regulated PSPs, while it is expected that payment arrangers dealing with consumers allow them to access the Financial Ombudsman Service (FOS).

Additionally, the FCA has clarified that, similar to non-bank payment providers, it cannot extend Financial Services Compensation Scheme (FSCS) protection to activities that are not in the Regulated Activities Order. As such, FSCS cover will not apply to payment services using stablecoins.

2. Overseas stablecoins used for payment services in the UK

Overseas fiat-backed stablecoins would only be permitted for use in payments in the UK if they meet certain standards. It is expected that these standards will closely follow those proposed for local regulated stablecoin issuers within Chapters 3 to 9 of the Discussion Paper.

To effectively ensure that overseas fiat-backed stablecoins used for payments in the UK meet the required standards, it is proposed that they must be assessed and approved by the FCA. In this regard, a potential new activity of acting as a ‘payment arranger’ could be created and subject to separate authorisation or registration by the FCA under the PSRs (in addition to any authorisation they might require to carry on any other regulated activities in the UK, including other payment services).

Assessing standards for overseas fiat-backed stablecoins

The FCA proposes that payment arrangers would have to assess overseas fiat-backed stablecoins against standards that are equivalent to those required for regulated stablecoins in the UK.

As part of the assessment and approval process, the FCA proposes that payment arrangers will be required to appoint an independent third party (such as an auditor) to verify certain elements of their assessment. For instance, the adequacy of the overseas stablecoin’s backing assets and arrangements for maintaining and managing them. For this purpose, the FCA would expect these independent third-party assessments to be made regularly to ensure the overseas stablecoin continues to meet the highest standards.

The FOS would also be available in circumstances whereby a payment arranger did not conduct adequate due diligence concerning an overseas stablecoin. However, the FCA does not anticipate that redress from the payment arranger would be available to consumers if the overseas stablecoin destabilises, or its issuer fails, provided that the payment arranger has complied with FCA rules.

Approved overseas stablecoins introduced to the UK payment chain would need to be monitored by the payment arranger on a weekly basis to ensure they remain compliant with the FCA standards.

Additionally, to ensure good consumer outcomes and to protect the UK payments network, the FCA is considering how to manage risks when an approved stablecoin ceases to be compliant with relevant FCA standards. In this sense, the FCA may require payment arrangers to communicate directly with the issuer, their customers, and the users of the payment service using the stablecoin, without undue delay, if an approved overseas stablecoin is no longer compliant. In this case, the facilitation of payments in the UK by the payment arranger must cease immediately and the situation must be promptly notified to the FCA.

Liability of payment arrangers for overseas stablecoins

Although it is expected that liability requirements for misdirected or failed payment transactions will apply to payment arrangers using stablecoins, the FCA does not expect them to be responsible for the approved overseas stablecoin failing to maintain its peg, provided they complied with the assessment requirements. In these cases, payment service users would not have a claim against the payment arranger for loss of value of the relevant stablecoin during the payment transaction or while it was held in custody with the payment service provider to execute payment transactions.

In any case, the FCA’s proposed standards would include ensuring the availability of a claim to redeem at par against the issuer, which should give some security for users of properly approved stablecoins. However, as the FCA recognises, these rights may not be as enforceable as those enjoyed by users of UK-issued regulated stablecoins, especially in the case of the issuer entering overseas insolvency proceedings where specific powers to protect consumers in these proceedings would not apply.

Next steps

The FCA is requesting relevant stakeholders’ views on the topics above by 6 February 2024.

Based on the feedback received, the FCA will be drafting appropriate new Handbook rules for consultation. The FCA will also consider whether there are any other aspects of its existing rules that may need changing and, should issues arise that are beyond its powers, the regulator will raise them with HMT and other stakeholders, as appropriate.

It is expected that a new consultation on final rules to regulate payment services using stablecoins might be published during the first half of 2024.

David R v2

David Rodriguez

David is a Consultant within our Payment Services team.

Contact David

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