The market they form is complex and ever evolving, but consistent regulation, both domestically and internationally, has been somewhat lacking to date. As such, the Financial Conduct Authority urges caution before investing in cryptoassets, stressing that “the cryptoassets you are using may not be regulated”.
However, the continued presence of cryptoassets including stablecoins suggests that regulation of such assets, rather than warning against them, is the better course of action. They are interconnected with the wider financial system, so taking steps to manage the risks posed by their vulnerabilities (whilst taking advantage of the benefits) could allow for confidence in secure trading and cross-border transfers. With the UK HM Treasury announcing plans to make the UK a global cryptoasset technology hub (our earlier article on this can be found here), the recent developments are a welcome step in a bid to generate interest rather than fear.
So what is the FSB proposing?
In October 2022, the FSB published its proposed framework for the international regulation of cryptoasset activities. This included recommendations concerning the regulation of cryptoasset activities and markets, plus revised high-level recommendations concerning stablecoin arrangements (which it originally consulted on in April 2020 and finalised in October 2020). Whilst it will be important for national regulatory regimes to cover AML/CFT, data privacy, cyber security consumer and investor protection, market integrity, competition policy, taxation, monetary policy, monetary sovereignty, currency substitution, or other macroeconomic concerns in relation to cryptoassets including stablecoins, the remit of the FSB and therefore its proposed framework is purely in relation to financial stability.
Recap: the difference between stablecoins and other cryptoassets
There is no universally agreed legal or regulatory definition of stablecoin – and indeed the value of a stablecoin may not in fact be stable. The FSB considers that a stablecoin will have two characteristics that other cryptoassets will not: (i) the existence of a stabilisation mechanism and (ii) the usability as a means of payment and/or store of value. A global stablecoin (“GSC”) will have a third characteristic: potential reach and adoption across multiple jurisdictions. The FSB notes that to be useable as a means of payment and/or store of value, a stablecoin arrangement typically provides three core functions. These core functions include (i) issuance, redemption and stabilisation of the value of the coins; (ii) transfer of coins; and (iii) interaction with coin users for storing and exchanging coins.
Whereas existing stablecoins are not widely used outside cryptoasset markets and have not to date posed a significant threat to global financial stability, their rapid growth, use across multiple jurisdictions, and potential to quickly scale in size may mean that they could pose a greater threat in the future if not subject to robust regulatory and supervisory policies. The FSB therefore considers that national authorities should apply some of the GSC recommendations more widely than just to stablecoins meeting the global threshold – and apply it to other stablecoins based on their size, complexity and the risks they present.
Interplay between GSC and cryptoasset (CA) recommendations
The FSB has clarified that the two sets of recommendations are closely interrelated, as they both cover issuers, intermediaries and service providers. They have been developed as stand-alone documents but are intended to be consistent where they cover the same issues and risks. In particular, issuers, intermediaries and service providers that are part of a GSC arrangement would be covered by the recommendations for their activities related to GSCs and would also be covered by the recommendations for crypto-assets for their activities more generally.
What are the FSB’s recommendations?
We have set out in the table below an overview of the CA and GSC recommendations, from which it is easy to make comparisons between the two sets of recommendations. We have also set out the key changes proposed to the GSC recommendations. The FSB has observed that most existing stablecoin arrangements are failing to meet GSC recommendations 4, 5, 8 and 9 and these are highlighted red in the table below.
| Recommendations for cryptoasset activities and markets | Authorities: facilitating effective regulation and oversight | Recommendations for GSCs: achieving approproproate structure, design and regulatory compliance |
| Governance framework CA Recommendation 4: Authorities, as appropriate, should require that crypto-asset issuers and service providers have in place and disclose a comprehensive governance framework. The governance framework should be proportionate to their risk, size, complexity and systemic importance, and to the financial stability risk that may be posed by the activity or market in which the crypto-asset issuers and service providers are participating. It should provide for clear and direct lines of responsibility and accountability for the functions and activities they are conducting. |
Powers and tools GSC Recommendation 1: Authorities should have and utilise the necessary and appropriate powers and tools, and adequate resources, to comprehensively regulate, supervise, and oversee a GSC arrangement and its multi-functional activities, and enforce relevant laws and regulations effectively. CA Recommendation 1: Authorities should have the appropriate powers and tools, and adequate resources, to regulate, supervise, and oversee crypto-asset activities and markets, including crypto-asset issuers and service providers, as appropriate. |
Comprehensive governance framework GSC Recommendation 4: Authorities should ensure that GSC arrangements have in place a comprehensive governance framework with a clear allocation of accountability for the functions and activities within the GSC arrangement. Revised to make clear that GSC operating structures must be set up in such a way that they do not impede the effective application of relevant regulations and standards, e.g. by decentralised governance structures and distributed business infrastructures. |
| Effective risk management framework CA Recommendation 5: Authorities, as appropriate, should require crypto-asset service providers to have an effective risk management framework that comprehensively addresses all material risks associated with their activities. The framework should be proportionate to their risk, size, complexity, and systemic importance, and to the financial stability risk that may be posed by the activity or market in which they are participating. Authorities should, to the extent necessary to achieve regulatory outcomes comparable to those in traditional finance, require crypto-asset issuers to address the financial stability risk that may be posed by the activity or market in which they are participating |
Functional and proportionate approach GSC Recommendation 2: Authorities should apply regulatory requirements to GSC arrangements on a functional basis and proportionate to their risks. Revised to clarify that custodial wallet providers, trading platforms and intermediaries providing services in relation to GSC also in scope. CA Recommendation 2: Authorities should apply effective regulation, supervision, and oversight to crypto-asset activities and markets – including crypto-asset issuers and service providers – proportionate to the financial stability risk they pose, or potentially pose, in line with the principle “same activity, same risk, same regulation.” |
Effective risk management frameworks GSC Recommendation 5: Authorities should ensure that GSC arrangements have effective risk management frameworks in place especially with regard to reserve management, operational resiliency, cyber security safeguards and AML/CFT measures, as well as “fit and proper” requirements. Revised to clarify the need for liquidity risk management to support an effective stabilisation mechanism, consistent with recommendation 9; and anti-money laundering and combating the financing of terrorism (AML/CFT) procedures for transactions from and to un-hosted wallets. |
| Robust data frameworks CA Recommendation 6: Authorities, as appropriate, should require that crypto-asset issuers and service providers have in place robust frameworks for collecting, storing, safeguarding, and the timely and accurate reporting of data, including relevant policies, procedures and infrastructures needed, in each case proportionate to their risk, size, complexity and systemic importance. Authorities should have access to the data as necessary and appropriate to fulfil their Robust data frameworks regulatory, supervisory and oversight mandates. |
Comprehensive cross-border and cross-sector regulation and co-operation GSC Recommendation 3: Authorities should ensure that there is comprehensive regulation, supervision and oversight of the GSC arrangement across borders and sectors. Authorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication and consultation in order to support each other in fulfilling their respective mandates and to facilitate comprehensive regulation, supervision, and oversight of a GSC arrangement across borders and sectors. CA Recommendation 3: Authorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication, information sharing and consultation in order to support each other as appropriate in fulfilling their respective mandates and to encourage consistency of regulatory and supervisory outcomes |
Robust data systems GSC Recommendation 6: Authorities should ensure that GSC arrangements have in place robust systems for safeguarding, collecting, storing and managing data. Revised to clarify the need for authorities to have access to relevant data wherever it is located. |
| Recovery and resolution plans GSC Recommendation 7: Authorities should ensure that GSC arrangements have appropriate recovery and resolution plans. |
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| Transparency CA Recommendation 7: Authorities should require that crypto-asset issuers and service providers disclose to users and relevant stakeholders comprehensive, clear and transparent information regarding their operations, risk profiles and financial conditions, as well as the products they provide and activities they conduct |
Monitoring and managing interconnectedness CA Recommendation 8: Authorities should identify and monitor the relevant interconnections, both within the crypto-asset ecosystem, as well as between the crypto-asset ecosystem and the wider financial system. Authorities should address financial stability risks that arise from these interconnections and interdependencies |
Transparency, particularly of stabilisation mechanism GSC Recommendation 8: Authorities should ensure that GSC arrangements provide to users and relevant stakeholders comprehensive and transparent information necessary to understand the functioning of the GSC arrangement, including with respect to its stabilisation mechanism. Revised to set out in greater detail requirements concerning disclosure of information, including common disclosure templates for reserve assets |
| Regulating combined functions CA Recommendation 9: Authorities should ensure that crypto-asset service providers that combine multiple functions and activities, for example crypto-asset trading platforms, are subject to regulation, supervision and oversight that comprehensively address the risks associated with individual functions as well as the risks arising from the combination of functions, including requirements to separate certain functions and activities, as appropriate. |
Redemption GSC Recommendation 9: Significantly revised as follows: Authorities should require that GSC arrangements provide a robust legal claim to all users against the issuer and/or underlying reserve assets and guarantee timely redemption. For GSCs referenced to a single fiat currency, redemption should be at par into fiat. To maintain a stable value at all times and mitigate the risks of runs, authorities should require GSC arrangements to have an effective stabilisation mechanism, clear redemption rights and meet prudential requirements. |
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| Ensuring compliance: before operations commence and on an ongoing basis GSC Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary. |
Design-inherent ability to adapt to new regulatory requirements GSC Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary. |
Conclusion and next steps
The FSB proposed recommendations are just that, recommendations, which require implementation by authorities in individual states to be enforceable. However they are influential and provide helpful clarification on the regulatory direction of travel. Whilst those involved early on in the cryptoasset industry may not have anticipated being subject to such detailed regulatory requirements, regulators are starting to catch up with the technology given its increasing ubiquity and interconnectedness with the traditional financial system. Recent events – ranging from the collapse of algorithmic stablecoin Terra to the world’s second largest cryptocurrency exchange FTX filing for bankruptcy – show the need to achieve effective regulation and oversight, proportionate to the risk, size, complexity and systemic importance of the cryptoassets and activities concerned. The UK is currently in the process of legislating to regulate stablecoins (referred to as ‘digital settlement assets’) and to expand the financial promotion regime to capture qualifying cryptoassets. It is also expected to consult later this year on the regulation of cryptoassets currently falling outside the regulatory perimeter.
In terms of the FSB consultations, the FSB will accept responses to the questions until 15 December 2022. The FSB will review and finalise the recommendations in 2023, with the aim of reviewing the implementation of the recommendations by the end of 2025.