The stable door is closing - the urgent issues facing the UK's stablecoin sector

Stablecoins – digital assets backed by real world assets so as to maintain their value (usually against a specific fiat currency) – come with a powerful set of use cases. They are increasingly mainstream, with over $200 billion in circulation, and major institutions such as Bank of America, Fidelity and PayPal either planning to or having launched a stablecoin offering. As long ago as October 2023, HM Treasury – under then-Prime Minister Rishi Sunak and then-Chancellor Jeremy Hunt – set out its policy to bring stablecoins (and subsequently other digital assets) into the scope of financial services regulation.

After a significant and frustrating delay (caused, in part, by the UK general election and change in government), in November 2024, Tulip Siddiq (the former Economic Secretary to the Treasury, or "City Minister") confirmed that the Starmer administration would continue with that policy. That welcome news was followed almost immediately by the publication of the FCA's Crypto Roadmap (although the length and ordering of that roadmap were not universally popular).

The Crypto Roadmap signposts a consultation paper on stablecoins for "Q1/Q2" 2025. The execution of the entire Roadmap depends on HM Treasury amending the Regulated Activities Order (RAO) to extend the regulatory perimeter to cover digital assets. For stablecoins, the Financial Services and Markets Act 2023 granted HM Treasury the power to make rules covering "digital settlement assets", which essentially equate to stablecoins for the purposes of this briefing.

Sadly, five months later, the only sign of progress is a written answer from Emma Reynolds, the new City Minister (on 5 February – two months ago already) to the effect that legislation regulating cryptoassets would be published "as early as possible this year", and that this would include creating a new regulated activity of issuing stablecoins.

Fintechs move quickly, and other jurisdictions have either already built regulatory frameworks (the EU, Singapore, UAE), or are actively working on doing so (most notably the US). While the sector is forcefully pressing HM Treasury to deliver the draft SI, our focus has shifted to include concerns about influencing some of the policy substance.

We propose four policy solutions that will help the sector flourish, with knock-on benefits for the economy.

We have identified certain issues to resolve with the FCA regime for backing assets (which is currently expressed to permit remuneration for the issuer). We accept that D23/4 concentrated on fiat-backed stablecoins, but to encourage the full breadth of the industry, now is the time to consider stablecoins backed by other assets, such as commodities like gold.

Two legal issues emerge immediately:

• The FCA's power to make backing assets subject to the "statutory trust" in the Client Assets Sourcebook (CASS) is limited only to "money" (this is section 137B of the Financial Services and Markets Act 2000 (FSMA)). The draft SI needs to widen the FCA's power to include tangible backing assets for asset-backed stablecoins.
• On a connected point, tangible commodities do not necessarily need to be subject to a trust. Bailment is an entirely sensible commercial alternative, and may even be preferable to issuers in some circumstances (e.g. where the commodities are physically located in a civil law jurisdiction). It also delivers the same level of protection to coin-holders, as they would technically be the legal owners of the bailed tangible assets. The rules on backing assets must not be limited solely to the statutory trust where an alternative exists and this should be clear in the draft SI.

On the broader topic, the importance of backing assets to stablecoin issuers has been thrown into sharp relief by Circle's announcement of its intention to float in New York. Its filings reveal that its 2024 gross revenue of approximately $1.676 billion consists of two elements: reserve income, earned on the cash and highly liquid assets used as backing assets, of $1.661 billion, and 'other income' (which includes transaction and other fees) of nearly $15.2 million – reserve income representing 99.1% of those revenues.

The current proposed regulatory structure would see the FCA regulating non-systemic stablecoins, but issuers of systemic stablecoins would fall into Bank of England supervision. The Bank's Discussion Paper on this dates back to November 2023, with a reminder of the proposals in a further Discussion Paper from July 2024. The thinking may have moved on in private, but at present, the proposals represent a powerful disincentive to scale to systemic status as they create a dramatic cliff edge for issuers' business models – backing assets would have to switch from high quality liquid assets in the FCA regime to only Bank of England reserves (even assuming the issuer meets the stringent requirements to obtain an account with the Bank of England). Critically, these reserves must be unremunerated – in other words, applying that cliff edge to Circle's figures would remove 99.1% of the revenue at a stroke. 

The FCA's DP23/4 on stablecoins (itself now nearly 18 months old) stated expressly that the prudential proposals were inspired by the Investment Firms Prudential Regime. This led the FCA to design a complex and quite onerous regime that, for example, requires the calculation of what the FCA calls "K-factors" when assessing capital requirements. How K-factors operate in practice is less important here than our argument that this was entirely the wrong regime with which the FCA should have started.

As the FCA itself noted, the prudential regime sits alongside the requirements for backing assets. We agree that a prudential regime is essential to mitigate the risks associated with firms failing, the protection from that for coin-holders are the backing assets.

This means that there is a much more logical regime – one which the FCA already oversees – on which to base the prudential requirements: that for electronic money institutions (EMIs), found in the Electronic Money Regulations 2011 (EMRs). Safeguarding requirements for e-money is a very obvious parallel. From the perspective of "same risk, same regulatory outcome", our view is that the prudential regime should be based on the EMRs. That would reduce the compliance burden and help different forms of digital money innovations compete from an equal starting point. Tellingly, for stablecoins backed by single fiat currencies, the EU's Markets in Crypto-Assets Regulation (MiCA), has adopted this approach. It would be internationally uncompetitive to be stricter than the EU in this area.  

There is a real risk that the UK could become an isolated "island" of liquidity if steps are not taken to ensure that overseas stablecoins can circulate freely. This would hamper adoption and innovation and could disadvantage businesses wishing to accept stablecoin payments.

Importantly, there is an obvious solution: extending the overseas person exclusion (OPE) in Article 72 of the RAO to cover stablecoin firms. As the OPE is statutory, this would need to be done through legislation.

There are three arguments in favour of this approach.

First, the risk with which HM Treasury claims to be concerned is overseas firms "dealing directly" with UK retail consumers. This is already managed through the structure of the OPE itself, which requires that a relevant transaction is either entered into "with or through" an authorised or exempt firm, or as a result of a "legitimate approach". This is an existing, proportionate and workable regime.

Second, HM Treasury itself previously recognised the need to avoid fragmentation of liquidity, and the risk of the UK market being isolated from global liquidity. This is especially pertinent given that accelerating cross-border payments is a global priority for the G20 and one of the major use cases already being adopted for stablecoins.

Third, it is preferable to any mooted mutual recognition or equivalence regime. Bearing in mind the UK's failure to obtain equivalence from the EU for its financial services sector post-Brexit, this does not strike us as realistic – and given current geopolitical instability and the Trump administration's aggressive approach to any international negotiations (plus its commitment to making the US the "crypto capital of the world"), creating the necessary global alignment for recognition seems exceptionally difficult for the foreseeable future, especially bearing in mind the localisation approach taken in MiCA, which is itself hardly conducive to globalising the stablecoin market. 

Away from stablecoin issuance itself, the market will depend on the smooth functioning of custodians (essentially wallet providers for stablecoins) and cryptoasset trading platforms (CATPs, i.e. businesses facilitating the trading and exchange of stablecoins).

In both cases, the proposed policy on the exposure of these firms to liability in certain circumstances is misguided.

For custodians, HM Treasury's policy objective appears somewhat confused. In its October 2023 paper on the Future Financial Services Regulatory Regime for Cryptoassets, it espouses an intention to create "a proportionate approach" to liability, while nevertheless continuing to progress with a regime, seemingly inspired by that for depositaries under the Alternative Investment Fund Managers Directive, under which custodians could be at risk of near-strict liability for hacks, for example. This is not appropriate for this sector. Instead, the policy should be based on that for custody of shares and other securities, where the parties may allocate the liability by contract.

This is not a theoretical point; the proposed approach will undoubtedly lead to higher costs and possibly reduced choice in the custodian market, with the knock-on impact of making UK custodians less competitive with overseas peers.

With regard to CATPs, it is the FCA's proposals in DP24/4 on admissions and disclosures, and market abuse, that have a clear gap.

The DP outlines a range of "quasi-regulatory" functions that CATPs on which stablecoins are admitted to trading will have to carry out, of which the prime example is the requirement to reject a stablecoin (or other digital asset) from admission in certain circumstances. If CATPs are to be expected to carry out these gatekeeper/police-style roles, it naturally follows that they will need a statutory immunity from liability in damages, equivalent to that for recognised bodies in section 291 of FSMA. As with custodian liability, failure to do so will discourage entrants to the market, narrow choice, and raise costs, all having detrimental effects on the health of the industry in the UK. These functions look to be very similar in nature to the "regulatory functions" discharged by recognised bodies under FSMA.

As described above, the draft SI is expected very shortly. The usual practice is to invite "technical" feedback for a short period. Experience has taught us that this is likely to be limited to queries as to whether the drafting itself is effective. It is unlikely to involve substantive policy discussions.

While there will be an opportunity to influence parliamentarians on the substance of the SI, in practice it is much harder to do so (and with a tighter window) once the draft is laid.

It is therefore imperative that policymakers hear these arguments – and others outside our scope, such as on the tax treatment of stablecoins – now.

The length of time HM Treasury has taken is very unfortunate and has arguably left the UK at risk of losing even second-mover advantage. However, getting the design of the regime right is essential. We cannot risk the UK being rendered irrelevant to such a dynamic, forward-looking and innovative industry.

Travers Smith can help firms design their services, identify legal and regulatory risks and engage with policymakers and regulators on these and other issues.