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UK Digital Asset Regulation: the Evolving Framework

Executive Summary


The United Kingdom is executing a phased and comprehensive strategy to integrate digital assets into its established financial services regulatory perimeter. Led by HM Treasury and the Financial Conduct Authority (FCA), the approach eschews a bespoke crypto-specific regime in favour of amending existing legal frameworks, principally the Financial Services and Markets Act 2000 (FSMA) and its associated Regulated Activities Order (RAO). This initiative aims to mitigate risks to consumer protection and market integrity while fostering innovation. The regulatory expansion is structured in phases, beginning with fiat-backed stablecoins and progressively extending to a broader range of cryptoasset activities, underpinned by a new, tailored prudential framework.

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Phase 1: Legislative Foundations and Stablecoin Regulation


The initial phase focused on creating the statutory authority to regulate cryptoassets and addressing the immediate risks and opportunities presented by fiat-backed stablecoins.


Key Legislative and Definitional Developments:


  • FSMA 2023: This foundational legislation empowered HM Treasury to bring cryptoassets within the regulatory perimeter. It introduced a broad definition of a cryptoasset as "a cryptographically secured digital representation of value or contractual rights."

  • Defining the Scope: The subsequent draft Statutory Instrument (SI) provides more granular definitions:

    • Qualifying Cryptoasset: A fungible and transferable cryptoasset, excluding e-money, central bank digital currencies (CBDCs), and specified investment cryptoassets.

    • Qualifying Stablecoin: A type of qualifying cryptoasset that references one or more fiat currencies and purports to maintain a stable value through the holding of backing assets.

  • Initial Regulated Activities: The first activities brought into scope under the RAO are the issuance of qualifying stablecoins in the UK (Art 9M) and the safeguarding of qualifying cryptoassets (Art 9O).


Core Requirements for Stablecoin Issuers (per CP25/14):


  • Asset Backing and Safeguarding: Issuers must maintain 1:1 backing for all minted stablecoins with high-quality, low-risk assets. These assets must be segregated from the issuer's funds and held in a statutory trust for the benefit of holders, with an independent third-party custodian appointed for safeguarding.

  • Redemption Rights: A universal and direct right of redemption at par value must be guaranteed for all holders, with settlement mandated by the end of the following business day (T+1).

  • Prudential Management of Backing Assets: To ensure liquidity and stability, issuers must adhere to specific composition rules for the backing pool, including:

    • On-Demand Deposit Requirement (ODDR): A minimum of 5% of the backing pool must be held in on-demand bank deposits.

    • Backing Asset Composition Ratio (BACR): For issuers using an expanded set of backing assets, a dynamic ratio is required to ensure sufficient core liquid assets are available to meet redemptions without forced sales.

  • Public Disclosures: Comprehensive and accessible online disclosures are required, detailing the backing asset composition, the total number of stablecoins in circulation, and an independently audited annual confirmation of the 1:1 backing ratio.


Phase 2: Expansion of the Regulatory Perimeter


The second phase significantly broadens the scope of regulation to encompass the core activities of the cryptoasset market. The draft SI proposes amending the RAO to introduce several new regulated activities.


Proposed New Regulated Activities:


  • Operating a qualifying cryptoasset trading platform (Art 9T)

  • Dealing in qualifying cryptoassets as principal (Art 9U) and as agent (Art 9X)

  • Arranging deals in qualifying cryptoassets (Art 9Z)

  • Qualifying cryptoasset staking (Art 9Z7)


This expansion requires firms conducting these activities within the UK or providing services to UK consumers to obtain FCA authorisation and comply with the relevant conduct and prudential rules.


Regulation of Cryptoasset Trading Platforms (CATPs)


The FCA's proposals for CATPs (per DP25/1) are designed to establish fair, orderly, and transparent market operations.


Key Regulatory Proposals for CATPs:


  • Authorisation and Geographic Scope: Firms operating a CATP in the UK or serving UK retail clients must be authorised. An "offshore branch" model is under consideration to allow UK-based entities to provide access to global liquidity pools while remaining subject to UK conduct rules.

  • Market Transparency Mandates: To support price discovery and market integrity, CATPs will be subject to mandatory pre-trade (public order book) and post-trade transparency requirements.

  • Conflict of Interest and Principal Dealing: The framework proposes stringent rules to manage conflicts of interest. Principal dealing by a CATP operator on its platform is expected to be prohibited due to unmanageable conflicts, and strict operational and legal separation will be required for affiliated principal trading firms.

  • Settlement and Custody: Recognising the operational realities of DLT, the rules will focus on ensuring CATPs have satisfactory arrangements for the timely and effective transfer of assets, with clear disclosure of responsibilities to clients.


A New, Integrated Prudential Framework


To ensure the financial resilience of authorised firms, the FCA is introducing a new prudential regime composed of two integrated sourcebooks: COREPRU (core prudential standards) and CRYPTOPRU (crypto-specific calibrations).


Key Prudential Requirements:


  • Own Funds Requirement (OFR): A firm's capital requirement will be the highest of the three components:

    1. Permanent Minimum Requirement (PMR): A fixed capital floor based on authorised activities (e.g., £350,000 for qualifying stablecoin issuance).

    2. Fixed Overheads Requirement (FOR): Capital equivalent to one-quarter of the firm's relevant annual expenditure to fund an orderly wind-down.

    3. K-Factor Requirement (KFR): An activity-based capital requirement that scales with business volume. Key K-factors include:

      • K-SII (Stablecoins in Issuance): 2% of the average value of qualifying stablecoins in issuance.

      • K-QCS (Qualifying Cryptoassets Safeguarded): 0.04% of the average market value of qualifying cryptoassets under safeguarding.

  • Liquid Assets Requirement: Firms must maintain adequate liquidity to meet liabilities. This includes a Basic Liquid Assets Requirement (BLAR) for all firms and a specific Issuer Liquid Asset Requirement (ILAR) for stablecoin issuers, designed to mitigate price risk within the backing asset pool.

  • Concentration Risk Management: All firms must implement and maintain robust systems and controls to monitor, manage, and mitigate concentration risks arising from exposures to single counterparties, asset types, or custodians.


Conclusion


The UK's regulatory approach is methodical, leveraging established legal principles while adapting them to the novel risks of the cryptoasset sector. The phased introduction of rules, starting with stablecoins and expanding to cover trading, custody, and staking, allows for a measured and informed development of the regulatory landscape. The creation of a dedicated prudential sourcebook, CRYPTOPRU, demonstrates a sophisticated understanding of the unique financial risks involved. This comprehensive framework is poised to enhance market integrity, provide robust consumer protection, and solidify the UK's position as a credible and competitive jurisdiction for digital asset innovation.



 
 

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