Cryptoassets and DeFi: mixed messages from regulators but some progress from the Bank of England
Innovate Finance analysis of regulatory statements on cryptoassets and DeFi, by Adam Jackson, Director of Policy, Innovate Finance, 25 March 2022
The Bank of England (“BoE”), Prudential Regulation Authority (“PRA”) and Financial Conduct Authority (“FCA”) published a number of documents regarding regulation of crypto-assets yesterday. This included welcome news that the BoE’s Financial Policy Committee (“FPC”) would support a systemic stablecoin issued by a non-bank, provided the BoE applies a regulatory framework that mitigates financial stability risks. The PRA published a ‘Dear CEO’ letter, and the FCA issued a Notice, setting out the approach regulated firms should take to crypto-assets.
On the positive side, these publications provide some clarity on the regulators’ current expectations and an indication of the direction of travel. Most importantly, the FPC has declared its support for non-bank, regulated systemic stablecoins. The FPC helpfully noted the potential for crypto-asset technology to reshape activities carried out by the traditional financial sector, including lending, exchange, investment management and insurance. The FPC also identified a wide range of benefits arising from the application of crypto-assets and blockchain technology including faster, cheaper and more competitive payments systems and greater transparency, efficiency and resilience in financial markets infrastructure.
Inevitably regulators focus on risk, and the PRA’s ‘Dear CEO’ letter and FCA’s Notice do so in terms of conduct and prudential risk management. Equally, the Bank of England strikes a cautious note whilst continuing to progress work on digital money. The economic risk for the UK is that global markets and industry players are only hearing these messages from the UK; this gives the impression that the UK is treating digital assets as primarily a risk to be managed and even subdued.
The UK needs to be communicating the opportunity and the desire to be a leading global economy for these technological transformations. This has to be led by the Treasury within the UK Government. We now need a strong vision from the UK government, leading a joined up strategy for the UK to be the leading G7 country for blockchain enabled financial services. We also need more pace. Regulators naturally proceed cautiously and do need to develop in conjunction with international bodies; but markets are developing fast and investors and innovators are choosing where to build new capability. The UK needs to keep up.
A number of statements were published by UK regulators on crypto-assets on 24 March:
- The BoE’s summary and analysis of responses to its June 2021 discussion paper on new forms of digital money: Responses to the Bank of England’s Discussion Paper on new forms of digital money | Bank of England
Given the need for more public debate, it is heartening that the bank received nearly 2500 responses from individuals, and 97% of responses were from the public (rather than businesses, trade associations and other organisations).
- Respondents asked for more public education on digital money and what it might mean for the public.
- The BoE explicitly recognises the need for competition in the provision of digital money. “A non-competitive outcome could diminish people’s welfare… stifle innovations and it could risk financial stability if firms became so important that they are ‘too-big-to-fail’.” It notes the need for the BoE to engage the Competition and Markets Authority, FCAand the Payments Systems Regulator on competition issues.
- The consultation and the BoE’s response also highlighted the importance of interoperability, whilst noting that the specific models for interoperability, the technology and access arrangements are yet to be defined by the Bank.
- Overall, the paper concludes that “while the Bank of England has not yet made a decision on any of the topics in the Discussion Paper, the feedback we received has shown strong support for the Bank to continue with its work on these topics. That said, respondents were clear about three things: access to cash should be preserved; the Bank should continue to engage with stakeholders including the wider public; and any regulation for systemic stablecoins should be clear, proportionate, and risk-based.”
- The FPC’s view on cryptoassets and decentralised finance: Financial Stability in Focus: Cryptoassets and decentralised finance | Bank of England
This does provide a good review of the market and different blockchain and digital-asset based products. As noted above it provides a good summary of use cases and benefits of crypto-assets and Distributed Ledger Technology (“DLT”), particularly in payments and financial markets infrastructure. It notes that the Bank is working with HM Treasury and the FCA on the development of a new Financial Market Infrastructure (“FMI”) Sandbox, which would allow firms to experiment with technologies such as DLT in the provision of FMI services.
It includes this key statement: ”The FPC judges that a systemic stablecoin issued by a non-bank could meet its expectations provided the Bank applies a regulatory framework that was designed to mitigate the risks to financial stability”, supporting the principle of a regulated stablecoin.
It does also rule out one model for regulated stablecoin – and the one which would be the closest to a market based approach: the deposit-backed model. The FPC judged that a systemic stablecoin that is backed by a deposit with a commercial bank would introduce undesirable financial stability risks. This has implications for stablecoin issuers who currently operate as e-money institutions. The ‘deposit-backed’ model would be similar to the backing model used by e-money firms in the UK and EU. The Bank of England has noted that the current e-money regime (or a comparable regime applied to stablecoins) does not meet the FPC’s expectations and would need enhancements. The FCA is also considering whether changes may be needed to the e-money regime and is looking at overlap and alignment with a future stablecoin regime.
- PRA “Dear CEO” letter: to CEOs of banks and designated investment firms on the treatment of crypto assets under the current frameworks: Letter from Sam Woods 'Existing or planned exposure to cryptoassets' (bankofengland.co.uk)
This sets out how firms should approach prudential risk of crypto. It is arguably overdue – the last one was 2018 – and whilst it emphasises risk, it does provide some clarity on how to approach that risk, and therefore shows PRA recognition of the role of crypto-assets in the financial system and providing a practical framework for that. It notes that further development of the prudential framework is in part contingent upon the work of the Bank of International Settlement to develop an international prudential framework for crypto-assets. It also includes a survey of regulated firms, seeking details of current and future plans on crypto-assets – which should help provide a clearer picture of the adoption of crypto-assets and DLT in the established PRA regulated market.
No surprises here. It does helpfully pull together in one place all the key FCA statements and guides on crypto-assets.
The most significant next step will be legislation to introduce a regulatory regime for stablecoins, bringing systemic stablecoins into the BoE’s regulatory remit. HM Treasury will bring forward legislation enabling this – perhaps in this summer’s much anticipated Financial Services Bill. The detailed regulatory framework that will apply to systemic stablecoins will then be the subject of a future BoE consultation after that.
You can get involved in the debate on cryptoassets and DeFi developments at our global summit - IFGS - on 4-5 April, featuring senior Government Ministers, UK and international regulators and global FinTech founders and financial services leaders. You can register to attend here.