Regulation of fiat-backed stablecoins: the FSRA’s consultation paper on its “Fiat-Referenced Tokens” rules

What is an FRT and how is it different from a stablecoin or a Virtual Asset?

The proposed new rules only cover a specific type of stablecoins that are backed by fiat or high-quality liquid assets. This means that although all FRTs may qualify as stablecoins, not all stablecoins would be considered to be FRTs. The proposed rules will not apply to stablecoins that are not backed by fiat or high-quality liquid assets. Further, stablecoins which are algorithmic in nature continue to be expressly prohibited.

Although FRTs and Virtual Assets share certain underlying similarities (in that they are underpinned by blockchain technology), the key difference is that an FRT can be redeemed on demand with the issuer who is required to deliver a certain amount of fiat currency or other thing of value. In contrast, a Virtual Asset’s value is generally speculative, and holders do not have a redemption right. The ability for FRT to be redeemed in a "timely and efficient manner" is a key concern for the FSRA.

With the above in mind, the FSRA has put forward the following definition of an FRT:

"a digital asset whose transfer and storage is achieved electronically through the use of distributed ledger technology, which:

1. is used as a medium of exchange; 
2. achieves a stable store of value by referencing a fixed amount of a single fiat currency; and 
3. enables the holder to redeem the FRT in exchange for the amount of the fiat currency referred to in (b) from its issuer upon demand.”

Will issuing FRTs be a new regulated activity?

The FSRA is considering to treat FRT issuance as a new separate regulated activity, or to keep it as part of an expanded “Providing Money Services” regulated activity.

We note that the proposed minimum capital requirement is USD 2 million or the issuer’s Annual Audited Expenditure, whichever is higher.

Finally, we note that:

1. FRT issuers will also be required to publish a white paper that discloses all relevant details of the FRT, including on redemption and reserve assets; and
2. the proposed application and annual supervision fees will be USD 70,000.

How much capital will an FRT issuer be required to hold?

The FSRA is proposing for FRT issuers to maintain a minimum capital resources which would be the higher of USD 2 million or the issuer’s “Annual Audited Expenditure” (with a minimum CET1 USD 2 million component). This is welcome development which does not follow other jurisdictions which impose a variable capital requirement based on the par value FRT in circulation.

What are the acceptable classes of reserve assets?

The FSRA proposes that FRTs be backed by “Reserve Assets” consisting of cash and investments comprising of high-quality liquid assets in the same currency of the FRT. The types of investments are limited to:

1. cash equivalents and debt securities with up to a three-month residual maturity issued by a government or central bank, organisations that are of both a governmental and international nature with a minimum long-term credit rating of AA- or equivalent;
2. reverse repurchase agreements over-collateralised by debt securities issued by a government or central bank on an overnight basis, with a counterparty that is not affiliated with the issuer and with a credit rating that meets or exceeds FSRA specified credit ratings;
3. public money-market funds investing in government debt securities (subject to FSRA-agreed limits on the value of investments held in such funds and credit ratings); and
4. any other instrument which the FSRA may approve.

The Issuers will also be required to submit their allocation limits for the various classes of Reserve Assets to the FSRA for approval. The FSRA proposes that the minimum percentage of cash against the total value of the FRT outstanding should consider the level of recent and anticipated redemption requests.

For completeness, FRT issuers will also be expected to publish an independent monthly assessment of their Reserve Assets.

How will Reserve Assets be custodied?

The FSRA is proposing to keep Reserve Assets segregated at all times with third party custodians to help ensure insolvency remoteness. This means that an issuer proposing to issue more than one type of FRT would need to maintain a separate Reserve Asset pool for each FRT.

Will yield bearing FRTs be allowed?

The FSRA has opted not to prohibit an FRT from accruing and distributing income derived from Reserve Assets.

However, the FSRA is proposing to prohibit the promotion of FRTs as an investment or savings product to mitigate the risks of:

1. issuers competing on the basis of the FRT-generated yield by investing in riskier Reserve Assets; and
2. FRTs being seen by consumers as a risk-free alternative to an interest-bearing bank deposit;

Moreover, FRT issuers are required to disclose in their white paper that an FRT will generate income only if the value of the Reserve Assets exceeds the par value of the FRT in circulation, and not by default (in addition to any redemption conditions such as fees). 

Incidentally, the CP7 states the reason for requiring FRTs to be backed by high-quality liquid assets with minimal market, credit and concentration risks, is to prevent FRT issuers competing to offer more yield to holders.

Will an issuer be able to carry on activities other than FRT issuance?

To ringfence the FRT issuer from risks that might impair redemption, the FSRA not only proposes to prohibit issuer from carrying on any other regulated activity alongside the issuance (and redemption) of FRTs but also from having any ownership stake in any other entity.

Note that the prohibition does not prevent members of the same group as the FRT issuer from carrying on regulated activities, especially given the FRT issuer’s prohibition from holding shares in other group members.

Can other ADGM entities accept and use FRTs?

Similar to its existing Accepted Virtual Assets regime, only FRTs that the FSRA deems to be “Accepted Fiat-Referenced Tokens” may be dealt with in the ADGM. However, this time around the FSRA is proposing to publish a list of which FRTs it deems as such.

Finally, note that the requirements set out in Chapter 17 of the COBS Rulebook (i.e., anti-money laundering, transaction monitoring, IT risk and travel rule requirements) will apply to FRTs.