The New Stablecoin Regime in Town: FSRA Publishes Consultation Paper on Fiat-Referenced Tokens

Key Takeaways

• The FSRA has proposed a new framework specifically for fiat-referenced tokens (“FRTs”), a type of stablecoin tied to traditional currencies.
• The FSRA has highlighted the need for a unique regulatory approach for FRTs, distinct from the current rules for Stored Value, due to the different risks and complexities involved.
• The proposed framework includes strict requirements for FRT issuers, such as maintaining high-quality liquid Reserve Assets, ensuring full backing of FRTs by these reserves, and submitting regular independent reports to the FSRA.
• Algorithmic stablecoins, which lack backing assets and derive value from algorithms, are prohibited under the proposed rules due to their inability to maintain stable value.
• FRT issuers are required to provide clear, comprehensive disclosures in a white paper, detailing the operation, risks, and redemption policies of the FRT.
• The FSRA also plans to introduce additional rules for anti-money laundering, transaction monitoring, and IT risk management, like those for Virtual Asset service providers.
• The consultation paper is open for comments until 3 October 2024, inviting feedback from potential FRT issuers and those involved in the stablecoin industry.

The Financial Services Regulatory Authority (“FSRA“) of the Abu Dhabi Global Market (“ADGM“) has proposed new rules for issuing stablecoins, specifically those tied to traditional currencies, known as fiat-referenced tokens (“FRTs“). These rules will only apply to FRTs and not to other types of stablecoins, like those backed by assets or commodities, for which the FSRA plans to create separate regulations in the future.

Because FRTs are used similarly to Stored Value (“SV“)—like prepaid cards or e-wallet balances—the current rules for SVs under the Financial Services and Markets Regulations 2015 (“FSMR“) would typically apply to FRTs as well. However, the FSRA believes that the existing SV rules don’t fully address the unique risks of FRTs, so they are developing a new, more appropriate regulatory framework.

FRTs vs Other Assets

FRTs are mainly used as a way to make payments, setting them apart from other Virtual Assets (“VAs“), which are often used for investments. The FSRA views VAs as commodities, not as money or payment tools, and their value can vary widely because they are not always backed by traditional currency.[1] In contrast, FRTs are linked to a fixed amount of traditional currency, allowing holders to exchange their tokens for money, which keeps their value stable and makes them suitable for payments.[2]

FRTs are also different from SV instruments. Money from SVs must be kept safe in an account and can only be used to make payments, with SV issuers required to hold the equivalent amount in cash.[3] On the other hand, the process for using and redeeming FRTs is more complex, and there can be a delay between when the FRT is issued and when it can be redeemed. In other places, FRT issuers are allowed to invest the money they receive in high-quality, liquid assets.[4]

The FSRA’s proposed definition of an FRT focuses on its role as a payment method, its stable value tied to a specific currency, and the right to exchange it for that currency.[5]

Regulatory Proposals

• Treatment of FRT issuance

The FSRA has proposed two options for regulating FRT issuance. The first (reflected in the proposals) is to treat it as a new, separate Regulated Activity.[6] The second is to expand the definition of the Regulated Activity of Providing Money Services (which encompasses the issuance of Payment Services, including SVs).[7]

• Prohibition of algorithmic stablecoins

The FSRA has prohibited algorithmic stablecoins, which derive value from arbitrage or algorithms. These are not permitted to be used within the ADGM as they have no backing assets, making it difficult to maintain a stable value.[8]

• Reserve Assets to be held by an FRT issuer

The FSRA has stipulated that FRT issuers must maintain the proceeds from the issuance of FRTs either as cash or in the form of specific eligible reserve investments, which are high-quality liquid assets in the same currency denomination as the FRT (“Reserve Investments“), which can be liquidated rapidly (together “Reserve Assets“). The FSRA has specified certain instruments as eligible Reserve Investments, which include cash equivalents, debt securities, reverse repurchase agreements over-collateralised by debt securities, and public money-market funds investing in government debt securities.[9] The FSRA has also proposed that FRT issuers must submit allocation limits for each category of eligible Reserve Assets to the FSRA.[10]

• Full backing of Reserve Assets

At the end of each day, the FRT issuer must hold Reserve Assets whose market value equals or exceeds the par value of all outstanding FRTs.[11] The FRT issuer must also submit an independently conducted monthly report to the FSRA attesting to the existence and composition of the Reserve Assets. The report must also be published on its website.[12]

• Segregation and Custody of Reserve Assets

The Reserve Assets must be separated from the other assets of the FRT issuer and must be held by third-party permitted custodians.[13]

• Income from Reserve Assets

The FRT must not be promoted as an investment or savings product. Despite this, the FSRA does not prohibit the issuer from distributing to the FRT holders any income earned and accrued from the Reserve Assets, explicitly permitting the same. [14] However, the FRT issuer must disclose in the white paper that the payment of any income from the Reserve Assets is conditional.[15]

• Redemption

The FRT issuer must ensure that the FRT holders have the right to redeem the FRT at par value. If the issuer cannot meet the redemption demand, then the FRT holder must be able to maintain a claim over the Reserve Assets.[16]

• Capital Resources

The FSRA has proposed that FRT issuers must maintain a minimum capital requirement (exclusive of Reserve Assets) equal to the higher of US$ 2 million (in the form of CET 1 capital) or the FRT issuer’s annual audited expenditure.[17]

• Business Restrictions

The FSRA has proposed that FRT issuers must not undertake any other Regulated Activities or have an ownership stake in any other entity so that risks are ringfenced to the FRT issuer alone. Related entities may, however, conduct other Regulated Activities.[18]

• White Paper

Every FRT issuer should provide clear and fair disclosures to the FRT holders in the form of a white paper. The white paper must be submitted to the FSRA at least 20 days before the FRT is issued and then published and maintained on the FRT issuer’s website.[19] The white paper must include the following information:[20]

Information about the FRT and the FRT issuer;

Operations of the FRT (value-stabilising mechanism and Reserve Asset management);

Potential risks of the FRT;

Rights and obligations of the FRT holder and FRT issuer;

Redemption policies; and

Underlying technology and standards.

• Stress Testing

FRT issuers should conduct stress testing on an annual basis or whenever the FSRA requests them to do so to identify any risks that may affect the valuation of the Reserve Assets. Stress testing involves demonstrating that the FRT issuer has systems and strategies in place to protect the Reserve Assets in cases of adverse market conditions and take appropriate action.[21]

The FSRA also intends to introduce rules regarding anti-money laundering, transaction monitoring, and IT risk, similar to those under Chapter 17 of the Conduct of Business Rulebook that govern VA service providers.

Accepted List of FRTs

FSRA intends to publish a list of accepted FRTs, including native FRTs issued by an FRT issuer operating within the ADGM. If an entity wishes to transact in any other FRT, they can apply to add the new FRT to the list. The guidance for the same will be published later.[22] A person authorised under the FSMR to operate within the ADGM may not issue, market or accept as payment any stablecoin other than those FRTs that FSRA accepts for use in ADGM.

Proposed Fees

The proposal includes a table of fees for a standalone Regulated Activity of issuance of FRTs, which stipulates an application fee of US$ 70,000 and an annual supervision fee of US$ 70,000.[23]

Conclusion

The consultation paper is addressed primarily to potential FRT issuers and entities active in the stablecoin industry who may wish to contribute to the development of the regulatory framework. The FSRA is inviting comments on the proposal till 3 October 2024, which are to be sent to the following address:

Consultation Paper No. 7 of 2024

Financial Services Regulatory Authority

Abu Dhabi Global Market

ADGM Square

Al Maryah Island

PO Box 111999

Abu Dhabi, UAE

Email: [email protected]

***

TLP Advisors is a dynamic and forward-thinking consulting, strategy and law firm specialising in providing cutting-edge solutions to our diverse clientele. With our roots deeply embedded in financial services, gaming, web3, and emerging tech, we offer unparalleled knowledge and support tailored to these rapidly evolving sectors’ unique challenges and opportunities.

TLP Advisors has consistently been the firm of choice for L1 chains, DeFi protocols, gaming companies, fintech and payment companies, foundations, funds, and investors. We have built a reputation for excellence through frequent collaborations with regulators, funds, and technology incubators. Our deep understanding of the intricate regulatory landscapes and industry dynamics allows us to provide strategic guidance and innovative solutions that empower our clients to navigate complex challenges and seize emerging opportunities.

www.techlawpolicy.com

***

[1] Paragraph 7, FSRA Consultation Paper No. 7 of 2024.

[2] Paragraph 8, FSRA Consultation Paper No. 7 of 2024.

[3] Paragraph 10, FSRA Consultation Paper No. 7 of 2024.

[4] Paragraph 11, FSRA Consultation Paper No. 7 of 2024.

[5] Annex A, FSRA Consultation Paper No. 7 of 2024.

[6] Paragraph 12, FSRA Consultation Paper No. 7 of 2024. A Regulated Activity, as per section 19 of the FSMR, is any activity mentioned in Schedule 1 of the FSMR. The consultation paper proposes the inclusion of paragraph 53B in Schedule 1, demarcating the issuance of FRTs as a separate Regulated Activity.

[7] Paragraph 52, Schedule 1, FSMR.

[8] Paragraph 13, FSRA Consultation Paper No. 7 of 2024.

[9] Paragraph 15, FSRA Consultation Paper No. 7 of 2024.

[10] Paragraph 16, FSRA Consultation Paper No. 7 of 2024.

[11] Paragraph 17, FSRA Consultation Paper No. 7 of 2024.

[12] Paragraph 18, FSRA Consultation Paper No. 7 of 2024.

[13] Paragraph 21, FSRA Consultation Paper No. 7 of 2024. This must be done in compliance with Chapters 14 and 15 of the FSRA’s Conduct of Business Rulebook regarding Client Money and Safe Custody.

[14] Paragraph 22, FSRA Consultation Paper No. 7 of 2024.

[15] Paragraph 24, FSRA Consultation Paper No. 7 of 2024.

[16] Paragraph 27, FSRA Consultation Paper No. 7 of 2024.

[17] Paragraph 30, FSRA Consultation Paper No. 7 of 2024.

[18] Paragraph 32, FSRA Consultation Paper No. 7 of 2024.

[19] Paragraph 33, FSRA Consultation Paper No. 7 of 2024.

[20] Paragraph 34, FSRA Consultation Paper No. 7 of 2024.

[21] Paragraph 35, FSRA Consultation Paper No. 7 of 2024.

[22] Paragraph 38, FSRA Consultation Paper No. 7 of 2024.

[23] Annex B, FSRA Consultation Paper No. 7 of 2024.