UAE: FSRA consults on proposed stablecoin regulatory framework for ADGM
On 20 August 2024, the Financial Services Regulatory Authority (“FSRA”) of the Abu Dhabi Global Market (“ADGM”) published a consultation paper No. 7 of 2024 (“CP”) on its proposed regulatory framework for the issuance of “fiat-referenced tokens” (“FRTs”) from the ADGM. These proposals mark a significant development in the regulation of FRT issuance, which has never been specifically addressed in FSRA legislation until now. We have set out the key proposals below.
1. FRT issuance as a new Regulated Activity
Under the proposed regulatory framework, FRT issuance would constitute a new Regulated Activity, distinct from the issuance of Stored Value within the Financial Services and Markets Regulations 2015 (“FSMR”).
The FSRA proposes to define an FRT as a digital asset whose transfer and storage is achieved electronically through the use of distributed ledger technology, which:
- is used as a medium of exchange;
- achieves a stable store of value by referencing a fixed amount of a single fiat currency; and
- 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.
2. Prohibition of algorithmic stablecoins
Considering the inherent difficulty of maintaining a robust stabilisation mechanism in the absence of any backing assets with inherent value, the FSRA remains of the view that algorithmic stablecoins which derive their value from arbitrage or algorithm will not be permitted within ADGM.
3. Range of permitted Reserve Investments
The FSRA stipulates that FRT issuers must maintain all proceeds from the issuing FRTs in:
- cash held as “Relevant Money” in accordance with the Conduct of Business Rulebook (“COBS”); and
- “Reserve Investments” comprising admissible high-quality liquid assets denominated in the same currency as the FRT, which can be liquidated rapidly with minimal adverse price effect,
collectively termed “Reserve Assets”.
The CP also specifies further limitations on the types of investments that constitute Reserve Investments.
4. Allocation limits
Applicants would be required to submit their allocation limits in relation to categories of eligible Reserve Assets to the FSRA for approval, rather than the FRSA prescribing express limits.
In order for issuers to maintain enough cash reserves to meet redemption demand, the FSRA is of the view that the minimum percentage of cash against the total value of the relevant FRT outstanding should take into consideration the volume of recent and anticipated redemption requests.
5. Full backing of Reserve Assets / Attestation and audit
The market value of the Reserve Assets held by an FRT issuer must be at least equal to the par value of all outstanding FRTs in circulation at the end of each business day, valued at a mark-to-market basis daily.
The FSRA would require a monthly independent attestation regarding the existence and composition of the Reserve Assets. Issuers would need to publish the report on their website and submit it to the FRSA by the end of the month following expiry of the period covered by the attestation.
In addition, an annual external audit of an issuer’s Reserve Assets, and the effectiveness of its management (including internal controls, structure and compliance procedures) must be conducted. The FSRA requires issuers to submit their audit report within four months of their financial year end.
6. Segregation and custody of Reserve Assets
Reserve Assets must be segregated at all times and held by permitted Third Party Agents, in line with COBS, to protect FRT holders’ priority claim on Reserve Assets against an FRT issuer’s insolvency. Issuers of multiple FRTs must operate and maintain segregated pools of Reserve Assets for each FRT, and manage each pool separately.
7. Income arising from Reserve Assets
In marked departure from the position in many other jurisdictions, including the EU under the recently enacted Markets in Crypto-assets Regulation (“MiCAR”) and onshore UAE under the Central Bank of the UAE’s recently enacted Payment Token Services Regulation (“PTSR”) (discussed further in the Comment section below), the FRSA proposes to allow issuers to accrue and distribute income earned from Reserve Assets to FRT holders. This is on the basis that on the basis that the utility of an FRT as an effective medium of exchange is correlated to it being an effective store of value. In the view of the FSRA, it would therefore be counterintuitive as a policy to prohibit payments of income for that purpose.
However, FRTs must not be promoted as or considered to be an investment or a savings product. Issuers must make clear in their white papers that payment from income arising from Reserve Assets is not by default, but subject to the value of the Reserve Assets exceeding the par value of the FRT in circulation, as well as regulatory compliance.
8. Redemption requests
FRT holders must have the right to redeem their FRTs at par value upon demand, and have a claim on the Reserve Assets if the issuer is unable to meet its redemption obligations. Conditions for redemption must be reasonable and disclosed upfront in the white paper. Issuers have two business days from the date of a redemption request to fulfil it; however the FSRA can alter this timeframe in exceptional circumstances, for instance in times of market stress.
9. Minimum Capital Requirement
Issuers must maintain minimum Capital Resources, independent of Reserve Assets, of the higher of:
- $2 million in the form of CET1 capital, corresponding to a Base Capital Requirement; and
- its Annual Audited Expenditure.
Where the latter is the higher figure, the Capital Resources must comprise a minimum component of CET1 equal to $2 million.
This fixed minimum capital requirement can be distinguished from the position in other jurisdictions such as the EU and Hong Kong, which have imposed a variable capital requirement based on the par value of an FRT in circulation, on top of a base capital requirement, similar to the Variable Capital Requirement imposed by the FSRA upon issuers of Stored Value in ADGM. However, the FSRA is of the view that a variable capital requirement is not risk-appropriate for FRT issuers.
Reserve Assets must not be loaned out or used for other purposes.
10. Business restrictions
Issuers would not be permitted to undertake other Regulated Activities, nor possess an ownership stake in any other entity. However, related entities (e.g. a sister company which the issuer does not have a stake in) will be permitted to conduct other Regulated Activities.
11. White paper issuance
FRT issuers must ensure the white paper is clear, fair and not misleading, and presented to FRT holders in a concise, comprehensible form. Issuers will need to provide the FSRA with a proposed copy of the white paper no less than 20 business days prior to initial issuance of the FRT. The white paper must then be published on the issuer’s website prior to FRT issuance, and remain available while the FRT remains in circulation.
Details that must be disclosed include, but are not limited to, information about the issuer and FRT, the operations of the FRT, potential risks arising from use of the FRT, the rights and obligations attached to the FRT, redemption policies, and underlying technology and standards applied by the issuer.
12. Stress testing
FRT issuers would be required to conduct stress testing annually, or as requested by the FSRA if there are concerns about the adequacy of Reserve Assets. An issuer must demonstrate that it has systems in place to regularly stress test the Reserve Assets against potential adverse events and market conditions. Issuers must also have a strategy and tools that enable it to address large-scale redemptions or tackle any risks identified in adverse scenarios (including run scenarios and liquidity stress scenarios) should they arise.
13. Publication of accepted list of FRTs
The FSRA proposes rules, similar to those in COBS concerning anti-money laundering, transaction monitoring, IT risk and Travel Rule requirements, that issuers must comply with. In addition, Authorised Persons would be prohibited from issuing, marketing or accepting as payment any stablecoins other than FSRA-approved FRTs for use in the ADGM.
The FSRA would also publish a list of accepted FRTs. Firms that intend to transact in FRTs other than those specified would need to apply for acceptance of new FRTs. Guidance on what is required for an FRT to be accepted will be provided when the regime is introduced.
14. Draft amendments to FSMR and FSRA Rules
To implement this regulatory framework, the FSRA proposes amendments to the FSMR to create the new Regulated Activity of Issuing an FRT and proposes to set the application fee and annual supervision fee for this new Regulated Activity at $70,000 each.
The relevant Rulebooks, including COBS, will be amended to implement the proposed framework and to reflect the proposed requirements, as set out in the annexes and appendices to the CP.
Comment
The FRSA’s proposals as set out in the CP represent an important development in the regulation of stablecoins globally and can be differentiated in a number of key respects from frameworks established in other jurisdictions, as outlined above. In particular, allowing issuers to pass on income earned on reserve assets to holders is a key differentiator which is likely to make ADGM an attractive jurisdiction for issuers, who will hope to attract a greater number of investors by offering a yield-bearing stablecoin, something which is prohibited un a number of jurisdictions, including the EU.
Given the jurisdictional proximity and nexus, it is also particularly interesting also to compare the proposals for ADGM as set out in the CP with the rules for onshore UAE as set out in the PTSR, published in June 2024, which we have discussed in a previous article. Both the CP and the PTSR propose bespoke regulatory frameworks for stablecoins; however, the CP is more targeted, with a specific focus on FRT issuance, whereas the PTSR covers a broader range of payment token services, including conversion, custody and transfer. There are also a number of differences in approach, including the PTSR, like MiCAR in the EU, prohibiting issuers from passing on reserve asset income to holders.
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