FMLC Response to FCA Consultation on Stablecoin and Cryptoasset Rules (CP25/14)

1.0 Executive Summary

The FMLC, while supporting the initiative to regulate cryptoassets, identifies material legal uncertainties and potential for unintended adverse consequences within the proposed framework. The analysis herein focuses on the FMLC's primary concerns regarding stablecoin issuance and cryptoasset custody, advocating for enhanced legal clarity, regulatory proportionality, and alignment with established financial market principles to mitigate legal risk and foster a sound, innovative market.

2.0 Stablecoin Issuance: Legal and Operational Concerns

The FMLC's critique of the proposed stablecoin issuance rules centres on the legal ambiguity of key definitions, the lack of a structured transition pathway for systemic entities, and potential conflicts of law in operational mechanics.

2.1 Scope of Regulation and Definition of "Issuer"

• FMLC Concern: The proposed definition of "issuing a qualifying stablecoin" lacks sufficient legal precision. The absence of a clear definition for jurisdictional nexus ("established in the UK") and the expansive application to third-party entities risk creating an overly broad regulatory perimeter. This approach could inadvertently subject ancillary service providers (e.g., technology vendors, distributors) to a disproportionate and inappropriate regulatory burden.

• Implications for Firms: The current drafting creates legal ambiguity, potentially imposing duplicative or disproportionate compliance obligations on entities whose functions are remote from the core risks of stablecoin issuance and management. The FMLC recommends refining the scope to apply to entities exercising substantive control and bearing principal responsibility for the stablecoin's operation, in line with the principle of proportionality.

2.2 Systemic Designation and Transition Risk

• FMLC Concern: The consultation paper fails to articulate a clear and predictable transition path for a stablecoin designated as a systemic one. The Bank of England's proposal—requiring systemic stablecoins to be backed by central bank deposits—could precipitate significant market dislocation if issuers are not afforded a commercially reasonable period to re-collateralise their backing assets.

• Implications for Firms: An abrupt transition mandate would introduce significant asset-liability management challenges, potentially forcing a rapid liquidation of assets (a "fire sale") that could induce procyclical selling pressure, destabilise the issuer, and create contagion risk in related markets. The FMLC insists on detailed guidance regarding the transition mechanics and timeline to mitigate this risk.

2.3 Mandated Statutory Trust for Backing Assets

• FMLC Concern: The FMLC objects to the imposition of a mandatory, "one-size-fits-all" statutory trust for backing assets. It advocates for a technologically neutral, outcomes-focused approach that prioritises demonstrable asset segregation and insolvency remoteness, regardless of the specific legal structure employed. This flexibility is paramount for global firms encountering conflicts of law, particularly where an English law trust is not recognised or is suboptimal in a foreign jurisdiction.

• Implications for Firms: A mandated trust structure creates significant legal and operational friction for multinational firms. A more flexible, principles-based requirement would permit firms to utilise diverse legal structures (e.g., nominee arrangements, orphan SPVs) that are better suited to their cross-jurisdictional operations while achieving the core policy goal of asset protection.

2.4 Redemption Process and Conflict with AML/CDD Obligations

• FMLC Concern: The proposals introduce a potential conflict between the prudential obligation for timely redemption (T+1) and a firm's statutory duties under the Money Laundering Regulations (MLRs). The discretion afforded to firms under the MLRs to request supplementary Customer Due Diligence (CDD) could be used to delay redemptions, creating legal uncertainty and undermining the principle of fair and objective processing.

• Implications for Firms: This ambiguity creates unacceptable legal friction and operational risk, challenging the enforceability of the redemption timeline. The FMLC recommends a more prescriptive and narrowly defined standard for CDD requests within the redemption process to ensure legal certainty for both issuers and holders.

2.5 Transfer of Contractual Obligations in Secondary Markets

• FMLC Concern: A key legal challenge identified is the effective transfer of contractual rights and obligations to subsequent holders of a stablecoin in secondary market transactions. Traditional legal mechanisms such as assignment (requiring notice) or novation (requiring consent) are operationally untenable for high-frequency, peer-to-peer trading environments.

• Implications for Firms: Without a robust mechanism for the automatic transfer of rights, issuers face legal uncertainty regarding the enforceability of their obligations to the universe of anonymous or pseudonymous holders. While a "deed poll" (a unilateral declaration of commitment to the world) is presented as the most viable solution, the FMLC notes the need for potential evolution in digital asset law to recognise a more seamless transfer mechanism formally.

3.0 Cryptoasset Custody: Divergence from Established Principles

The FMLC's analysis of the cryptoasset custody proposals highlights concerns with the expansive definition of "safeguarding" and the creation of unworkable distinctions from the well-established CASS regime for traditional securities.

3.1 Overly Broad Definition of "Safeguarding"

• FMLC Concern: The proposed definition of "safeguarding" extends beyond traditional possessory custody to include scenarios where a firm has "control" or a "contractual obligation" without holding the asset. The FMLC argues that applying rules designed for physical custody (e.g., insolvency protection) to the broader concept of constructive control constitutes a category error, resulting in illogical and unworkable compliance requirements.

• Implications for Firms: This definitional mismatch creates a disconnect between the regulated activity and the substance of the rules, making effective compliance difficult. The FMLC recommends that specific regulations about asset protection in insolvency should be narrowly tailored to apply only to firms engaged in genuine possessory custody of client cryptoassets.

3.2 Asset Segregation and Reconciliation

• FMLC Concern: The FMLC opposes the mandating of a non-statutory trust, advocating instead for an outcomes-focused approach consistent with the principles of the CASS 6 regime. This would provide firms with the flexibility to use proven structures recognised in global custody chains. Furthermore, the committee deems specific proposed rules on segregation and reconciliation to be operationally untenable due to a lack of technical clarity.

• Implications for Firms: The proposals risk imposing overly rigid and inefficient requirements, precluding the use of globally accepted custody models. A principles-based approach would enable firms to achieve the required standard of insolvency remoteness through structures best suited to their operational and legal environments.

3.3 Third-Party Appointments (Sub-custody)

• FMLC Concern: The proposed rules governing the appointment of sub-custodians are viewed as excessively restrictive and failing to accommodate the multi-tiered intermediated custody chain fundamental to modern securities markets. The singular focus on direct custody would effectively preclude established financial intermediaries from participating in the market.

• Implications for Firms: The current proposals could render it operationally impossible for institutional custodians and intermediaries to offer cryptoasset services, thereby fragmenting liquidity, limiting investor choice, and potentially increasing systemic risk by concentrating custody among a smaller set of direct providers. The FMLC strongly recommends aligning the rules with CASS 6.3 to recognise and accommodate both "direct" and "intermediated" custody models.

4.0 Conclusion and Recommendations

The FMLC's response underscores the imperative for the FCA to refine its proposals to ensure legal precision, operational viability, and consistency with established financial market law. The committee's primary recommendations are to:

1. Refine the Regulatory Perimeter: Focus regulatory obligations on entities that exercise direct control and bear principal risk, thereby upholding the principle of proportionality.

2. Adopt a Principles-Based, Outcomes-Focused Approach: Enable firms to meet key regulatory objectives, such as asset segregation, through a variety of legally sound structures tailored to their global operations.

3. Harmonise with Existing Frameworks: Align the cryptoasset custody regime with the proven, flexible principles of the CASS framework to leverage existing legal and operational infrastructure and foster robust competition.

   
   

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