Financial Services and Markets Bill

 Written evidence submitted by Circle Internet Financial, LLC (FSMB16)

Call for Written Evidence: Financial Services and Markets Bill

 

EXECUTIVE SUMMARY

Circle Internet Financial LLC ("Circle") appreciates the opportunity to provide evidence to the House of Commons Public Bill Committee on the Financial Services and Markets Bill ("FSMB"). Circle commends the Public Bill Committee’s efforts to scrutinise the FSMB with the objective to implement the Future Regulatory Framework ("FRF"), bolster the U.K.’s position as a financial services and technology hub, enhance U.K. competitiveness, and promote financial inclusion and consumer protection.

Circle’s response addresses six key areas specifically related to the inclusion of stablecoin regulation within the FSMB:

● Prudential regulation of Stablecoins

● Managing the failure of systemic Digital Settlement Asset firms, including stablecoins

● Co-Supervision of Digital Settlement Asset firms, including stablecoins

● Territoriality provisions and jurisdiction considerations

● Future ‘Review of Rules’ provisions

● Granting new or modified powers to HM Treasury (HMT)

Circle would welcome the opportunity to participate in any future hearing to expand on this written evidence.

ABOUT CIRCLE

Circle is a global financial technology firm that provides internet-native payments and treasury infrastructure. It has developed foundational technology centred on payments and banking in the age of digital assets and the internet. Since its founding, Circle has prioritised responsible financial services innovation and constructive engagement with regulators and authorities globally.

Circle is the sole issuer of USD Coin ("USDC"), a United States dollar-backed digital currency, which is one of the world’s largest digital currencies with over $46 billion in circulation as of September 30, 2022. Circle also recently launched Euro Coin ("EUROC"), a euro-denominated digital currency. USDC is 100 percent backed by cash and short-dated U.S. treasuries so that it is always redeemable 1:1 for U.S. dollars, and EUROC is 100 percent backed by euros held in euro-denominated banking accounts so that it is always redeemable 1:1 with euros. USDC and EUROC enable the holder control of how to send, spend, save and secure their money. With an ability for transmission on nine blockchains, USDC is one of the largest stablecoins measured by market capitalisation globally. Further, USDC is integrated as a settlement option in leading merchant and credit card networks, supports cross-border remittances and is deployed as a payment option by e-commerce platforms.

Circle has a keen interest in the development of a transparent and well-regulated digital assets market that facilitates capital formation, maintains fair, orderly and efficient transactions, and protects consumers. Partnership between the public and private sector is critical in developing technology-neutral, principled, activity-based regulation. Circle is supportive of the U.K.’s efforts to amend its existing regulatory framework as well as create robust regulatory structures that ensure the growth of both existing and novel financial services and technology firms.

Circle supports the U.K. Government’s efforts to set out new and updated legislative and regulatory clarity for digital assets firms - and financial services firms more broadly - in the wake of the U.K.’s departure from the European Union. In particular, Circle supports the development of a regulatory framework for stablecoins, not least because this should increase investor confidence. However, such measures need to be proportionate and tailored to the specific role of actors within the system. As the sole issuer of USDC, various of the regulations to be made under the powers enumerated in the draft FSMB would have an impact on how Circle structures its business operations.

1. FSMB KEY CONSIDERATIONS

1.1. It is likely that Circle’s digital currency products would fall under the definition that Parliament has set out in the FSMB of a "digital settlement asset" ("DSA"), which is defined as "a digital representation of value or rights, whether or not cryptographically secured, that (a) can be used for the settlement of payment obligations, (b) can be transferred, stored or traded electronically, and (c) uses technology supporting the recording or storage of data (which may include distributed ledger technology." Circle would also potentially fall within the proposed extension of Part 5 of the Banking Act 2009 as a "DSA service provider" or at least a "service provider connected to" a payment system, subject to meeting the threshold of being systemically important.

1.2. Circle encourages the Committee to carefully consider the provisions in the FSMB related to digital settlement assets, including stablecoins and DSA firms, against the Government’s stated intention of ensuring the U.K. is a global hub for digital assets and financial services innovation broadly and supports driving growth and investment in the U.K. Provisions currently being considered in the FSMB should not unduly stifle industry, but rather bolster the current pace of innovation in the digital assets, device-centric and internet payments, and fintech space to better position the U.K. as a leader in these industries.

1.3. Prudential Regulation

Integrating payment stablecoins into the U.K. regimes for payment services/e-money and, where a firm is systemically important, making them subject to Bank of England ("BoE") oversight will protect consumers and increase payments competition.

1.3.a If so integrated, the Government should give stablecoin issuers of privately-issued, regulated electronic money and digital currencies who maintain reserve assets in the care, custody, and control of the U.K. regulated banking system access to the BoE’s balance sheet with the same reserve account provisions as commercial banks.

1.3.b Circle notes that currently the FSMB gives flexibility to the BoE and the Financial Conduct Authority ("FCA") that could be used to implement a number of prudential regulatory models. In Circle’s view, a number of these models may be inappropriate, and therefore, a better approach would be for the BoE and FCA to only be empowered to introduce a prudential model that acknowledges that where an issuer must safeguard customers funds, the capital requirements that are applied to e-money institutions would be the most appropriate approach.

1.3.c Circle has also emphasised that the operational and risk profile of stablecoin issuers like Circle, and novel digital financial products like USDC, differ from traditional financial firms and services that are currently regulated and supervised prudentially - in the U.K. and elsewhere.

i) The reserve models for USDC and EUROC payment stablecoins require full 1:1 backing of all issued digital currency with high quality liquid assets. Given that Circle does not participate in fractionalised lending or lend against the reserves which back USDC and EUROC, traditional prudential regulatory mechanisms such as capital buffers would not be appropriate for a payment stablecoin issuer such as Circle. Circle would expect payment stablecoins to ordinarily be subject to a safeguarding regime (akin to that already applying to stablecoin arrangements constituting e-money pursuant to the Electronic Money Regulations 2011), which would better protect customer funds and accurately reflect the 1:1 backing which supports the value of the stablecoin.

ii) Further, transaction limits - either for a total volume of a circulating digital asset on a given basis, or a limit on the total number of transactions processed - would severely hinder the use, utility and function of products like USDC, EUROC and other payment stablecoins.

1.4 Managing the failure of systemic Digital Settlement Asset Firms (including

stablecoins )

Circle recently responded to HMT’s consultation on the Government’s proposed approach to managing the failure of a systemic DSA firm (the FMI SAR consultation), [1] a category that may include a stablecoin issuer such as Circle should the FSMB pass as currently written. HMT proposed to handle a potential failure by way of a modified Financial Market Infrastructure Special Administration Regime ("FMI SAR"). In its response to this consultation, Circle expressed two points:

i) Elements of the existing FMI SAR could indeed serve as a guide for future, comprehensive regulation of DSA firms (the FMI SAR only covers failure scenarios); but,

ii) The entirety of the FMI SAR would not be an appropriate pathway to regulate a DSA firm such as Circle.

1.4.a Both points stem from fundamental differences between digital assets circulating on public blockchains and financial institutions net settling corporate liabilities on public payments infrastructure.

1.4.b First, while Circle is encouraged that HMT is taking seriously the prospect of widespread DSA adoption, the application of a modified FMI SAR to "systemic" DSA firms is premature. To this end, the BoE should provide guidance on when a systemic designation for DSA firms such as stablecoin issuers will be met, and ideally there should be a statutory obligation to provide a statement of policy setting out how the BoE would apply the designation criteria and how the systemic designation test will be applied. Application of the FMI SAR framework may put the cart before the horse as the U.K. has not yet established a comprehensive crypto-asset regulatory regime. While development and implementation of a modified FMI SAR could be an important part of such a regime, we encourage HMT to first focus on attracting digital asset firms, implementing basic consumer protections, and providing for the widespread use of payment stablecoins prior to worrying about the possible failure of a "systemic" DSA firm.

1.4.c Second, in developing any digital assets regulation - including a modified FMI SAR framework - HMT should understand in detail the fundamental differences between digital assets circulating on public blockchains and traditional inter-bank or closed loop payment systems. Rules built for closed consortia are not appropriate for peer-to-peer networks built with the express purpose of removing financial intermediaries prone to failure. For example, public blockchains validate transactions based on open-source cryptographic rules. When an Ethereum user pays a merchant with USDC, the transaction is broadcast directly to the network as a whole instead of being routed through a dedicated payment service provider. This differs from traditional payments networks which generally consist of proprietary software and closely related financial institutions, which are either (a) bound by rules imposed by the network operator; and/or (b) able to transact by reason of a bilateral agreement with another network participant. To adequately supervise public blockchain payments infrastructure, it may be more appropriate and effective to review the open-source code for networks, as well as the historical performance of networks on which DSAs circulate.

1.4.d Circle does not operate as an inter-bank payment system, CSD, or third party service provider. Numerous market participants make up a dynamic and complex ecosystem of DSA firms servicing various functions of a complete FMI architecture on which USDC (and other stablecoins) are transacted. Circle believes that the financial stability and consumer-facing risks of a payment stablecoin issuer may differ greatly from that of a traditional FMI. Likewise, the risks of a payment stablecoin issuer differ from other DSAs such as digital wallet providers and digital asset marketplaces.

1.4.e Circle believes that HMT should examine carefully that some stablecoins issuers will be potentially straddling multiple special administration regimes, for example, the FMI SAR or Payment and E-Money Special Administration Regime ("PESAR") frameworks. While there are some similarities between DSA firms such as Circle and traditional payments infrastructure providers, the PESAR (either in its entirety or in parts) may be more closely aligned to the activities related to payments firms, as it was specifically established to address the risks posed by the possible failure of payment and electronic money institutions. HMT should consider whether there is any overlap between the objectives of the FMI and PESAR which may undermine the efforts of a special administrator if appointed.

1.5 Co-Supervision

For the avoidance of doubt, Circle agrees that stablecoin-based arrangements should be brought into the established regulatory regime for electronic money and payments. The effective implementation of the new co-supervisory responsibilities proposed in the FSMB will be critical for any future regime to work effectively. If adopted, Circle would encourage HMT to commit to a review of the new co-supervisory regime within two years of implementation to ensure it is working as intended. Such a review should include all existing and future Memoranda of Understanding between agencies and recommend necessary revisions.

1.6 Territoriality Provisions and Jurisdiction

In its recent consultation entitled "Payments Regulation and the Systemic Perimeter", HMT discussed the subject of territorial-based restrictions and jurisdictional questions related to BoE and FCA supervision for digital assets firms operating in the U.K. and elsewhere. Based on paragraphs 2.35 and 2.36 of the Payments Consultation, Circle understands that HM Treasury intends to give the BoE discretion regarding whether to impose a location requirement on a firm. Further, the BoE could be tasked with setting out its approach to this matter in the future.

1.6.a Circle urges Parliament and HMT to request that the BoE address this matter in its "Approach to FMI Supervision" document. Circle agrees that there appears value for firms and other stakeholders in setting this out ex ante, and would generally be supportive of such a provision. Regulation 63(1) of the EMRs currently prohibits the issuance of electronic money "in the United Kingdom" unless a firm has a licence or is an exempt entity. Greater clarity is needed to determine if HMT expects changes to the territorial scope rules in the EMRs (and the PSRs) to accommodate stablecoin arrangements. Circle cannot see a policy reason why the position on territoriality should not reflect the existing scope of the Electronic Money Regulations 2011 (which don’t apply to offshore issuers).

1.6.b Currently, HMT has excluded e-money from the definition of "qualifying cryptoasset" in the proposed changes to the financial promotions regime. This means that offshore issuers (and other service providers) may promote future "digital settlement assets" to U.K.-based holders without being subject to financial promotion rules. Circle views this as the correct outcome, which aligns with the primary purpose of a stablecoin as a means of payment that is most often transferred peer-to-peer or via exchange providers.

1.6.c However, further guidance is required to determine if HMT intends to apply the existing capital requirements set out in Schedule 2 of the EMRs to stablecoin issuers. If the safeguarding regime would apply to them, there does not appear to be any clear justification for imposing anything more onerous.

1.7 Review of Rules

Circle supports the addition of ‘call in powers’ provided for by Section 27 of the FSMB that would allow HMT to require the regulators to review their rules. Given the novelty of activities that will be regulated under these new frameworks, Circle agrees that it will be valuable to have a mechanism to allow the government to review rules without undermining the independence of the regulators.

2. FSMB MODIFIED POWERS

2.1 As the FSMB contemplates granting new or modified powers to HMT to regulate payment systems that involve digital settlement assets, digital settlement asset service providers, and service providers connected to these entities, Circle urges Parliament to carefully consider a few points of clarity as the bill moves through the House of Commons.

2.2 There is additional area of cryptoasset activity which are being assessed with a view into bringing the activities within existing regulatory frameworks:

2. 2.a Financial Promotions Regulations

HM Treasury has confirmed that it intends to bring "qualifying cryptoassets" within the scope of the U.K.'s financial promotion regime. This definition excludes electronic money, certain payment tokens, and central bank money but would include most cryptoassets, such as the Bitcoin and Ether tokens, that are traded on retail exchanges. Circle agrees that a regulatory framework for financial promotions involving cryptoassets is needed.

2.2.b Circle strongly supports the principle of ensuring that crypto financial promotions are fair, clear, and not misleading. Financial promotions should be effectively regulated and robustly enforced. This is essential to building consumer trust, protecting consumers, ensuring consistent standards, and stamping out irresponsible practices. However, the FCA’s proposed "FSMA s21 approver" rules are onerous, not proportionate to the rules for other industries, and will create an unlevel playing field that negatively impacts smaller firms.

2.2.c The FCA recently proposed to amend the Financial Promotions Order to require firms to have their financial promotions approved by an FSMA-regulated firm under "FSMA s21 approver" rules. But without changes, this would prevent the majority of responsible cryptoasset firms in the U.K. from approving their own financial promotions, even if clearly compliant. This is because any firm that does not hold Part 4A permissions under the Financial Services and Markets Act (2000) cannot approve its own financial promotions. This would include the many electronic money and payment institutions authorised separately under the Electronic Money Regulations 2011 and Payment Services Regulations 2017 respectively that provide cryptoasset-related services. Such firms are subject to supervision by the FCA and sophisticated regulatory frameworks, hence their inability to approve financial promotions is a significant disadvantage.

2.2.d Given that the majority of crypto firms in the U.K. do not have (and do not require) Part 4A FSMA permissions, the practical effect will mean all crypto firms in the U.K are forced to seek approval from a third-party approver. The advertising regime will be concentrated in the hands of a small number of firms who may not have the requisite experience in crypto or the financial promotion regime to give confidence that the FCA’s rules and principles are being applied appropriately.. The ultimate impact may be a de facto ban on crypto advertising, which will significantly stifle the U.K.’s global competitiveness in attracting growth.

CONCLUSION

Circle appreciates the opportunity to provide evidence to the House of Commons Public Bill Committee. We look forward to working constructively with the Committee and Government in the development of new legislation and regulations for the stablecoin and cryptoasset sector. We would welcome the opportunity to engage in future discussions and would be happy to answer any questions the committee may have regarding the evidence submitted.

Yours sincerely,

Teana Baker-Taylor

Vice President

Policy & Regulatory Strategy, U.K. & Europe

October 2022