In its recent consultation (“Managing the failure of systemic Digital Settlement Asset (including stablecoin) firms”), the Government has proposed that one of two special administration regimes (SARs) which currently apply to certain financial institutions (the Financial Market Infrastructure Special Administration Regime (FMI SAR) or the Payment and E-Money Special Administration Regime) be modified and extended so that they apply to certain cryptocurrency platforms (including stablecoins).
SARs are bespoke insolvency processes specifically legislated for companies within certain sectors, where companies carry out statutory functions of a public nature or where the general administration process is not considered to be in the public interest. SARs tend to follow the general administration regime set out in the Insolvency Act 1986 but with certain amendments, for example, the administrator will have modified objectives and will be granted additional powers in order to achieve those objectives. SARs have been particularly in focus over the past 18 months, following the collapse of at least three energy supply companies, which have been subject to the energy sector SAR (known as the Energy Supply Company Administration).
Initially there were a very limited number of SARs where the general administration process was not considered to be in the public interest for that sector and where Government intervention was required. However, in recent years the Government has legislated for more sectors (including water, energy, financial institutions, further education, transport and social housing) to have their own SARs. Further to the Government consultation referred to above, the next expansion to SARs is expected to be to the administration of digital settlement asset firms (DSAs) (such definition includes stablecoin payment systems and the operator of such systems, including the issuer, a wallet and third party service provider).
This consultation follows two key events:
- The Government’s response published in April 2022 to a consultation issued in January 2021 by the Treasury with respect to the UK’s regulatory approach to cryptoassets and stablecoins. In this response, the Government confirmed:
- its intention to publish legislation to bring stablecoin based arrangements into existing regulatory regimes, which provide the FCA with the powers to regulate and supervise firms engaged in relevant electronic money and payment activities; and
- the need to manage risks related to the failure of a systemic DSA which either acts as a systemic payment system and/or is a service provider of systemic importance. Such risks are thought to be magnified due to lack of regulatory oversight with respect to stablecoins (compared to banks and other systemically important financial institutions).
- The recent collapse of Terra (an algorithmic stablecoin, pegged to the US dollar, which was previously the third largest stablecoin).
The Government has suggested that the FMI SAR would be the most appropriate existing SAR for DSAs, primarily due to the role of the Bank of England in the SAR (the Government considers that the Bank of England (rather than the FCA) should be the lead regulator in systemic DSAs’ administrations). The consultation notes that the FMI SAR was established to address the risks posed by the possible failure of systemic payment systems, for example, BACS, where the Government considered that disruption to such a system due to insolvency would not be in the public interest because of the potential impacts on financial stability. The consultation states that the following amendments would be required to the FMI SAR in order to apply to systemic DSAs (note, these amendments would only apply to the administration of systemic DSAs and not to other firms which fall within the scope of the FMI SAR):
- Under the FMI SAR, an administrator’s objective is to pursue the continuity of the failed payment system’s services ahead of the interests of the creditors. For traditional payment systems this is considered to be appropriate as the primary impact on financial stability would arise from such a payment system ceasing to operate.
- DSAs differ from traditional payment systems in that they also allow users to store value, then used for the movement of funds. Therefore, the Government argues that, just ensuring the continuity of service upon the failure of a systemic DSA, may not be sufficient to mitigate the impact on financial stability. To address this, the Government has proposed an additional objective covering the return or transfer of funds and custody assets to allow administrators to take into account the return of customer funds and private keys as well as continuity of service. Specific regulations to ensure that administrators have the necessary framework to address this objective are also being considered.
- Role of the Bank of England
- It has also been proposed that the amended FMI SAR shall authorise the Bank of England to direct administrators as to which objective (set out in paragraph 1(b) above) should take precedence in an administration.
- The Bank of England shall be mandated to consult with the FCA before seeking a special administration order for a systemic DSA firm and directing administrators with regard to the SAR’s objective.
Feedback with respect to: (i) whether the FMI SAR should be the primary SAR for DSAs; and (ii) the proposed amendments to the FMI SAR, has been requested from “stakeholders” by 2 August 2022. The Government has also noted that further work will need to be completed to consider whether it would be appropriate to put in place a bespoke legal framework for failure of DSAs.