On August 20, 2024, the Financial Services Regulatory Authority (FSRA), the financial services regulator of the Abu Dhabi Global Market (ADGM), announced its Consultation Paper No. 7 (CP7) of 2024 on the Proposed Regulatory Framework for Issuance of Financial Services. announced. A fiat-backed stablecoin, or what CP7 calls a “Fiat Reference Token” (FRT).
The proposed FSRA regulations come at a time when major players in the stablecoin industry are showing strong interest in the UAE. The purpose of this briefing note is to provide an overview of FSRA’s proposed rules and address some important questions commonly raised by prospective issuers.
What is FRT? How is it different from stablecoins and virtual assets?
The proposed new rules only target certain types of stablecoins that are backed by fiat currencies or high-quality liquid assets. This means that while all FRTs may qualify as stablecoins, not all stablecoins are FRTs. The proposed rules would not apply to stablecoins that are not backed by fiat currencies or high-quality liquid assets. Additionally, stablecoins that are algorithmic in nature remain explicitly prohibited.
Although FRTs and virtual assets share fundamental similarities (in that they are backed by blockchain technology), the main difference is that FRTs require surrender of a certain amount of fiat currency or other assets. It is redeemable at the request of some issuer. value. In contrast, the value of virtual assets is generally speculative and the owner does not have the right of redemption. The ability to redeem FRT in a “timely and efficient manner” is a key concern for FSRA.
With the above in mind, FSRA has proposed the following definition of FRT:
“Digital assets that are transferred and stored electronically using distributed ledger technology, such as:
Used as a medium of exchange. By referencing a fixed amount of money in a single fiat currency, it provides a stable store of value. The holder will then be able to redeem the FRT on demand in exchange for fiat currency in the amount referred to in (b) from the issuer. ”
Is issuing an FRT a new regulated activity?
FSRA is considering treating FRT issuance as a new, separate regulated activity or retaining it as part of the expanded ‘providing money services’ regulated activity.
Please note that the proposed minimum capital requirement is the higher of US$2 million or the issuer’s annual audited expenditures.
Finally, note the following:
FRT issuers are also required to publish a white paper disclosing all relevant details of the FRT, including redemption and accumulated assets. The proposed application fee and annual supervision fee will be $70,000.
How much capital must an FRT issuer hold?
FSRA proposes that FRT issuers maintain minimum capital resources of US$2 million or the issuer’s “annual audited expenditures” (minimum component of CET1 US$2 million), whichever is higher. Masu. This is a welcome development that does not follow other jurisdictions that impose variable capital requirements based on the circulating nominal FRT.
What are the acceptable classes of reserve assets?
FSRA proposes that the FRT be backed by “reserve assets” consisting of investments consisting of cash and high-quality liquid assets in the same currency as the FRT. The types of investments are limited to:
Cash equivalents and debt securities with remaining maturities of three months or less issued by governments or central banks, and organizations, both government agencies and international organizations, with a minimum long-term credit rating of AA or equivalent. A reverse repurchase agreement that overcollateralizes bonds issued by a government or central bank on an overnight basis, with a counterparty that is not affiliated with the issuer and has a credit rating equal to or higher than the credit rating specified by the FSRA. Public money market funds that invest in government debt (subject to limits agreed to by FSRA on the amount of investments held in such funds and credit ratings). and other means approved by FSRA.
Issuers are also required to submit allocation limits for various classes of reserve assets to FSRA for approval. FSRA proposes that the minimum percentage of cash to total FRT outstanding should take into account recent and anticipated levels of redemption requests.
For completeness, FRT issuers are also required to publish independent monthly valuations of their reserve assets.
How are accumulated assets stored?
FSRA suggests that reserve assets be kept segregated from third-party custodians at all times to ensure remoteness of bankruptcy. This means that issuers proposing to issue more than one type of FRT will need to maintain a separate pool of reserved assets for each FRT.
Is FRT with yield considerations allowed?
FSRA has chosen not to prohibit FRTs from accruing and distributing income derived from reserve assets.
However, FSRA proposes to prohibit the promotion of FRTs as investment or savings products to reduce the risks of:
Issuers compete based on the yields generated by FRTs by investing in riskier reserve assets. FRT is seen by consumers as a risk-free alternative to interest-bearing bank deposits.
Additionally, FRT issuers disclose in their whitepaper that (in addition to redemption terms such as fees) the FRT generates income only in the event that the value of the reserve assets exceeds the par value of the FRT in circulation, and not in the event of default. Must be. ).
Incidentally, the reason CP7 requires FRTs to be backed by high-quality liquid assets with minimal market, credit, and concentration risk is because FRT issuers compete to offer higher yields to holders. It states that this is to prevent
Can issuers continue with activities other than FRT issuance?
To protect FRT issuers from risks that could impair redemptions, the FSRA not only prohibits issuers from conducting other regulated activities concurrently with the issuance (and redemption) of FRTs, but also prohibits issuers from engaging in other regulated activities. It also proposes to prohibit holding ownership of any business entity.
that this prohibition does not prevent members of the same group as an FRT issuer from carrying out regulated activities, particularly given that the FRT issuer is prohibited from holding shares in other group members; Please note.
Can other ADGM entities accept and use FRT?
Similar to existing approved virtual asset regimes, only FRTs that the FSRA deems to be “approved fiat reference tokens” will be covered under ADGM. But now, FSRA is proposing to publish a list of which FRTs it considers as such.
Finally, please note that the requirements set out in Chapter 17 of the COBS Rulebook (anti-money laundering, transaction monitoring, IT risk and travel rule requirements) apply to FRTs.
