Digital Tokens and Customer Protections – Stablecoins (Part 2)

I.   Introduction

In our previous article, we focused on regulatory developments in Singapore specific to “cryptocurrencies” — under Singapore law, generally “digital payment tokens” (“DPT”) —including recent proposals relating to customer protection requirements and the integrity of the DPT market.

In this article, we delve deeper into the proposals by the Monetary Authority of Singapore (“MAS”) on the stablecoin regulatory framework in Singapore, and the operation of the Financial Services and Markets Act 2022 (“FSMA”).

II.   The Current State of Play

In Singapore, the term “stablecoin” is not a term of art. On the other hand, terms such as “e-money” and “DPT” are defined in the Payment Services Act 2019 (“PS Act”). Carrying on regulated “payment services” in respect of “e-money”, “DPT” or both, may require an entity to obtain a licence from MAS, unless exempted or excluded.

In the context of the PS Act, “e-money” and “DPT” are, at least prima facie, defined so as not to intersect. One of the limbs of the definition of “e-money” under the PS Act is that it is “denominated in any currency, or pegged by its issuer to any currency”. Conventional examples of “e-money” are balances held in e-wallets or other types of stored value facilities.

By contrast, a limb of the definition of “DPT” under the PS Act is that it is “not denominated in any currency, and is not pegged by its issuer to any currency”. Examples of DPT include Bitcoin and Ethereum, the values of which fluctuate according to market mechanisms.

“Stablecoins” do not fit squarely in either category. On the one hand, they appear to be (or their issuers purport to have them) pegged or denominated in one or more fiat currencies. On the other hand, they are commonly issued on distributed ledger technology, much in the same way as other types of “DPTs” the values of which do fluctuate according to market mechanisms (and are thus not “pegged” or “denominated” in fiat currency).

Indeed, in an early consultation paper published in December 2019, MAS had noted that: “By exhibiting characteristics typically associated with money, stablecoins may be blurring the line between our e-money and DPT regimes”.

Since the publication of this consultation paper in December 2019, the fundamental concepts and use-cases associated with stablecoins as a type of digital token have become clearer. In its Frequently Asked Questions on the Payment Services Act updated as at 7 March 2022, MAS had stated that it “expects that in general, stablecoins, including SCS, will not meet the definition of “e-money”. Stablecoins may meet the definition of “digital payment token”. [...] USD Coin and Tether are examples of SCS which, based on their characteristics today, are considered DPTs. Entities which provide DPT services will be regulated accordingly under the PS Act”.

It is now more broadly recognised that stablecoins, where they are well-regulated for the purposes of maintaining value stability, can act as a trusted medium of exchange, whether for the payment of goods and services or otherwise, and by so doing support innovative use-cases in the context of blockchain technology. An entity which conducts a regulated “DPT service” in relation to SCS may therefore require a licence under the PS Act whether now or in the future (depending on the precise “DPT service” triggered), as discussed in Part 1 of this article, unless exempted or excluded under the PS Act.

III.   The Proposed Stablecoin Framework

1.      Scope of Framework

It is against this backdrop that MAS published a Consultation Paper on Proposed Regulatory Approach for Stablecoin-Related Activities dated 26 October 2022, which set out MAS’ proposals to support the development of stablecoins as a credible medium of exchange in the digital asset ecosystem (the “Stablecoin Consultation Paper”). The consultation closed on 21 December 2022; and on 15 August 2023, MAS published its Response to Public Consultation on Proposed Regulatory Approach for Stablecoin-Related Activities (the “Stablecoin Consultation Response”).

Set out below is a summary of the key aspects of the proposed stablecoin framework arising out of the Stablecoin Consultation Response.

Regulation of SCS Issuers

Under the proposed framework, an entity is required to hold a major payment institution licence under the PS Act for undertaking a “stablecoin issuance service” where — (a) the SCS is issued in Singapore; (b) the SCS is pegged to the Singapore dollar or any currency of the Group of Ten; and (c) the value of SCS in circulation exceeds S$5 million. MAS has indicated that the term “stablecoin issuance service” will cover activities necessarily undertaken by a stablecoin issuer, such as custody of that issued SCS and management of reserve assets backing that issued SCS (para 2.7 of the Stablecoin Consultation Response).

To be clear, a non-bank SCS issuer which does not fall within this criteria, would not need to a hold an MPIL for providing a “stablecoin issuance service”. Having said that, such issuers may be required to obtain a licence for other types of “payment services” (including “DPT services”) to the extent their business involving the stablecoin in Singapore falls within the scope of these other “payment services”.

Separately, in relation to SCS issuers that are banks, MAS’ initial Stablecoin Consultation Paper had proposed that (a) for banks issuing SCS as tokenised liabilities, additional reserve backing and prudential requirements not be imposed, but other requirements (e.g. timely redemption at par and disclosure) may still apply; and (b) for banks issuing reserve-backed SCS, this be subject to the same regulatory regime as non-bank SCS issuers, except for prudential requirements.

Industry feedback to MAS’ initial proposal pointed out, inter alia, the differences in value-stabilising mechanisms used for — and concomitantly, the risks posed by — fully reserve asset-backed stablecoins as opposed to tokenised bank liabilities.

Pursuant to consideration of this feedback, MAS confirmed in its Stablecoin Consultation Response that it would exclude tokenised bank liabilities from the scope of the SCS framework. MAS did note that it reserved the discretion to impose additional requirements on such tokenised liabilities in the future, as well as the discretion to consider other types of tokens as stablecoins under the SCS framework, taking into account the design of such tokens.

The key proposed issuer requirements relate to value stability, audit and segregation of reserves and timely redemption at par value, disclosures in the form of a white paper containing prescribed information (including redemption rights), and prudential standards, details of which may be found in the Stablecoin Consultation Response and the infographic released therewith. Among these requirements, we highlight the following key observations:

(i)   MAS has stated that, under the proposed framework, it will not allow multi-jurisdictional issuance at the onset and will require SCS issuers to   issue solely out of Singapore, given (a) the difficulty in establishing regulatory equivalence and cooperation with other jurisdiction at this nascent state of global stablecoin regulation; and (b) practical difficulties with tracing SCS’ issuance origin and its implications on monitoring and establishing the adequacy and availability of foreign reserve assets.

(ii)   MAS confirmed that it would implement “labelling” requirements in relation to “MAS-regulated SCS” versus non-MAS regulated SCS, in order to help customers make informed decisions on the risks involved in using unregulated stablecoins.

(iii)   Another key aspect of MAS’ response is the emphasis placed on SCS issuers not exposing themselves to risks beyond the primary activity of “stablecoin issuance services” (and ancillary custody or transmission activities), including (a) investing in/lending to other companies (including holding a stake in other companies); (b) lending or staking activities in relation to SCS and/or other DPTs; (c) DPT trading activity.

Regulation of SCS Intermediaries

Separately from the regulatory regime as it relates to SCS issuers, the Stablecoin Consultation Response also sets out MAS’ final proposals in relation to SCS intermediaries; that is, entities which do not act as the issuer of a given SCS.

Such entities, should they conduct a regulated “DPT service” in relation to SCS, would require a licence under the PS Act whether now or in the future (depending on the precise “DPT service” triggered), as discussed in Part 1 of this article, unless excluded or exempt from the PS Act.

In this regard, MAS’ proposals highlight that such SCS intermediaries would be subject to requirements relating to: (a) timely transfer of SCS (i.e. within 3 business days from payer to payee); and (b) segregation of customers’ SCS in line with MAS’ recent proposals applicable to customer assets (including DPTs) (see Part 1 of this article).

2.      Under the Financial Services and Markets Act

The FSMA has been passed in Parliament and has come into force in part. Under section 137 of the FSMA (which has not yet come into force), a person would be regulated for providing a “digital token” or “DT” service in Singapore where such person (a) is an individual or partnership, has a place of business in Singapore and carries on a business providing DT services outside of Singapore; or (b) is a Singapore-incorporated corporation and carries on a business, whether from Singapore or elsewhere, of providing DT services outside of Singapore.

A “DT” is defined in the FSMA to include (a) DPTs; and (b) digital representations of “capital markets products” (e.g. shares, debentures, securities-based derivatives contracts, units in funds).

The scope of “DT services” under the FSMA comprises services largely similar to those comprising “DPT services” under the PS Act once the Payment Services (Amendment) Act 2021 comes into force; namely — (a) dealing in DTs; (b) facilitating the exchange of DTs; (c) transmission of DTs; (d) providing DT custody services; and (e) inducing or attempting to induce the buying and selling of DTs.

Where a person has a place of business in Singapore or is a Singapore-incorporated corporation, and provides “DT services” outside of Singapore, this would be regulated once the relevant Parts (including section 137) of the FSMA come into force.

IV.   Concluding Remarks

In relation to the proposed stablecoin framework, as the payment use cases in relation to SCS are in some respects more expansive than those of more volatile cryptocurrencies, it can be seen from MAS’ proposals — particularly those in relation to ensuring value stability, reserve requirements and prudential standards — that the requirements sought to be imposed on SCS issuers in Singapore are geared strongly toward the protection of retail customers who may grow to hold a not insubstantial amount of their assets in such SCS, alongside other macro-economic policy objectives related to promoting the stability of Singapore’s financial system in general.

In relation to the commencement of the FSMA, the manner in which the operative section is scoped underscores the policy of preventing bad actors from operating in a regulatory “twilight zone” — by incorporating shell companies in Singapore, while situating the substantive operations of that entity entirely outside of Singapore — in an attempt to circumvent regulatory requirements both in Singapore and their jurisdiction of operation.

 

AUTHOR INFORMATION

Adrian Ang is a Partner and Co-Head of Allen & Gledhill’s FinTech Practice, and also Co-Head of the Public Policy Practice.
Email: adrian.ang@allenandgledhill.com

Alexander Fong is an Associate in the FinTech Practice and Financial Regulatory Practice at Allen & Gledhill.
Email: alexander.fong@allenandgledhill.com