Abu Dhabi's Regulatory Framework for Fiat-Referenced Tokens

In light of the increasing significance of stablecoins and their potential effects on financial systems and consumers, the Financial Services Regulatory Authority (FSRA) has unveiled a detailed regulatory proposal for stablecoin issuers within the Abu Dhabi Global Market (ADGM), Abu Dhabi's International Financial Centre.

This article aims to provide a comprehensive analysis of the FSRA's proposal, highlighting key regulatory requirements and drawing parallels with similar frameworks in other major financial hubs like the EU, UK, and Hong Kong. 

Understanding the Regulatory Landscape for Stablecoins in Abu Dhabi

Abu Dhabi Global Market (ADGM) was one of the pioneers globally in establishing a comprehensive regulatory framework for crypto assets. This early work, which dates back to 2018, marked a significant milestone in the global financial landscape, as it was among the first instances where a financial center provided clear and detailed regulations specifically tailored to the emerging sector of crypto assets. 

Since the launch of its original crypto-assets framework in 2018, the Financial Services Regulatory Authority (FSRA) of the ADGM has continuously evolved its approach to regulating virtual assets. However, until now, the issuance of fiat-referenced tokens (FRTs) has not been specifically addressed in their regulations. 

On August 20, 2024, the FSRA released a consultation paper outlining a new regulatory framework specifically designed for FRTs issued within the ADGM. This new framework is designed to align with best practices in leading jurisdictions, including regulatory approaches from New York, the European Union, Singapore, the UK, and Hong Kong. The goal is to create a robust and effective regulatory environment for FRTs within the ADGM.

Defining the Scope of Fiat-Referenced Tokens in ADGM's Framework

Similar to approaches taken in Hong Kong and the UK, the FSRA plans to prioritize regulation of fiat-backed stablecoins in the initial phase. 

The proposed framework focuses exclusively on fiat-referenced tokens (FRTs), a specific type of stablecoin, and the primary focus on regulating these assets stems from their potential to gain widespread acceptance as a means of payment, posing more immediate risks to monetary and financial stability compared to other stablecoins. This perspective is supported by BIS 2024 insights, which highlight that certain stablecoins, particularly those pegged to fiat currencies, have a higher likelihood of being used as a means of payment. 

Based on the Consultation Paper, FRTs are defined as digital assets that:

• Serve as a medium of exchange.
• Maintain a stable value by referencing a fixed amount of a single fiat currency.
• Allow holders to redeem the token for its fiat value from the issuer upon demand.

To ensure transparency and compliance, the FSRA proposes to publish a list of accepted FRTs. This list would include FRTs issued by licensed entities within the ADGM. Firms wishing to use FRTs not on this list would need to apply for their inclusion.

Excluded Stablecoins: What’s Outside ADGM’s Regulatory Scope?

This proposed ADGM framework does not address (1) asset-referenced tokens or (2) commodity-backed tokens, which are excluded due to the inherent value fluctuations of their underlying assets. However, the FSRA may consider regulations for these types of tokens in the future. In contrast, the EU’s Markets in Crypto-Assets Regulation (MiCAR) adopts a broader approach, encompassing a wider range of stablecoins, including those backed by commodities or other crypto assets.

The FSRA proposal also omits coverage of stablecoins that are pegged to a basket of currencies, which the EU’s Markets in Crypto-Assets Regulation (MiCAR) categorizes as Asset-Referenced Tokens (ARTs). These types of stablecoins are similarly included in the regulatory frameworks proposed by both Hong Kong and the UK. While the FSRA focuses specifically on stablecoins backed by a single fiat currency, this approach contrasts with the regulatory strategies in the EU, Hong Kong, and the UK, where stablecoins linked to multiple currencies are also subject to regulation.

Why ADGM Prohibits Algorithmic Stablecoins

Given the challenges in maintaining stability without backing assets, the FSRA in Abu Dhabi has decided to prohibit algorithmic stablecoins within the ADGM. These stablecoins derive their value from algorithms or arbitrage mechanisms, which the FSRA believes are too unstable to be permitted. This approach is consistent with the recent updates to the Bahamas' DARE 2024, which prohibit the issuance of stablecoins that attempt to maintain a stable value through protocols that adjust supply in response to demand fluctuations.

In contrast, Hong Kong's recent proposal treats all FRS issuers equally, regardless of the stabilization mechanism or underlying backing assets. This means that issuers of FRS that rely on arbitrage or algorithmic mechanisms will still fall under the regulatory framework. However, it is highly unlikely that such issuers will meet the stringent licensing criteria, particularly in areas like reserves management, making it difficult for them to obtain a license. Similarly, the EU's MiCAR applies to both E-Money Tokens (EMTs) and Asset-Referenced Tokens (ARTs), irrespective of the design or stabilization mechanism used by the issuer. This includes algorithmic 'stablecoins' that aim to maintain a stable value relative to an official currency or a basket of assets through protocols that adjust supply in response to demand fluctuations. MiCAR's definition of EMTs does not differentiate between various methods of maintaining stability, meaning that EMTs can be either collateralized or rely on algorithmic mechanisms.

Issuance Regulations: How ADGM Governs Fiat-Referenced Tokens 

The FSRA proposes to categorize the issuance of FRTs as a distinct regulated activity, separate from the issuance of Stored Value under the existing Financial Services and Markets Regulations 2015 (FSMR). This classification ensures that FRT issuers are subject to specific conduct and prudential rules tailored to the unique characteristics of FRTs.

Key Regulatory Requirements for Fiat-Referenced Tokens in ADGM

Most of the regulatory requirements outlined in the consultation align with global standards and recent proposals established worldwide, with some nuances, such as the approach to interest-bearing stablecoins. 

Here are the key regulatory requirements:

Reserve Assets

Similarly to other jurisdictions, FRT issuers must ensure that the market value of their reserve assets is at least equal to the total value of all FRTs in circulation at the end of each business day. Reserve assets must be held in cash or high-quality liquid assets that can be quickly liquidated with minimal impact on their price. These assets include government debt securities, reverse repurchase agreements, and public money-market funds, all subject to stringent credit ratings.

Segregation

Similarly to other jurisdictions, to protect FRT holders, reserve assets must be segregated and held by one or more approved third-party custodians. If an issuer offers multiple FRTs, each must have its own separate pool of reserve assets, managed independently.

Granting Interest

Unlike other jurisdictions such as the EU, UK, and Hong Kong, which prohibit or plan to prohibit the distribution of income earned from reserve assets to stablecoin holders, the FSRA allows issuers to distribute such income to FRT holders. However, FRTs must not be marketed as investment or savings products. Any distribution of income must be clearly disclosed in the issuer’s white paper and marketing materials, with a clear emphasis that these payments are not guaranteed. This approach contrasts with the stricter regulations in other regions, reflecting a more flexible stance by the FSRA.

Redemption Rights

Similarly to other jurisdictions, FRT holders have the right to redeem their tokens at par value at any time. Issuers must process redemption requests within two business days (T+2). 

In extraordinary circumstances, such as market stress, the FSRA may allow issuers to extend this period to protect the value of the reserve assets. A similar approach has been proposed by the UK. In certain situations, external events may make it difficult for a regulated stablecoin issuer to continue processing redemptions. For instance, a run on the stablecoin or a de-pegging event caused by unforeseen external factors could occur. During such times, consumers would still retain a legal right to redeem their stablecoins from the issuer. However, the issuer would be granted additional time to fulfill the redemption request using the backing assets.

Capital Resources

The FSRA proposes that FRT issuers maintain minimum capital resources independent of reserve assets. This requirement would be the higher of $2 million or 12 months of annual audited expenditure, ensuring that issuers have sufficient financial stability.

White Paper

Similarly to other jurisdictions, issuers must provide clear, fair, and non-misleading disclosures about their FRTs in a white paper, which must be submitted to the FSRA at least 20 business days before issuance. This document must remain publicly available on the issuer’s website for as long as the FRT is in circulation.

Business Restrictions

To minimize risk, FRT issuers will be restricted from engaging in other regulated activities or holding ownership stakes in other entities. However, related entities, such as sister companies, may conduct these activities as long as the issuer does not have a stake in them.

AML Compliance 

Issuers in Abu Dhabi must comply with all applicable regulations and rules for licensed virtual assets service providers, including anti-money laundering and transaction monitoring requirements.

Conclusion

The FSRA's proposed regulatory framework for fiat-referenced tokens (FRTs) represents a a major step forward in aligning the Abu Dhabi Global Market (ADGM) with global best practices in stablecoin regulation and crypto asset compliance. By concentrating on critical areas such as reserve asset requirements, asset segregation, and redemption rights, the FSRA is working to establish a robust and secure environment for FRT issuers and holders. While the framework reflects international standards, it also incorporates unique provisions that demonstrate the FSRA's balanced and cautious approach, particularly in addressing the specific needs of the ADGM's financial ecosystem.

The public has until October 3, 2024, to submit comments on this proposal. After this period, the regulator will assess whether any modifications are necessary before finalizing the framework. Once this review is completed, the Board of the ADGM and the FSRA will proceed to enact the regulatory framework in its final form. While the exact details of the final rules are yet to be determined, this step aligns closely with the global regulatory trends of 2024, which have increasingly focused on the regulation of stablecoins. This initiative not only positions the ADGM at the forefront of crypto asset regulation but also contributes to the broader effort to ensure stability and trust in the crypto asset ecosystem.