Regular readers of the TQ blog will have discerned the authors’ increasing exasperation at the UK’s piecemeal approach to cryptoasset regulation. The recent, inconsistent changes to the scopes of the anti-money laundering regime and the financial promotions regime and the previous approach of legislating only for fiat-backed stablecoins was creating a regime that was neither simple and light touch nor robust. The UK was trying to balance a pro-crypto stance with appropriate consumer protection and getting it all wrong.
This approach was already at odds with that taken by the UK’s closest neighbour, the EU, in its Markets in Cryptoassets Regulation (MiCA) but the position has been brought into particularly sharp focus with the widespread fall-out from FTX’s failure. The impact of FTX’s failure, particularly on its retail customers, has made it increasingly difficult to argue the case for light-touch regulation. HM Treasury now takes the view that mitigating the risks brought to light by FTX’s failure will require “a combination of robust prudential safeguards, operational risk controls, transparency and data reporting arrangements, measures to manage conflicts of interest, good governance and adequate record-keeping” – quite a change from the almost entirely unregulated regime applicable to much of the crypto-industry.
It is therefore somewhat to the authors’ relief to see the UK Treasury publish a consultation and call for evidence on the future regulatory regime for cryptoassets which proposes a more holistic approach to regulation in the sector.
Some in the UK have been called for the UK to copy MiCA but politically and philosophically that has never appeared likely. However, these proposals certainly go some way to regulating the industry more comprehensively. One of the ways in which the proposals differ is that MiCA will set out a new regime that covers all cryptoassets which are not currently in scope of regulation. The Treasury, on the other hand, proposes to use the existing, well-understood regime under the Financial Services and Markets Act (FSMA) by expanding the list of “specified investments” to cover “cryptoassets”. This will mean that persons carrying on certain activities by way of business in the UK (more on that concept later) would need to be authorised or exempt. This adaptation of the existing financial services regime will go some way to allaying concerns about an entirely new (and untested) regime. However, we are told that there may well be tailored rules depending on the type of cryptoassets made through the FCA’s rule-making powers. The devil will, as ever, be in the detail and that devil is currently in hibernation.
We also note that the Treasury mentions its other legislative options for regulating activities if it decides that the FSMA regime is not appropriate and particularly noted the “designated activities regime” (DAR) set out in the new Financial Services and Markets Bill (more on which is available here). The DAR permits activities related to financial markets to be made subject to rules which apply to unauthorised persons.
Maintaining the UK’s long held approach, financial services regulators will continue to regulate activities carried out in relation to particular types of asset, rather than the investments themselves. The activities which the Treasury has particularly focussed on in the consultation paper are in the following categories: issuance, payments, exchange/trading (that is, most other types of regulated activity) and custody.
The consultation sets out a phased approach to implementation of the regulation of activity relating to cryptoassets, which is prioritised according to the areas of greatest risk and opportunity identified by the Treasury. The first phase is financial promotions (on which, more below) and fiat-backed stablecoins, neither of which is the focus of this consultation paper. Phase 2 will look at a broader range of cryptoasset activity, with future phases to follow depending on the market’s evolution.
What is a “cryptoasset” for these purposes
As readers may recall, part of our concern with the UK’s multiple regimes was the lack of clarity as to scope - some unregulated cryptoassets could be “qualifying cryptoassets” for the purposes of the financial promotions regime, but not a “cryptoasset” for the purposes of the MLRs, and vice versa.
The Treasury’s current thinking as to what would constitute “cryptoassets” for the purposes of these proposals is very broad – the Treasury lists a number of different types of cryptoasset that could in the future be subject to financial services regulation when used for financial services activities. The cryptoassets listed in the paper range from exchange tokens (such as bitcoin and ether) to fan tokens (like those offered by certain sports teams), non-fungible tokens (NFTs) and governance tokens (used to vote on a network’s decisions). This would at least provide a consistent approach, although does provide the perhaps slightly counterintuitive result that operating a platform for trading sports tokens or NFTs would be a regulated activity.
Key thoughts from initial review
Whilst we, like you, are still working through the detail (some of which will undoubtedly be discussed over the consultation period and in future blog posts), we’ve set out some specific points that caught our attention.
- Issuance – the government proposes the establishment of an issuance and disclosures regime for cryptoassets which is based on the UK’s prospectus regime (post-reform) and the Treasury has proposed that for admission of cryptoassets to a UK cryptoasset trading venue, a similar model to the MTF model (e.g., regarding content requirements for admission and disclosure) would apply. On its own, this seems understandable, but looking into the detail, the Treasury proposes that where there is no issuer, the trading venue would be required to take on the responsibilities of the issuer if the venue wishes to admit the asset to trading. We query if this is an express policy decision, but it looks to us like this is a significant move against tokens without an issuer. The operator of a trading venue admitting bitcoin and ether, for example, would need to be responsible for disclosures (and for the admission documents) and we do not expect that many operators of trading venues would be willing to take this risk. With different venues admitting bitcoin and ether, there is also the likelihood of inconsistency.
- Territoriality – in stark contrast to the way in which many of the existing financial services activities are regulated, the Treasury proposes to capture cryptoasset activities provided in or to the United Kingdom – that is, where either (or both) of the service provider and the customer are located in the UK. The basic territoriality proposition at least has the benefit of being simple to understand, even if some readers may take issue with it, given the large number of cryptoasset businesses located outside the UK. There is reference to considering whether a physical UK establishment would be required, although the Treasury defers to the FCA and its existing framework for international firms. One example where Treasury indicates that a UK presence would likely be required is firms operating cryptoasset trading venues. We also note that the Treasury’s proposals are not necessarily as simple as they first appear. HMT leaves the door open to allowing exceptions to its territoriality rule and has indicated that it will consider certain exceptions – e.g., reverse solicitation - which has the potential to provide quite a grey area for firms to navigate.
- Financial promotions – although it was published separately, we noted the Treasury’s plans to introduce a bespoke exemption from the requirement for financial promotions relating to “qualifying cryptoassets” to be issued or approved by authorised persons. This exemption will enable registered cryptoasset businesses which are not otherwise authorised persons to communicate their own financial promotions in relation to qualifying cryptoassets. The exemption is intended to be temporary and the government will review its approach to the exemption alongside the future regulatory approach to cryptoassets. We expect that the industry will welcome this stop-gap solution, as many industry participants had thought (perhaps correctly) that it was likely to be difficult to find a third party authorised person who would feel comfortable approving cryptoasset financial promotions. However, the AML registration regime is not a substitute for being authorised (and the FCA takes a dim view of those firms that hold themselves out as such). Allowing MLR-registered businesses to benefit from an exemption, and giving the FCA powers to regulate the financial promotions of those cryptoasset businesses in a similar way as they regulate other financial promotions in the financial services market, blurs lines that were already hard to for retail customers to see.
It is not clear how many of the proposals will come into force. However, it is certain that we are at the start of a new chapter for cryptoasset regulation in the UK. For those of you who’ve read our fintech predictions for 2023, we promise we didn’t know this was coming but it’s gratifying to see one or two of our predictions come true so quickly! You can check out our other predictions here.
[B]oth retail and institutional participation in the sector continues to grow. On the retail side, most recent surveys show that 5-10% of UK adults now own cryptoassets, an increase of more than 100% over the past 1-2 years. Institutional participation has been limited but is growing. A number of large banks and other traditional financial services institutions with a material presence in the UK are undertaking crypto-related activities including execution, brokerage, market making, custody and tokenisation of traditional assets.