This is the third post in our series analysing the FCA’s proposed cryptoasset regime. Having covered the key policy decisions underpinning the proposals and the finalised Cryptoasset Regulations, we now turn to the FCA’s proposed conduct rules that would govern the day-to-day operations of certain cryptoasset firms. CP25/40 sets out the proposed conduct framework for firms undertaking various cryptoasset activities including those involving CATPs, intermediaries (i.e. firms dealing or arranging transactions in qualifying cryptoassets), lending, borrowing and staking. These activities were not covered in any detail as part of the FCA’s earlier consultation papers, which addressed stablecoin issuance and custody (CP25/14, discussed here) and the prudential regime for cryptoasset firms (CP25/15, covered here). Below, we assess the key proposals and explore what they mean for firms positioning themselves within the UK’s emerging cryptoasset perimeter.
CATP-specific rules
CATP operators would be subject to a holistic suite of authorisation, governance, market operation and consumer protection rules. Significant attention has also been devoted to how operators ought to manage conflict of interests where the same legal entity performs multiple roles. Several of the more significant changes contained in the FCA’s latest proposals will be relevant to CATP operators, including the following:
- CATP operators dealing as principal: the FCA has significantly relaxed its initial position on principal dealing for CATP operators. In its earlier discussion paper (DP25/1), the FCA had proposed prohibiting legal entities operating a UK CATP from carrying on such activities. Following industry feedback on that proposal, CATP operators would now be permitted to hold a principal dealer permission in the same legal entity, which could be used either to trade as matched principal dealer or to run a principal dealing desk for the firm’s own account (subject to functional separation and conflicts management). However, the FCA’s view is that UK CATPs should be risk-neutral trading systems, because credit risk exposure could undermine platform stability and operation, so the FCA proposes that activities which result in credit exposure (beyond that arising from settlement) must be separated legally. The FCA has clarified that firms holding permissions as a UK CATP operator and as a principal dealer may assume settlement risk arising from both types of activity. This development is an important one given the spectrum of activities that CATP operators often undertake in practice.
- CATP admitting tokens in which they have an interest: as a related point, the FCA has also decided not to proceed with its proposed prohibition on UK CATPs admitting tokens to trading in which they have an interest. Under the revised proposals, CATPs would be allowed to admit their own tokens if they comply with all relevant requirements (e.g. A&D, MARC, conflict of interest rules) which includes the disclosure of the inherent conflict of interest to users of the CATP. The FCA indicates that it would expect CATPs to mitigate the conflicts as far as possible through means other than legal separation – e.g., functional separation, such as independent committees (with members who do not have any financial interest in the token) to determine whether the token should be admitted to trading.
- Affiliates of CATPs providing leverage: the FCA is proposing to allow affiliated entities of a UK CATP operator to offer leverage, provided (i) no other rules restrict them from doing so, (ii) the affiliated entity has the appropriate permissions to do so and (iii) the affiliated entity complies with all applicable rules and associated prudential requirements. This approach would enable CATP operators to offer a wider range of services to consumers via affiliated entities.
- No prescriptive algorithmic trading rules: rather than introducing prescriptive rules for algorithmic and automated trading on CATPs (as previously contemplated), the FCA has responded to feedback on its proposed algorithmic trading rules in DP25/1 and now proposes a principles-based approach which would focus on disclosure, limits and monitoring. This should be well-received by those operators captured by the rules.
These are pragmatic shifts that should be welcomed by the many respondents who reacted negatively to the FCA’s initial plans.
Other notable developments
To briefly summarise other notable proposals in CP25/40, some of which are new while others have been retained and clarified:
- Pre- and post-trade transparency: CATP operators and intermediaries dealing as principal would only be subject to pre-trade transparency obligations if their revenue exceeds £10 million applying to the entire revenue of the relevant authorised entity. The CATP’s revenue would be calculated as their average annual revenue over a rolling three year period, including revenue from all activities and also revenue from predecessor entities. Where pre-trade transparency requirements apply, CATP operators and firms dealing as principal should make the prescribed information publicly available (e.g. on their websites). Post-trade transparency obligations would, by contrast, apply to all UK CATP operators and intermediaries dealing as principal, regardless of their revenue.
- Intermediary-specific rules: cryptoasset intermediaries which are authorised to carry on cryptoasset activities would also be subject to requirements such as customer disclosure, reporting, conflict of interest and conduct requirements. CP25/40 also sets out the FCA’s proposal for the best execution obligation to apply where a firm owes contractual or agency obligations to the client when executing orders – the FCA expects that best execution will be owed by default when a firm serves retail clients. Like for traditional finance, for retail clients, the focus to determine the best possible result is on total consideration (for a cryptoasset transaction, that will include the price of the cryptoasset and the costs involved in execution, such as gas fees). Where best execution obligations are imposed, intermediaries would be required to check at least three reliable price sources from UK-authorised execution venues (if available).
- Staking rules: firms that arrange qualifying cryptoasset staking will need to obtain a separate regulatory permission to carry on that activity. They would then be subject to a range of rules including (i) record keeping and information provision requirements, (ii) a requirement to obtain their clients’ express prior consent before staking their cryptoassets, (iii) prudential rules and (iv) safeguarding requirements. It is worth noting that the FCA has scrapped its original proposal that would have required regulated staking firms to compensate retail clients for any losses arising from preventable operational and technological failures. Although that change will be beneficial to service providers, it may make these services less attractive to consumers – despite the imposition of other requirements that aim to address related risks (e.g. safeguarding requirements). The proposed application of CASS safeguarding requirements to staking will be outlined in a future consultation paper.
- Lending and borrowing: consistent with earlier proposals, qualifying cryptoasset lending and borrowing activities will be in scope of the future regime. Service providers should be aware of the following points:
- Authorisation required: firms undertaking qualifying cryptoasset lending and borrowing activities will need to obtain permission for dealing in qualifying cryptoassets as principal and/or arranging deals in qualifying cryptoassets, depending on their business model.
- Retail customer restrictions: lending and borrowing may be permitted to retail customers following the strong negative responses the FCA received to the prospect of potential retail access restrictions. The consumer credit requirements in the FCA’s Handbook (CONC) would not apply to cryptoasset borrowing activities either. However, a number of bespoke requirements are proposed. For example, the FCA is consulting on prudential requirements set out in CP25/42 which would help mitigate liquidity and counterparty credit risks associated with L&B services. Service providers would be required to ensure that all cryptoasset borrowing is over-collateralised to address credit risk to the firm in the absence of affordability testing. As an extension of that approach, the FCA has also introduced a new “negative balance protection” requirement – the FCA is proposing that a firm's recourse against a retail customer is limited strictly to the collateral posted by the retail customer for the borrowing activity, protecting the customer’s other assets. Firms would also need to obtain a retail customer’s express consent prior to supplementing the collateral on their behalf and may only apply a maximum additional amount of 50% of the market value of the initial collateral.
- DeFi would remain outside the perimeter where it is "truly decentralised", although the ambiguity surrounding that concept remains unresolved (as explored in our recent blog post). Given that uncertainty, DeFi businesses will welcome the FCA’s confirmation of plans to consult in the future on indications of control/(de)centralisation. Those indications, once published, should help DeFi firms assess whether they are likely to fall within the regulatory perimeter.