3 February 2023
On 1 February 2023, HM Treasury unveiled its much awaited plans for the regulation of cryptoassets activities and confirmed its approach to cryptoasset financial promotions. In this article, we review the key aspects of the Treasury's announcements.
Almost a year after the then Chancellor, Rishi Sunak, declared his ambition for the UK to become a global hub for cryptoasset technology, HM Treasury has published a consultation paper exploring what the future regulatory regime for cryptoassets might look like. In its paper, it has recognised the pace of development and complexity of cryptoasset markets, with the technology bringing both risks (which the government wishes to manage) and opportunities. This necessitates "clear, effective, timely regulation and proactive engagement with industry", noting measures that have already been implemented such as bringing certain activities into scope of the UK's anti-money laundering regime, as well as those that are already in the pipeline, such as the regulation of certain stablecoins and the extension of the financial promotions regime to qualifying cryptoassets (also see below).
Policy objectives and design principles
The government thinks that cryptoassets and activities involving them should follow standards expected of similar financial services activities, and that having a suitable framework in place will stimulate growth and innovation. The Treasury's four overarching policy objectives are:
The Treasury has also reiterated the core design principles that it will be guided by, which have been set out in previous consultations:
How does this consultation fit into the cryptoasset regulatory roadmap?
Activities involving tokens which are specified investments (such as security tokens) are already covered by existing regulations made under FSMA. This consultation forms the first step in Phase 2 of the Treasury's broader cryptoasset regulation roadmap, with Phase 1 focusing on fiat-backed stablecoins. Both phases are made possible by provisions in the Financial Services and Markets Bill 2022/23 (FSM Bill). For both phases, high-level requirements will be set out in secondary legislation, with detailed rules and guidance being made by the Financial Conduct Authority (FCA) following consultation. This approach is in line with the Future Regulatory Framework and supports the "agile and flexible" design principle.
Draft legislation for Phase 1 is expected to be laid in the first half of 2023, and will cover the issuance, and custody of fiat-backed stablecoins, as well as the use of such assets in payment services. Phase 2, which is the subject of this consultation, will focus on the issuance and custody of other cryptoassets, and the exchange and trading of both these assets and fiat-backed stablecoins.
Definition of cryptoassets
The consultation adopts the definition of cryptoasset which is proposed in the FSM Bill (and which is slightly different to the definition of a cryptoasset for AML purposes):
""cryptoasset” means any cryptographically secured digital representation of value or contractual rights that— (a) can be transferred, stored or traded electronically, and (b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology)."
However, it is expected that the future regulation of cryptoassets is applied to a more defined subset of cryptoasset depending on the matter being regulated. The consultation notes that it is an activity which will be regulated, rather than a particular cryptoasset. That said, the term "cryptoassets" may include tokens such as exchange tokens, utility tokens, security tokens, and stablecoins. The definition is also expected to extend to non-fungible tokens (NFTs) and "fan tokens"; however, the Treasury notes that the proposed regulatory framework is not intended to impose regulation on any underlying non-financial services activity which a cryptoasset might be used for.
The consultation sets out the government's views on activities involving certain types of "stablecoin". To the extent that a commodity-backed or crypto-backed stablecoin is not caught as an existing specified investment or financial instrument, activities involving it will be caught under the broader regime, along with those regarding algorithmic stablecoins (which avoid regulation in other jurisdictions).
Likewise, NFTs which are not covered by existing regulation may be brought within the regulatory perimeter, depending on the activities which are undertaken in relation to them.
What activities will be regulated and how?
The Treasury has provided an "illustrative" and non-exhaustive list of activities it proposes to bring within the regulatory perimeter in Phase 2 (subject to exemptions, which are yet to be determined):
|Issuance activities, including admitting a cryptoasset to a cryptoasset trading venue, and making a public offer of a cryptoasset||The government proposes a similar approach to the issuance of securities, under which the listing of a cryptoasset by a trading venue, and public offer of a cryptoasset will be regulated (in a way tailored to the specific attributes of cryptoassets). The creation of the cryptoasset will not be regulated. This means that there would be a general prohibition on offerings of cryptoassets, subject to certain exemptions, such as requiring a public offer of tokens to be made via a regulated platform. There will also be information and disclosure requirements, and provisions regarding liability for information. Trading venues and certain platforms will need to be authorised by the FCA.|
|Exchange activities, including operating a cryptoasset trading venue (or exchange)||The government proposes a framework based on the existing framework for regulated trading venues, including the operation of a multilateral trading facility. Such a regime will need to take into account specific risks (such as conflicts of interest as highlighted by recent events at FTX) and would mean that exchange providers would need to adhere to prudential and consumer protection rules. Exchange providers will need to be authorised by the FCA.|
|Investment and risk management activities, including dealing as principal or agent, arranging deals in cryptoassets, and making arrangements with a view to transactions in cryptoassets||This could include dealers and liquidity providers and other market intermediaries. The government proposes adapting requirements applying to "traditional" intermediaries for cryptoasset market activities. Such intermediaries will need to be authorised by the FCA.|
|Lending, borrowing and leverage activities such as operating a cryptoasset lending platform||Operating a cryptoasset lending platform will be regulated and persons carrying out that activity will need to be authorised by the FCA. The government proposes to adapt existing rules to apply to such persons, including requiring them to meet certain prudential requirements and to make certain disclosures to consumers, especially regarding the risks involved in lending cryptoassets.|
|Custody activities, such as safeguarding cryptoassets||In order to be caught, cryptoasset custodians will only need to safeguard cryptoassets (rather than safeguard and administer, which is the requirement for traditional finance). The government is proposing to base regulation on existing frameworks for traditional finance custodians, including the rules and guidance in the FCA's Client Assets Sourcebook. Core components will include having: (a) adequate arrangements to safeguard investors' rights to their cryptoassets, (b) adequate organisational arrangements to minimise risk of loss/diminution of custody assets, (c) accurate books and records of custody assets holdings, and (d) adequate controls and governance over safeguarding arrangements of custody assets holdings. Cryptoasset custodians will need to be authorised by the FCA.|
If an authorisation regime for cryptoasset businesses is implemented, businesses which have already been through the process of registering with the FCA for AML supervision will need to make a further application.
It is important to note that the territorial scope of the proposed regime will be wide as HM Treasury is proposing that activities provided to the UK as well as those that are provided in the UK will be caught. This is in line with the approach taken in a number of other areas of financial services and means that the activities of cryptoasset businesses based overseas which provide services to UK customers may be brought within the regulatory perimeter. Whilst not particularly surprising, given the nature of cryptoasset activities and the ease of accessing services online, it is likely to reduce the number and range of services which are available to UK-based customers. The consultation suggests that reverse solicitation may be available; however "this would likely be defined in a way to prevent misuse and regulatory arbitrage."
Moreover, some cryptoasset businesses are likely to be required to have a physical presence in the UK in order to obtain authorisation. The consultation calls out "cryptoasset trading venues" (also known as exchanges) specifically for this treatment, although also notes that businesses established in jurisdictions with "equivalent" regimes may be able to provide services to UK customers without a specific UK authorisation.
The government recognises that the existing market abuse regime does not readily translate to cryptoasset markets, due to differences in how cryptoassets and securities are issued, and how information is maintained and exchanged. That said, the inherent transparency of a blockchain may have advantages for identifying market abuse practices (such as "pump and dump" schemes). The government has a set of what it says are sensible and realistic initial outcomes, including that market participants should have a shared understanding of what constitutes unfair and abusive practice, and their obligations to prevent, detect and take action against these practices. Abusive practices must be able to be sanctioned. Markets should be structured to prevent market abuse, and to make it easier to detect and take action against abuse when it does occur. Finally, there should be a proportionate regime, with an appropriate balance between the benefits to consumers arising from market integrity and the cost to market participants.
The government notes that, for market abuse, it does not consider "same risk, same regulatory outcome" to be achievable (at least, without international coordination on standards and cooperation).
The government has requested industry views on where the balance of responsibilities between the FCA and exchanges should lie, noting that its proposed model, based on the market abuse regime for traditional financial instruments, would put the primary responsibility for preventing, detecting and disrupting market abuse on trading venues, with the FCA supervising participants.
Calls for evidence
The consultation paper includes a number of calls for evidence, in areas where the government needs more information in order to make a proposal. Areas include:
The consultation proposes a regime for cryptoasset activities which draws heavily on existing regulation for traditional financial services activities and would bring a wide range of cryptoasset activities within the UK regulatory perimeter. The proposals, if implemented, would have a broad impact on cryptoasset businesses located in the UK and also those which are located overseas but which solicit business from UK customers. The consultation closes on 30 April 2023.
In July 2020, the government launched a consultation on a proposal to bring certain cryptoassets in scope of the Financial Promotion Order and on 18 January 2022 this course of action was confirmed in HM Treasury's consultation response. The move would mean that communications which are "invitations or inducements" to engage in certain controlled activities regarding qualifying cryptoassets and which are not exempt, will be prohibited unless: (i) the content of the communication is approved by a firm that is authorised by the FCA or the PRA, or (ii) the individual or business making the communication is authorised itself.
On 1 February 2023, HM Treasury has conceded in an updated Policy Statement that this would have unintended consequences, given that currently most cryptoasset businesses are not required to be authorised by the FCA. This mismatch would mean that the "pool" of businesses able to make their own financial promotions would be incredibly small, with most cryptoasset businesses needing to have promotions approved by an authorised person (and willing and able authorised persons being far and few between). This effectively would amount to a ban on financial promotions regarding qualifying cryptoassets, which was not the intended outcome.
The government has therefore decided to introduce a limited and temporary exemption to the restriction on communicating a financial promotion, meaning that cryptoasset businesses which are registered with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the MLRs) will be able to communicate their own promotions (but will not be able to approve those of non-registered businesses). Such businesses will need to meet the FCA's requirements as regards systems and controls for the approval of financial promotions. The exemption will be reviewed alongside the consultation on the future regulatory approach to cryptoassets set out above.
The statutory instrument giving effect to the planned extension of the financial promotions regime will be introduced as parliamentary time allows. The government has decided to reduce the implementation period from 6 months to 4 months, given "recent volatility in cryptoasset markets, and the risks presented to consumers".
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by Charlotte Hill and Daniel Hirschfield
by Charlotte Hill and Daniel Hirschfield