The regulation of cryptoassets is a complex and evolving process with calls for everything from a complete ban to regulation in line with the rules governing gambling (on the grounds that bringing cryptoassets into the existing financial services regulatory regime could provide unwanted legitimacy).
HM Treasury has now published responses to its recent consultation on proposals for the financial services regime to apply to cryptoassets. The proposed changes could see cryptoassets added to the list of specified investments governed by the Financial Services and Markets Act 2000 (FSMA) (but not classified as financial instruments) rather than having their own bespoke regulatory regime.
The FSMA provides the legislative framework for the regulation of a wide range of financial services, including insurance, investment business, and banking, and is responsible for the creation of the Financial Conduct Authority (FCA) and Financial Ombudsman Service.
Level playing field
An overwhelming majority (94%) of consultation respondents agreed that cryptoassets should fall under the remit of the FSMA rather than having a separate regulatory regime. The governmental view is that this will create a more level playing field between cryptoassets and more traditional financial assets. If the proposal goes through, it will mean businesses that undertake relevant activities involving cryptoassets will have to be authorised by the FCA.
One of the areas where a significant amount of stakeholder feedback was received was around the definition of cryptoassets used in the consultation, which was widely felt to be too broad. The government response noted a need to make provision for new types of cryptoassets which may exist in the future but confirmed that assets such as security tokens, utility tokens and other data objects that are already regulated as specified investments will not be covered by the proposals.
On non-fungible tokens (NFTs), HMT confirmed that as these are comparable to digital collectables or artwork, financial services regulation is not appropriate.
Respondents also felt that more clarity is needed to define and distinguish cryptoassets and regulated stablecoins and queried whether exchanges which already have FCA Money Laundering Regulation (MLR) registration would need to do anything more. The Treasury confirmed that FCA authorisation for cryptoassets will be required even where an exchange firm is already MLR registered with the FCA. There are to be specific FCA asset admittance requirements to be fulfilled by crypto exchanges (trading venues) including the provision of detailed disclosure documents, a need to undertake due diligence on asset issuers and possible post-admittance ongoing disclosure requirements.
HMT noted that the recklessness/dishonesty and negligence standards incorporated into the FSMA should enable trading venues to manage their liability for any losses their investors may suffer as long as they make reasonable enquiries of their issuers, though a need for professional indemnity arrangements has not been ruled out.
The response document clearly sets out that the government is firmly against a complete ban on cryptoassets, which it feels would fail to address the risks associated with the industry, provide no guarantees consumers would be protected and also stifle innovation.
Likewise, the government discounted the idea of applying gambling rules to cryptoassets on the basis this would create unclear and overlapping mandates between the financial services regulator and the Gambling Commission.
Safe environment
The underlying principle outlined by the Treasury is that the government wants to create a safe environment for crypto and digital asset innovation to flourish in the UK.
With this in mind, the government acknowledges that a requirement for overseas trading venues to set up subsidiaries in the UK could result in unwanted fragmented liquidity in the cryptoasset markets and affect the UK’s ability to be competitive in the international crypto markets, though the final say on location requirements will be left to the FCA.
The government is implementing a phased introduction of the proposals with phase 1 dealing with fiat-backed stablecoins used for payment and phase 2 covering the broader cryptoasset regime. Secondary legislation relating to phase 1 is expected to be put to Parliament in early 2024, subject to available parliamentary time, whilst phase 2 seems unlikely to be introduced before 2025.
Comment
If a repeat of the FTX scandal where more than $8bn in customer assets went missing is to be avoided, some sort of regulation of the UK cryptoasset market is necessary.
The government’s reluctance to create a new bespoke regulatory system for cryptoassets ties in with its approach to the taxation of crypto, where it is also determined to try and make the existing capital gains and income tax rules apply despite these being designed for assets and investments that often share few of the characteristics of crypto. So far this has only served to create confusion for investors and advisers alike. It is to be hoped that the regulatory rules do not follow the same path or they will fall short of what is required.
Whilst the old adage about not reinventing the wheel could apply here, it remains to be seen whether a regulatory system designed for traditional investments within the centralised finance arena is appropriate for the ever-changing ecosystem that is decentralised finance.
