Oliver Rees, Solicitor, and Roman Kubiak, Partner, from our Private Wealth team discuss the UK government’s consultation and call for evidence for regulation of cryptoassets.
HM Treasury has published its proposals for a new regulatory regime for cryptoassets in what is the next stage of the government’s project to regulate cryptoassets in the UK. By seeking to establish a regulatory framework for cryptoassets in the UK, HM Treasury is pursuing four overarching policy objectives:
1. Encourage growth, innovation and competition in the UK
2. Enable consumers to make well-informed decisions, with a clear understanding of the risks involved
3. Protect UK financial stability
4. Protect UK market integrity
The government intends to include the financial services regulation of cryptoassets within the regulatory framework established by the UK’s Financial Services and Markets Act 2000 (FSMA). The hope is to create equal opportunities for both traditional and emerging financial services where the same regulatory outcomes are applied.
The key proposals are discussed below.
Cryptoasset activities
HM Treasury has the power to specify activities within the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). Given the complex array of cryptoasset activities, a “one size fits all” approach to its regulation is unlikely to work. Different activities present different forms of risks. HM Treasury therefore intends to create a number of new regulated or designated activities tailored to the cryptoassets market, with the idea that they will mirror, or at least closely resemble, regulated activated performed in other, more traditional financial services.
For newly defined RAO activities, firms which are already FSMA-authorised and intend to undertake the activity will likely need to apply for a variation of their permission from the Financial Conduct Authority (FCA).
HM Treasury proposed to capture cryptoasset activities provided in or to the United Kingdom. This means that it should avoid the scenario whereby a firm moves offshore to try and evade UK regulations but still services UK customers, which would be the case if regulations only captured those activities provided in the United Kingdom.
Cryptoasset issuance and disclosures
The government proposes that cryptoasset issuance and disclosure should follow a similar approach to that seen in the securities markets. For example, in the UK, company shares are governed first by company law and financial services securities regulation is applied to transferable securities at the point at which they are offered to the public or admitted to trading on a regulated market. HM Treasury therefore does not intend to directly regulate the “creation” of unbacked cryptoassets under financial services regulation.
The government proposed to establish an issuance and disclosures regime for cryptoassets tailored to their specific needs, generally following the principles of the intended reform of the UK prospectus regime – the Public Offer and Admissions to Trading Regime.
Operating a cryptoassets trading venue
HM Treasury proposed to establish a regulatory framework based on existing RAO activities of regulated trading venues. Specific characteristics and risks of cryptoassets trading activities will need to be accommodated.
Cryptoasset intermediation activities
A number of risks have been identified from cryptoasset intermediation activities, from conflicts of interest to credit and liquidity risks. The government proposes to adopt the approach of article 25 of the RAO – involving “arranging deals in investments” and “making arrangements with a view to transactions in investments” being used and adapted for cryptoassets market intermediation activities.
The government does not consider that many major changes would need to be made to existing requirements for investment firms, though some additional rules or guidance may be needed to address those risks specific to cryptoassets market intermediation activities.
Cryptoasset custody
In financial services, custody broadly refers to a firm holding an asset on behalf of another. In the UK, this is already regulated for traditional finance. Currently there is no regime for cryptoasset custody in the UK. If a cryptoasset custodian was to fail today, the lack of a clear regulatory framework results in uncertainty that would likely cause harm by delay and cost to investors in obtaining their assets back. This may also mean that cryptoassets are not safeguarded correctly, which creates a risk of loss if the firm enters insolvency, something which has affected investors in FTX.
The government is proposing to apply and adapt existing frameworks for traditional finance custodians under Article 40 of the RAO for cryptoasset custody activities, making modifications where necessary to accommodate unique cryptoasset features. Again, the scope of this will be whether firms are incorporated in the UK or where services are being provided to the UK.
Market abuse requirements
The UK has a market abuse regime (MAR) for traditional financial services. The MAR places obligations on market participants to prevent and detect market abuse. While the technology and channels used to conduct market abuse may be different in cryptoasset markets compared to traditional markets, the types of activities and behaviours are similar.
Given the global and borderless nature of cryptoasset markets, this makes the cross-border challenge of identifying and controlling market abuse behaviour far more difficult than it would be in a more localised market. Despite this, HM Treasury believes there is a strong case for including a MAR in the proposed cryptoassets regulatory framework. A key consideration is the appropriate balance of responsibilities between the FCA and cryptoasset trading venues, something on which HM Treasury is keen to hear views from the industry.
The proposal is for a cryptoasset MAR based on elements of the MAR for financial instruments. The offences will apply against market abuse on cryptoassets requested to be admitted to trading on a UK trading venue, regardless of where the person is based or where the trading takes place.
Cryptoasset lending platform
Lending and borrowing make up a significant amount of activity in the cryptoasset market, which typically falls outside the current regulatory perimeter. HM Treasury believe there is a strong case for developing a cryptoasset lending and borrowing regime as a priority. Again, this would involve applying and adapting existing RAO activities, making modifications where necessary to accommodate those unique cryptoassets features.
Sustainability: A call for evidence
The mechanisms in place to facilitate cryptoassets can have a high environmental impact. The government has reiterated its commitment to making the UK a competitive location for sustainable finance. The government is therefore seeking further views from respondents as to what information about environmental impact customers should be aware of when making decisions about investing in cryptoassets.
Closing
HM Treasury intends to continue to pursue a phased approach to regulating cryptoassets, which is prioritised according to what it sees as the areas of greatest risk and opportunity. The proposals covered by this consultation represent the next step in a longer process. The consultation, which is open until 30 April 2023, poses a number of questions to respondents. Implementation of the new regulatory proposals will likely go ahead before the EU’s launch of cryptoassets legislation, expected to take place in 2024.
