The global markets watchdog has urged the UK to regulate cryptocurrencies in the same way as traditional assets such as stocks and bonds, countering MPs’ calls last week for the risky investments to be treated as a form of gambling. Cryptocurrency activity is currently not regulated by the UK’s Financial Conduct Authority; however, digital asset service providers that operate within the country’s borders must go through the watchdog’s anti-money-laundering review process. Around 85 per cent of crypto groups that attempt to obtain FCA registration have failed, stirring criticism from the industry that the UK has stifled innovation. We are reminding all regulated firms of their existing obligations when they are interacting with or exposed to cryptoassets and related services. Crypto native firms that want to continue to sell their products and services to UK clients need to be prepared to become subject to financial services regulation and the supervision that comes with it. Expectations are that authorised firms have good governance, systems and controls around financial resources, operational resilience and conduct — and firms will need to evidence this in the authorisation process.
The FCA’s rules follow government legislation to bring crypto promotions into the regulator’s remit. Regulators are racing to draw up rules to manage cryptocurrencies amid concern that their growing popularity could threaten established financial systems. UK Financial Services Minister John Glen said the UK saw “enormous potential in crypto” and had a “detailed plan [for] harnessing the potential of blockchain and supporting the development of a world-best crypto ecosystem”. NFTs are assets in the digital world that can be bought and sold, but which have no tangible form of their own. They are exchanged via “peer-to-peer” transactions, meaning there are no banks or other third parties involved. The Treasury has not yet confirmed which stablecoins will be regulated; well-known ones include Tether and Binance USD.
This approach delivers on the original policy intention of the measure to promote innovation, enhance consumer protection and ensure that cryptoasset promotions can be held to equivalent standards as promotions of financial services products with similar risk profiles. Importantly, the custody of FBS issued outside the UK will not be captured — nor will self-custody activities. HMT intends to expand this activity to cover a broader set of cryptoassets in Phase 2, in order to avoid separate, overlapping regimes.
Given the ability of UK consumers to access cryptoassets services anywhere in the world, HMT is proposing to regulate cryptoasset activities provided in or to UK clients. Therefore, offshore firms providing activities to UK clients will need to become authorised in the UK. However, HMT is considering exceptions to this approach — e.g. allowing `reverse solicitation’ — i.e. if a UK customer accessed a particular cryptoasset service entirely at their own initiative. It is not clear how this would be enforced to prevent regulatory arbitrage, and `reverse solicitation’ is already a challenging concept within traditional financial services. HMT is also considering equivalence or deference arrangements with other jurisdictions that have equivalent standards.
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Where cryptoassets are specified investments (ie, security tokens), firms carrying out regulated activities involving custody of these assets are likely to be subject to the CASS regime. If firms have any questions about how the CASS rules may apply, they should speak to their relevant FCA supervisory contact. While cryptoassets and their underlying technologies can offer benefits to financial services firms e.g., reduce costs and increase efficiencies, they also present risks to market integrity and consumers, particularly when used as a speculative investment. This is additional to significant risks in relation to financial crime and money laundering. While there are currently no specific prudential treatments that explicitly mention cryptoassets, we remind FCA regulated firms that there are still regulatory obligations in this area. Firms subject to our new investment firm prudential regime (IFPR), have obligations (under MIFIDPRU 7) to assess and mitigate the potential for harm to clients, to the markets in which the firm operates and to itself, that could arise from all of their business.
- Overseas cryptoasset trading venues would likely require subsidiarisation in the UK — but HMT would like equivalence type arrangements with countries with similar regulatory frameworks.
- In addition, to address industry concerns about the small number of Financial Conduct Authority (FCA) authorised cryptoasset firms who can issue their own promotions, HM Treasury is also introducing a time limited exemption.
- Many e-money institutions also allow customers to purchase certain cryptoassets through their platforms.
- The time taken to verify and record a transaction using the DLT varies among cryptoassets.
The consultation also asks whether regulatory treatment should differentiate between lending (where title of the asset is transferred) vs staking or supplying liquidity (where title of the asset is not transferred). HMT also hopes to accommodate FBS not issued in or from the UK (‘overseas stablecoins’) for use in UK payments — more information below. Cryptoassets can also be traded through over-the-counter brokers, who facilitate direct trades between private individuals. This service is particularly vulnerable to abuse by criminals who take advantage of the reduced Anti-Money Laundering/Know Your Customer (AML/KYC) checks. The process of generating digital coins via banks of powerful computers, called mining, is also highly energy intensive.
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Also on the topic of FSCS protections, HMT states that it is not the Government’s intention for FSCS protections to apply to investor losses arising from cryptoasset exposures. However, it is the responsibility of the PRA and FCA as the UK’s independent financial regulators https://www.xcritical.in/ to set the limits of FSCS protection in respect of regulated activities. Overseas cryptoasset trading venues would likely require subsidiarisation in the UK — but HMT would like equivalence type arrangements with countries with similar regulatory frameworks.
Cryptoassets are borderless and can be transferred among users living in different countries at the same high speed. The international banking system does not exhibit this level of efficiency and varying jurisdictional rules and regulations may slow the process. We continue to develop our understanding of how cryptoasset technology affects custody arrangements. We will continue to monitor the use of cryptoassets in custody arrangements and act where appropriate, supporting responsible innovation, while protecting consumers and ensuring market integrity.
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Iosco also said global standards were crucial for avoiding regulatory arbitrage – a practice in which businesses take advantage of loopholes in different countries’ regulations. The Treasury also said on Tuesday that it would seek to strengthen cryptocurrency regulation in the UK rules surrounding companies that facilitate crypto transactions and safeguard customer assets. Notably, the expectations are wider than under the Money Laundering Regulations that some crypto native firms have already obtained FCA registration.
Sustainability — concerns continue around the energy consumption of mining some cryptoassets. Across the financial services sector, various sustainability-related reporting requirements are increasingly being applied to firms. But applying similar rules could be difficult as consumers interact in different ways with cryptoassets to traditional finance and there is no currently agreed upon set of indicators or metrics for measuring the impact of cryptoassets.
As is common in emerging technology markets, the crypto sector continues to experience high levels of volatility and a number of recent failures have exposed the structural vulnerability of some business models in the sector. In the case of firm failure (for issuers — as well as for custodians and payments providers), HMT proposes that standard corporate insolvency procedures under the Insolvency Act 1986 would apply. However, they will consider whether bespoke insolvency arrangements should be developed in due course. Prior to Onfido, he spent over 10 years as Head of Policy for UK and Ireland at Verizon, the US tech giant, overseeing policy across a range of areas including digital competition, cyber security and privacy. Matt holds a law degree (UEA), MBA (Henley Business School), post-graduate diploma in Competition Law (Kings College) and diploma in business international relations and the political economy (London School of Economics).
The new rules come into effect as research from the FCA shows that the estimated crypto ownership has more than doubled from 2021 to 2022, with 10% of the 2,000 people surveyed stating that they own crypto. As part of a package of measures designed to ensure those who buy crypto understand the risk, ‘refer a friend’ bonuses will also be banned. Sir Jon Cunliffe told the BBC that if the value of cryptocurrencies fell sharply, it could have a knock-on effect. “But we think that by making this country a hospitable place for crypto we can attract investment [and] generate swathes of new jobs.” Tether, a Hong Kong based company, has faced questions over its business practices and was fined $41m in 2021 by the US Commodities Futures Trading Commission for allegedly misstating its reserves.
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Therefore, for cryptoassets that already meet the definition of a specified investment (security tokens), the existing regulatory framework that currently applies will be replaced by the new custody regime. The PRA letter has clarified how these new activities will interact with traditional financial services. Most significantly, deposit-taking entities (regulated under Article 5 of the RAO — ‘Accepting Deposits’) will only be permitted to provide innovative forms of deposits to retail consumers — i.e. ‘tokenised deposits’ — that meet full eligibility for FSCS protection.
Next steps for UK stablecoin regulation
The Task Force has also explored possibilities for the regulation of stablecoins which are currently banned by the FCA. Post-trade activities in cryptoasset transactions — HMT is considering whether similar regulatory requirements for the clearing and settlement of traditional financial instruments (e.g. EMIR) need to apply to crypto assets. I am looking for information on the number of crypto companies which are regulated by the FCA. This can include firms which primarily carry out activities related to crypto trading, digital asset custody or financial services for crypto holders as well as firms which offer clients exposure to digital assets. In this package, the government defines FBS as “a cryptoasset that seeks or purports to maintain a stable value by reference to a fiat currency and by holding fiat currency, in whole or in part, as backing”. The definition specifically excludes crypto-backed stablecoins, commodity-linked tokens and e-money.
This applies whether or not that business consists of Markets in Financial Instruments Directive (MiFID) investment business, other regulated activity or is unregulated. It also applies irrespective of operating on an agency basis, principal basis, or in some other capacity. On Wednesday 1 February, HM Treasury published a consultation on the ‘Future Financial Services Regime for Cryptoassets’. The announcement comes fresh in the wake of the recent high-profile collapse of FTX in November 2022 — once valued by investors at over $25 billion, FTX is now valued at $0. The new proposals aim to enable crypto firms to innovate, while improving financial stability and consumer protections.
However, there are currently only 40 or so FCA-registered crypto providers — with Bitpanda, Gemini, and Kraken being the biggest brands. Many of the world’s largest exchanges and wallets are operating offshore, meaning they are not obliged to comply with the UK MLRs and perform comprehensive KYC/AML procedures. Keep abreast of significant corporate, financial and political developments around the world. Stay informed and spot emerging risks and opportunities with independent global reporting, expert commentary and analysis you can trust. As authorities around the world are grappling with how to regulate the crypto sector, firms are racing to register with financial watchdogs.
