UK consults on future financial services regulatory regime for crypto-assets
On 1 February, 2023, the UK Government published its long awaited Consultation Paper on the country’s proposals on the future financial services regulatory regime for crypto-assets. The Consultation, which comes on the back of an earlier exercise in April 2022 focused on stablecoins, is yet another sign that regulatory authorities are ramping up their frameworks on the back of increased scrutiny surrounding crypto-assets.
Approach, Principles and Objectives
The Government believes crypto-assets need to follow the standards expected of similar financial services activities, with a framework in place to give responsible actors regulatory certainty and confidence to participate, and give investors the confidence to invest in the UK.
This consultation focuses on the future UK regulatory framework for crypto-assets used within financial services and takes into consideration the initiatives and discussions from the HM Treasury, FCA, Bank of England, and international organizations such as the FSB, BIS, IOSCO, OECD, and FATF.
Importantly, the approach taken by the UK Government relies on bringing crypto-assets regulation within the already existing Financial Services and Markets Act 2000 (“FSMA”) as opposed to creating a bespoke regime, which is seen as going against creating a level playing field between financial assets and crypto-assets and potentially creating confusion. The Government’s intention is to expand the list of “specified investments” in Part III of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“RAO”) to include crypto-assets, which would mean that those providing certain types of activities involving crypto-assets would need Part 4A FSMA authorisation.
By seeking to establish a regulatory framework for crypto-assets in the UK, HM Treasury is pursuing four policy objectives using three principles:
A key point to note is the proposed approach from the Government to regulate activities rather than assets.
HMT intends to pursue a phased approach to regulating crypto-assets, which is prioritised according to the areas of greatest risk and opportunity.
- Phase 1 will focus on stablecoins and crypto-assets used for payments
- Phase 2 is then intended to introduce a regime to regulate broader crypto-asset activities, such as the trading of and investment in crypto-assets
Definition of crypto-assets
Crypto-assets are defined as digital representations of value or contractual rights that are secured with cryptography and can be transferred, stored, or traded electronically. The definition covers all types of crypto-assets, including those relying on Distributed Ledger Technology (“DLT”), and is purposely left broad enough to enable the framework to remain technologically agnostic.
The definition is also similar to the definition of crypto-assets used in the EU's Markets in Crypto-Assets legislation (“MICA”) and the FATF's recommendations.
Scope of crypto-assets and crypto-assets activities
Non-exhaustive list of crypto-assets
HM Treasury proposes to capture crypto-asset activities provided in or to the United Kingdom.
There may be exceptions and nuances for specific activities, such as "reverse solicitation". Whether firms must have a physical presence in the UK to obtain authorisation is still under consideration. The final decision will depend on the nature, scale, and risks of the activities.
Overview of the current regulatory landscape for crypto-assets
Certain types of crypto-assets may fall within the existing FSMA regulatory perimeter as "specified investments" and are already subject to regulation. These include security tokens which provide rights and obligations similar to shares or debt instruments. Other types of crypto-assets may fall under other financial services regulation, such as e-money or facilitating regulated payment services.
Security tokens are defined as crypto-assets which use a technology such as DLT to support the recording or storage of data and already meet the definition of a specified investment under the RAO and are therefore already subject to regulation. As described above Security Tokens, are a tokenised, digital version of traditional securities and so, unlike utility and exchange tokens, security tokens fall directly within the existing scope of the FCA.
In 2020, the FCA became the supervisory authority for crypto-asset exchange providers and custodian wallet providers in relation to Anti-Money Laundering (“AML”) and Counter-Terrorist Financing (“CTF”) obligations. Existing crypto-asset businesses were required to be registered and comply with the MLR by March 2022. When the broader crypto-asset regulatory regime becomes effective, firms undertaking regulated crypto-asset activities will be expected to adhere to the same financial crime standards as traditional financial services.
The FCA will have the power to write and amend rules in relation to financial crime and may update the financial crime rules to apply to new crypto-asset activities.
Firms conducting crypto-asset activities would also be subject to extensive regulatory requirements including:
- Senior management appointments
- Governance arrangements, including a compliance and risk function
- Financial crime requirements
- Regulatory capital requirements
- Operational resilience
- Conflicts management
- Conduct of business rules towards clients
- Obligations to monitor transactions, prevent market abuse and report suspicious transactions
- Detailed custody rules
- Redress in the event of loss to customers
- Data reporting
- Resolution and insolvency
- Enforcement liability for authorised firms and individuals
Proposed Regulatory outcomes
Crypto-asset Issuance and Disclosures Regime
Crypto-asset Issuance and Disclosures Regimes will follow a similar approach to the one used for securities and will apply regulation when the asset is admitted to trading on a regulated crypto-asset trading venue.
Operating a Crypto-asset Trading Venue
A regulatory framework will be established based on the existing RAO activities of regulated trading venues – including the operation of a Multilateral Trading Facility (“MTF”).
The requirements applying to analogous regulated activities – such as “arranging deals in investments” and “making arrangements with a view to transactions in investments” set out in article 25 of the RAO – will be used and adapted for crypto-asset market intermediation activities.
Existing frameworks will be adapted for traditional finance custodians under Article 40 of the RAO for crypto-asset custody activities. Existing custody provisions in the Client Assets Sourcebook (“CASS”) will be used as a basis to design bespoke custody requirements for crypto-assets.
Market abuse requirements
A crypto-assets market abuse regime will be established based on elements of the Market Abuse Regulation (“MAR”) for financial instruments. The offences relating to market abuse will apply to all persons committing market abuse on a crypto-asset that is requested to be admitted to trading on a UK trading venue. This will apply regardless of where the person is based or where the trading takes place.
Crypto-asset lending platforms
Existing RAO activities will be adapted and applied to crypto-asset lending platforms. The UK Government intends to include the financial services regulation of crypto-assets within the regulatory framework established by the UK’s Financial Services and Markets Act 2000 (“FSMA”). Bringing crypto firms within the regulatory perimeter of FSMA and amending the geographical scope to business conducted in or to the UK will enable authorities to operate a single register and a single authorisation process. Crypto firms already registered under the MLR regime will be required to also seek authorisation under the new FSMA-based regime.
Lending platforms will have:
- Adequate risk warnings for consumers lending to said platform
- Adequate financial resources, capital, liquidity and wind down arrangements
- Clear contractual terms on ownership
- If applicable, ringfencing of retail funds in case of insolvency
HMT has asked for respondents to submit their responses to the Consultation Paper by 30 April, 2023.
Furthermore, some questions are not covered and will be dealt with in Phase 3 and subsequent Phases. These include De-Fi, mining and staking, sustainability issues, post-trade activities in crypto-assets and advising on crypto-assets.
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