Back in April 2022, the then Chancellor of the Exchequer (and now Prime Minister) Rishi Sunak announced intentions to “make the UK a global hub for cryptoassets technology.”

On the 1st February 2023, HM Treasury published the Future Financial Services regulatory regime for cryptoassets consultation paper which sets out the proposals for this future regime and gives a strong indication of what the industry can expect by way of the UK regulatory landscape in the future.

The consultation is a fairly lengthy and in-depth paper, which can be found here [link]. In this article, we will be distilling the most important points from the consultation paper and summarising the key takeaways.

Cryptoassets as specified investments

In contrast with the EU’s approach with the Markets in Crypto-Assets regulations (MiCA), the UK’s proposes to bring cryptoassets within the scope of existing legislation instead of a bespoke approach.

One of the ways in which this is proposed to be achieved is by including cryptoassets within the list of specified investments under the Financial Services and Markets Act (Regulated Activities) Order 2001 (RAO).

This sets the foundation for most of the other proposals in the paper, by bringing the financial services regulation of cryptoassets within the already established Financial Services and Markets Act 2000 (FSMA) framework.

Cryptoassets activities

The proposal to designate cryptoassets as a specified investment means that it will be the activities in relation to cryptoassets that will be regulated as opposed to the tokens themselves. As well as existing regulated activities being applicable in relation to cryptoassets, there are also additional proposed activities specific to cryptoassets which will fall within the scope of being regulated, including:

  • Safeguarding and/or administration (custody) activities;
  • Issuance, payment and exchange activities;
  • Investment and risk management activities;
  • Lending, borrowing and leverage activities;
  • Validation and governance activities.

As such, carrying out these activities involving cryptoassets by way of business would be a regulated activity and would therefore require authorisation under part 4A of FSMA.

Notably, the proposals indicate regulatory permissions will not automatically be granted for firms which are already authorised, and authorised firms which intend to undertake newly in-scope activities would likely need to apply for variation to their authorisation.

Custodians

The consultation proposes a cryptoassets custody regime which would be similar to that seen in TradFi, with an overall aim to protect investors’ assets such that if and when the custodian becomes insolvent, those assets are returned to investors promptly without causing significant harm to consumers and market participants.

There is no current regime for cryptoassets custody in the UK, and so the proposal is clearly aiming at introducing a clear regulatory framework to ensure cryptoassets custodians are safeguarding assets adequately and mitigating the risk of loss.

Cryptoasset Trading Venue

Proposals relating to cryptoasset trading venues (exchanges) appear to be placing particular importance on consumer protection, operational resilience, and data reporting requirements (no doubt inspired in part by the events of 2022) for those operating a cryptoassets trading venue.

As mentioned above, authorisation will be required as operating a cryptoassets trading venue will be a regulated activity.

It is also proposed that cryptoassets trading venues be subject to prudential requirements to hold certain amounts of financial resources in order to conduct business and ensure the ability to wind down in an orderly manner, with thresholds set by the FCA.

Given the integral role that exchanges play in the crypto ecosystem, by their nature they often conduct many more activities than solely operating a trading venue. For example, custodial services, issuance, lending etc.

The proposals state that the government would expect that such entities follow the rules governing all of the activities in which they are involved in, not just those relevant for operating a trading venue.

For example, a cryptoassets exchange akin to Binance, in addition to complying with the rules for operating a trading venue, would also likely be required to comply with:

  • Issuance and disclosure rules for assets they admit for trading;
  • Rules relating to surveillance and reporting requirements to detect and prevent market abuse;
  • Rules for market intermediaries;
  • Cryptoasset custody rules;
  • Cryptoasset lending platform rules.

The proposals appear to be aiming at enhancing consumer protection by preserving market integrity and ensuring customers assets are returned to them in case of a trading venue becoming insolvent.

The proposals also suggest that the FCA will set specific requirements in relation to data reporting for these entities. Given the size and structure of the cryptoassets markets, the government currently considers that regime requiring reporting requirements and regularity on par with those imposed on market participants in TradFi would not be proportionate, but would retain the ability to propose more regular and wider reporting over time.

Cryptoasset Lending platform

The consultation appears to put forward a proposals for a world-first regime for cryptoassets lending, with recognition that lending and borrowing makes up a significant amount of activity in the cryptoassets and DeFi market.

As it stands currently, cryptoassets lending and borrowing activities conducted by platforms tend to fall outside of the existing regulatory perimeter. Consequently, safeguards that are in place for TradFi are not available to users of similar services in the crypto space.

As mentioned above, operating a cryptoassets lending platform would be a regulated activity for which authorisation would be required. Cryptoassets lending platforms will be subject to prudential requirements to hold certain amounts of financial resources in order to conduct business and ensure the ability to wind down in an orderly manner, with thresholds set by the FCA.

In addition, the proposals envisage that lending platforms should have clear contractual terms on ownership as well as standards in conduct of business requirements, in addition to measures relating to ring fencing of funds in case of insolvency.

Financial Services Compensation Scheme

Whilst the consultation specifically states that it is not the intention of government for FSCS protection to apply to investor losses arising from cryptoassets exposure, it does propose, as a measure of consumer protection, that FSCS protection be available for claims against failed authorised cryptoassets custodians.

The practical application of this is still uncertain. The FSCS primarily exists to mitigate the effect of bank runs on fractional reserve banks, but if the proposed rules from the consultation take effect as envisaged, it appears likely that any entity offering crypto custodial services (by itself or combined with other services) would have to ensure the safety and segregation of users’ assets, making those funds always accessible thus negating the need for the FSCS.

Territorial scope

One of the main points is perhaps best summarised by referring to the illustrative representation in the consultation paper itself:

The main consideration in the proposal here is that if you offer services to UK consumers from abroad, then it is likely that will be caught within the scope.

So as well as capturing activities provided by UK firms to persons based in the UK or overseas, it will also apply to those activities provided by overseas firms to UK customers. This would bring an element of parity between firms operating in the UK and those operating off-shore but still seeking to serve UK customers.

Whilst this approach may be subject to exemptions, for example, to make allowance for ‘reverse solicitation’, it is likely that any such exemptions will be carefully carved so as to prevent misuse and regulatory arbitrage.

Cryptoasset issuance and disclosures

The proposals envisage that a cryptoassets issuance will occur when admitting, or seeking the admission of, a cryptoassets to a trading venue, or making a public offer of cryptoassets- including by way of an initial coin offering (ICO).

Whilst we will write about these proposals at length in a soon to come separate article, one of the main points from the proposals is the indication that for public offers of cryptoassets which are not security tokens, the government may consider an alternative route- such as the Designated Activities Regime (‘DAR’)- to prohibit such public offers unless they were conducted via a regulated platform.

Market Abuse Requirements

In TradFi, the UK has a market abuse regime (MAR) which defines and prohibits insider dealing, unlawful disclosure of inside information and market manipulation. The MAR places various duties on market participants to prevent, detect and report market abuse.

Given that ‘pump and dump’ schemes and other instances of market abuse have been endemic, and mostly unchecked, in the cryptoassets space to date, the proposals bring a welcome recognition to this issue.

The proposals appear to seek to being a cryptoassets MAR based on elements of the TradFi MAR, with an aim to protect consumers and preserve market integrity. The proposals include specific offences for insider dealing, unlawful disclosure of insider information, and market manipulation. The offences would apply regardless of where the trading takes place or where the person is based.

Some of the proposals include cryptoasset trading venues being required to establish systems and controls to prevent, detect and disrupt market abuse. Trading venues would also be required to investigate suspected abuse on their markets and to sanction individuals.

The consultation also recognises the inherent challenges presented by the borderless nature of the cryptoassets space and states that there should be a proportionate regime, with an appropriate balance between the benefits to consumers arising from market integrity versus the cost of obligations on market participants

In conclusion, the recent consultation publication by the HM Treasury is a significant step towards establishing a clear and comprehensive regulatory framework for the cryptoasset sector in the UK. The proposals aims to address the various challenges and issues faced by the industry, while ensuring the protection of consumers and the financial stability of the marketplace.

Many of the proposals have, thus far, received broad support from the crypto community and other stakeholders, whilst much remains to be seen as to how the proposals will be executed into firm regulations. As the consultation process moves forward, it will be interesting to see how the final framework will shape the future of the cryptoasset sector in the UK and beyond. Overall, this consultation and call for evidence marks a significant milestone in the development and maturity of the cryptoasset industry in the UK and sets a positive example on the world stage.

Share