The future of crypto regulation in the UK

James Alleyne was recently asked to talk to an international audience in London about the UK’s position on regulating the crypto-space. Here is what he said:

A recent survey estimated that 4.2 million people, approximately 6.2% of the UK population, currently own cryptocurrency with almost half having invested in the last year.

The proliferation of crypto assets and their increasing popularity places the FCA in a uniquely difficult position.

As a regulator the FCA has specific objectives, set out in law, of protecting consumers and upholding the integrity of the financial markets.  It has a range of supervisory and enforcement tools at its disposal to take action against firms, individuals and products that threaten these objectives in the traditional financial services space. However, when it comes to crypto assets and firms, the FCA has no power to act or regulate on a consumer protection basis. Its remit has hitherto been strictly limited to supervising crypto providers’ compliance with AML legislation only.

The conundrum for the FCA and lawmakers is how this should evolve, especially in light of ambitions in some Government quarters to make the UK a global crypto hub.

The story so far

The FCA became the anti-money laundering supervisor of UK crypto assets in January 2020 and its first main act was to impose a registration regime for firms involved in crypto business.

This required all existing UK crypto asset businesses (including those which exchange cryptoassets for FIAT or vice versa, operate ATMs or provide custodian services) to register with it – and be compliant with applicable AML legislation – by January 2021. To give the FCA the time to assess applications properly, it imposed a temporary registration regime that allowed firms who had registered to continue trading whilst their applications were being determined.

The FCA assessed just 38 of the 106 who applied as being compliant and a large number of applicants ultimately withdrew their applications. The digital bank Revolut was the final applicant to be processed, with approval being granted to it on 27 September 2022.

However it should be recognised that just because the FCA has approved a business, this does not mean it is poses no risk to consumers or is a fully compliant financial services operation. It simply means it has met the FCA’s requirements with regard to compliance with money laundering legislation.

Aside from AML, the FCA has taken steps this year to ban the marketing, distribution and sale of crypto derivatives (excluding security tokens) to retail clients. And it also brought UK registered crypto businesses into the scope of its change of control regime, meaning that any acquisition of more than 25% of shares or voting rights requires FCA approval.

However these steps still fall short of any wide-ranging regulatory net which strikes at the heart of a belt and braces consumer protection role.

The future of crypto-asset regulation

In early September, those surrounding our new Prime Minister Liz Truss confirmed that her Government wants the UK to be a “dominant global hub for crypto technologies” (see report here).

Richard Fuller, the Economic Secretary to the Treasury, said “We want to become the country of choice for those looking to create, innovate and build in the crypto space. By making this country a hospitable place for crypto technologies, we can attract investment, generate new jobs, benefit from tax revenues, create a wave of ground-breaking new products and services, and bridge the current position of UK financial services into a new era.”

Although there are signs the UK may seek to exploit post-Brexit opportunities to offer a lighter touch regulatory framework for financial services than exists the EU, we still await the detail so far as crypto is concerned. What we can say with a degree of certainty at this point is that the Government’s most recent focus in terms of enhancing supervision of crypto providers falls in two priority areas and so we can likely expect these will feature in the regulatory landscape in the near future - namely:

Financial Promotions:

We know the FCA is working with the Treasury and BoE to target financial promotions and advertising as a priority area. In January 2022 the Government announced its intention to bring crypto assets within the scope of financial promotion legislation. The likely impact of this will be that any promotion of crypto assets (excluding NFTs) will need to be carried out, or approved by, FCA regulated persons. This should hopefully provide a significant degree of consumer protection.

Stablecoins

The Financial Services and Markets Bill, published in July and now on its passage for Parliamentary approval, looks set to enable the BoE to regulate and supervise systemically important stable coin payment systems and related service providers to mitigate financial stability risk.

Significantly the same Bill contained extensive provisions aimed at providing a safe environment for the use of crypto assets and will give HM Treasury the power to establish an FCA authorisation and supervision regime for the use of crypto assets, although the timing of implementation of this is still unclear.

Issues to be resolved

We know from the FCA’s ‘crypto sprint’ event held in May 2022 that the following issues are on the table for UK policy maker and regulators in devising a suitable framework.

1. The level of disclosure to be provided to buyers of crypto assets for exchange traded products and where the obligations for this lies – exchange or issuer;
2. How to identify where regulatory obligations should be placed given the difficulty of decentralised operator models with no obvious UK HQ or presence;
3. How to create a custody regime in the context of an industry which spans different jurisdictions, may not record ownership on underlying ledgers and which often uses pseudo-anonymous technology.

It is too early to predict the likely detailed response to those specific challenges and clearly there are several tensions to be grappled with - creating a safe environment for consumers whilst encouraging innovation and, at the same time, recognising the UK’s response will not exist in isolation given the global nature of crypto providers’ business models.

Meantime with the instability of investments in more traditional financial markets, the appeal of the digital asset space is only likely to increase.

FURTHER INFORMATION

If you have any questions regarding the blog above, please contact James Alleyne in our Criminal team.

ABOUT THE AUTHOR

James Alleyne is Legal Counsel in the firm’s Financial Services Group. He advises clients on the full spectrum of financial services and FCA-related matters, including on authorisation applications, perimeter and supervisory issues, enforcement investigations and cases before the Regulatory Decisions Committee and Upper Tribunal.