Crypto – Q1 2023

Updates from the FCA show that the sector contains bad actors, but existing regulation can be adapted and extended to provide a blueprint for cryptoasset regulation. However, due to its technological nuances and inherent complexity, the question remains as to whether without purposely designed regulation, it can ever be as effective as it is in traditional quarters.

The UK Government outlines potential approach to ‘Digital Pound’

The Digital Pound would be a new form of digital money issued by the Bank of England to meet everyday retail payment needs. In an extensive consultation, The Government lays out a potential approach where the Digital Pound would "replicate the role of cash in a digital world, so that it is risk-free, highly trusted and accessible". Although the Government state "no decision has been taken at this stage to introduce a digital currency", this latest step by the BOE and HMT suggests they believe a digital currency will be needed in the near future.

An in-depth summary of the consultation can be found here:

HMT provides policy statement on cryptoasset promotions consultation

HMT’s intended legislation aims to promote innovation while protecting consumers, ensuring that FCAs existing rules relating to financial services promotions are applied proportionately to the Crypto sector. The government also cited evidence from the 2018 Cryptoassets Taskforce report, highlighting the misleading nature of existing promotions as a source of harm for consumers.

The government intends to use the Financial Services and Markets Act 2000 (FSMA) as the basis for the regulations, requiring businesses to have cryptoasset promotions approved by an authorised person and be in line with FCA requirements, including being “fair, clear and not misleading”.

Responses to the consultation suggested that the Crypto sector does not contain enough willing and able authorised persons to approve promotions. Many take the view that blanket application of the FSMA would effectively ban cryptoasset promotions.

The government has therefore proposed an exemption to the FSMA, Section 21, meaning FCA-registered cryptoasset businesses who cannot secure the approval of an authorised person will still be able to communicate promotions relating to cryptoassets. The exemption aims to “significantly widen” the number of cryptoasset businesses that can communicate promotions.

HMT instigates a consultation and call for evidence with regards to a future financial services regulatory regime for cryptoassets

The consultation is centred on proposing future regulatory requirements for cryptoasset activities provided in, or to, the UK’s financial services industry. HMT recognises the potential of cryptoassets to disrupt traditional financial services but acknowledges the market vulnerabilities, reaffirming the need for robust regulation.

The paper states that sectoral issues have been exacerbated by a lack of requirements relating to disclosures, governance, and risk management, providing further motivation for creating comprehensive cryptoasset regulation.

This paper reiterates the government’s intentions to adapt the FSMA as the basis for a proposed regulatory regime, citing “confidence, credibility and regulatory clarity that this existing system affords”.

According to HMT, some forms of cryptoasset already fall under the Regulated Activities Order 2001 (RAO), via the legislation’s “specified investments” classification. The paper proposes updating this aspect of RAO to include all cryptoassets. Doing so would grant the FCA “general rule-making powers” to create tailored regulations to account for any new activities within the Crypto sector. HMT provide a broad list of cryptoasset-related activities for which it intends to introduce regulation as part of its ‘phased approach’ to regulating cryptoassets in the UK:

Cryptoasset issuance and disclosures

HMT have drawn a comparison between cryptoasset issuance and the issuance of securities. They intend to mirror their approach in that sector by not directly regulating the issuance of unbacked cryptoassets. Despite similarities, they also highlighted that those issuing cryptoasset are often unidentifiable and possess limited control over their products when compared to companies issuing traditional securities.

Proposed regulatory outcomes include:

• A minimum standard of information regarding individual cryptoassets to enable informed investment decisions.
• Liability and compensation frameworks to remediate misleading disclosures.
• Investor protection relating to advertisements.

Cryptoasset Trading Venues (exchanges)

The paper frames cryptoasset exchanges as embryonic versions of traditional financial market infrastructures. The risk profile associated with this activity is therefore similar, specifically the impact of operational disruptions and fraudulent trading.

Proposed regulatory outcomes include:

• Transparent and fair access to exchanges.
• A requirement to implement people, processes, systems, and controls that facilitate fair, orderly, and efficient trading.
• Provision of accurate, real-time, market data relating to the exchange.

Cryptoasset Intermediation

inadequate credit and liquidity are all areas identified in which regulation could promote stability and protect consumers. Both the RAO and the FCA’s SYSC legislation are presented as potential blueprints for future regulation.

Proposed regulatory outcomes include:

• Clients’ trades executed in a way that best serves their interest.
• Controls to prevent conflicts of interest.
• Systems and processes to detect market abuses.

Cryptoasset Custody

Cryptoasset investors require both access and storage. Under the proposed regulation, associated custodians would be expected to maintain a standard of business practice to prevent harm and cost to investors.

Proposed regulatory outcomes include:

• Safeguards for investors rights to cryptoassets; if a cryptoasset custodian became insolvent, assets would be returned to investors.
• Custodians would be expected to have sufficient resources to operate, wind down, and fail without harming consumers and market participants.
• Clear processes for redress in instances of cryptoasset loss.

Cryptoasset Lending Platforms

Parallels are drawn between existing cryptoasset lending platforms and traditional lending products. HMT considers credit risk and liquidity mismatch to be the primary targets of proposed regulation, but also recognises that cryptoasset lending platforms possess a wide range of lending business models.

Proposed regulatory outcomes include:

• Adequate capital and liquidity.
• Wind down arrangements.
• Clear contractual terms on ownership and appropriate ringfencing of retail funds in cases of insolvency.

General Market Abuse Requirements

The paper proposes extending the Market Abuse Regulation (MAR) regulations relating to insider dealing, unlawful disclosures, and market manipulation to include cryptoassets.

Proposed regulatory outcomes include:

• An understanding amongst market participants of unfair and abusive practices.
• An understanding of the obligation to prevent, detect and act against such practices
• Sanctioning of abusive practices.
• Market structuring to prevent abuse and to make the detection of abuse easier.

Get in touch

If you require support or would like to know more, please get in touch via the button below.

Contact us