Cryptoasset regulation
Latest developments
The second half of 2023 will bring most promotions concerning fungible cryptoassets into the scope of the UK financial promotions regime.
Summary
The financial regulatory environment in the UK in relation to cryptoassets is in the process of significant change. Some of these changes have already come into force whilst other proposed changes are planned to take effect gradually over the next couple of years.
The UK Government’s (the Government) view is that the technology underpinning crypto could bring benefits to the UK and in 2022 HM Treasury (the Treasury) set out the UK’s ambitions to become a cryptoasset technology hub. Alongside this, the Government is also working on building a smarter regulatory framework which is tailored to the UK. The new regulatory approach provides a vehicle for UK regulators to have the ability to put in place safeguards for certain cryptoassets and associated activities through the Financial Services and Markets Act 2023 (FSMA 2023). Currently, cryptoassets are only subject to a very limited degree of regulation in the UK:
- AML Registration Regime: Persons carrying out certain activities in relation to cryptoassets (issuing or exchanging cryptoassets and safeguarding cryptoassets) must have an anti-money laundering registration (which is not a full FCA authorisation).
- Financial Services Regime: If a cryptoasset resembles a traditional financial instrument (for example, it gives rights similar to a share or debt instrument) then it will be treated accordingly. This means a person carrying on activities in relation to such a cryptoasset may need a traditional financial services authorisation.
- Electronic money: Cryptoassets which meet the definition of an electronic money (e-money) token are also likely to fall under the FCA regulatory perimeter if the token meets the definition of e-money under the Electronic Money Regulations 2011. For example, this could include stablecoins as their value is typically linked to fiat currency.
- The “Travel Rule”: Implements a new international standard, concerning information sharing requirements for wire transfers to cryptoassets and, as of 1 September 2023, applies to cryptoasset exchange providers or custodian wallet providers at a threshold of EUR 1,000. This change will take place through The Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022. Specifically, Regulation 5 on cryptoasset transfers came into force on 1 September 2023.
The (ever) evolving regulatory landscape
In October 2023, amendments to the UK’s financial promotions regime will come into force. This regime restricts persons from promoting investments (such as shares or debt instruments) unless the person making the promotion is authorised by the FCA (or the promotion has been approved by such a person). The amendments will bring fungible cryptoassets into the scope of the financial promotion’s regime. Broadly, this means that most promotions concerning traditional cryptoassets (such as Bitcoin) can only be promoted in the UK by an FCA authorised firm (including a firm with a cryptoasset anti-money laundering registration).
In addition to changes around financial promotions for cryptoasset businesses FSMA 2023, which revokes retained EU law and creates modifications to better suit the UK market, introduces several regimes which will also impact cryptoasset regulation:
- Digital Settlement Assets (DSAs): i) DSAs can be used for the settlement of payment obligations, ii) can be transferred, stored or traded electronically, and iii) uses technology supporting the recording or storage of data (which may include distributed ledger technology)[1]. This approach will enable the recognition of future systemically important stablecoins used as a means of payment.[2] It’s considered that stablecoin legislation will fall under the regulation of systemic DSAs if the stablecoin meets the criteria[3]. The Government has stated that it intends initially to use the powers to regulate stablecoins that are used for payment[4].
- New Designated Activities Regime (DAR): under FSMA 2023 the DAR will broadly provide an alternative route to regulating an activity if it relates or is connected to; i) the financial markets or exchanges of the United Kingdom, ii) or financial instruments, financial products or financial investments that are (or are proposed to be) issued or sold to, or by, persons in the United Kingdom[5]. HM Treasury (the Treasury) will have powers to designate certain unregulated activities as DARs to tailor to the cryptoasset market where these activities mirror, or closely resemble, regulated activities performed in traditional financial services. The FCA will then have supervisory powers to create rules for these activities regardless of whether or not they are carried out by authorised persons[6]. The Treasury could also use DARs to prohibit services unless they are conducted via a regulated platform. Designated activities will be set out in new Designated Activities Regulations which will fulfil a similar purpose to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO)[7].
- s22 of FSMA 2023 brings cryptoassets within the definition of “investment” for UK Regulated Activities. The effect of this change is that that there is an ability in the future for the RAO to be amended to include certain cryptoassets as “specified” investments under the RAO. The type of cryptoassets that will be categorised as specified investments is being considered under the UK Government’s current consultation.
“Whether activities are regulated through the RAO or being added to the DAR, the Government expects to create a consistent regulatory framework across legislation that will follow a single set of principles[8]”.
The Future Financial Services Regulatory Regime for Cryptoassets: consultation and call for evidence (published in February 2023) provides proposals to address gaps in the current framework to regulate cryptoassets more broadly and introduced plans for a phased approach in which aspects of cryptoasset would become regulated at different stages.
Phase 1 is considered already in motion with the aim of regulating activities such as the issuance and custody of fiat-backed stablecoins. The Government’s plan for Phase 2 is to regulate cryptoasset activities such as the trading of and investing in cryptoassets in or to the UK. Phase 2 will be focused on targeting the activity areas associated with (i) a higher degree of risk from a consumer and overall market perspective and (ii) greater opportunities to support the UK’s growth agenda. As a consequence, not all cryptoasset activities are proposed to form part of Phase 2[9].
The Government and Treasury are expected to continue to assess developments in the market to determine future phases of work. The FCA will be reflecting in future iterations of the Regulatory Initiatives Grid the timings and impacts of any further changes under the Government’s reforms as they are confirmed[10].
Future activities outside of Phase 2 may be included in regulatory frameworks due to the evolving nature of the world of cryptoassets and in the spirit of “same risk same regulation”, which is the theme of HM Treasury’s (HMT) approach. Any of the following cryptoassets may be subject to future financial services regulation where they are used for financial related activities, such as; Exchange tokens, Utility tokens, Security tokens, Non-Fungible Tokens (NFTs), Stablecoins, Asset-referenced tokens, Commodity-linked tokens, Crypto-backed tokens, Algorithmic tokens, Governance tokens and Fan tokens.
How could it be relevant for you?
At present a large proportion of cryptoassets fall outside or are likely to fall outside the UK regulatory perimeter. This means they may not be subject to the same consumer protections or safeguards found in other areas of financial services and payments. However, forthcoming changes in respect of financial promotion restrictions for fungible cryptoassets and wider changes to be introduced by FSMA 2023 will have the potential to bring a significant number of persons into the scope of UK cryptoassets regulation.
Next steps
FSMA 2023 gives the FCA and the PRA a new secondary objective to facilitate the international competitiveness and growth of the UK economy. In addition, FSMA 2023 also creates new power for the Government to require regulators to have regard to particular matters when making rules.
An increased number of initiatives relating to cryptoassets will require significant collaboration between Government, the regulators and industry to be successful. This will be reflected in secondary legislation to meet Government objectives and we expect further timetabling of cryptosasset related regulatory activity towards the end of the year through the publishing of the final Regulatory Initiatives Grid for 2023.
Written by Gavin Punia, Tom Hepplewhite and Melissa Pentecost-Daley
*Information is accurate up to 27 November 2023
[1] Financial Services and Markets Act 2023 (s23(2))
[2] Payments Regulation and the Systemic Perimeter - Consultation Response, (para 1.8)
[3] Future Financial Services Regulatory Regime for Cryptoassets: Call for Evidence (Figure 3.A)
[4] Cryptoassets: What does the future hold? - House of Lords Library (parliament.uk)
[5] Financial Services and Markets Act 2023 (Part 5A, S71K)
[6] Building a Smarter Financial Services Regulatory Framework for the UK (para 3.7)
[7] Building a Smarter Financial Services Regulatory Framework for the UK (para 5.6)
[8] Building a Smarter Financial Services Regulatory Framework for the UK (para 3.8)
[9] Future Financial Services Regulatory Regime for Cryptoassets: Call for Evidence (para 1.16)
