HM Treasury consults on next steps for the regulation of cryptoassets

Introduction

On 1 February 2023, HM Treasury published a consultation on its proposed next steps for the regulation of cryptoassets. The consultation follows a previous consultation (published in April 2022) on the regulation of fiat-linked stablecoins, which HM Treasury refers to as “Phase 1”.

The consultation paper also contains a call for evidence on more nascent areas of the market, so that the government can better understand how those areas could potentially be regulated in the future. These include decentralised finance, sustainability and cryptoasset activities such as investment advice and portfolio management, post-trade activities including clearing and settlement and crypto mining and validation.

Policy and background

The consultation sets out further details of Phase 1, as well as proposals to regulate certain other categories of cryptoassets and the trading and investment activities related to them, which HM Treasury refers to as “Phase 2”. Overall the proposals are intended to design a regime which achieves the same regulatory outcome for the same risk for crypto assets when compared to traditional asset classes; is proportionate and focused on where the risks and opportunities are most acute; and which is agile and flexible so that it can be adjusted as both the cryptoasset market and international standards develop in the future. 

At the moment there are few clues as to timing but after the consultation process (for which responses are required by 30 April 2023), the government would need to lay secondary legislation, the FCA would need to consult on its approach and the industry would need to prepare for authorisation and the new rules. There are therefore a number of steps, so we would not envisage this regime taking effect until 2025 at the earliest.

New regulated activities

Importantly, HM Treasury is not discriminating on what forms of cryptoasset can be a specified investments for the purposes of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). All cryptoassets - security tokens, exchange tokens, utility tokens, NFTs, stablecoins etc. – have the potential to be captured by the regulatory perimeter if specified activities are performed in relation to those cryptoassets. 

The core of the proposals is to expand the scope of regulation to include a number of cryptoasset activities. Many of these resemble regulated activities performed in traditional financial services but there are also some novel cryptoasset activities for which there is no suitable basis in the existing regulatory framework. Persons that carry on certain activities in relation to cryptoassets will need to be authorised to do so under the RAO. Other activities may be subject to requirements to be included in the new Designated Activities Order, which is being legislated for under the Financial Services and Markets Bill which is current making its way through Parliament. The list of activities below is taken from the consultation paper and is intended to show the types of activities HM Treasury intends to regulate and in which phase.

Proposed scope of cryptoasset activities to be regulated

Source: HM Treasury Future financial services regulatory regime for cryptoassets Consultation and call for evidence – note that we have removed one of the columns

Firms would need to be authorised where they carry on these activities in the UK or for clients in the UK but there may be an exception for reverse solicitation where a UK customer accesses a service provided by an overseas firm entirely at its own initiative and without solicitation. Some firms may be required to have a physical presence in the UK in order to perform these activities and those operating trading venues may be required to do so from a UK subsidiary in the UK. The requirements here may be informed by the FCA’s existing approach to international firms. Interestingly, there is a reference to a desire to pursue equivalence type arrangements where firms authorised outside the UK could provide services in the UK without needing a UK presence provided they are subject to equivalent standards and there are cooperation arrangements in place.

As well as those currently unregulated businesses needing to apply for authorisation,  firms that are already authorised under the Financial Services and Markets Act 2000 would need to apply for variations of their permissions if they wish to carry on cryptoasset activities. There is no discussion as to whether there might be any transitional arrangements for firms that are registered under the Money Laundering, Terrorist Financing and Transfer of Funds Regulations 2017.

The FCA will have power to make tailored rules for firms carrying on cryptoasset activities, which would be consulted on at a later stage. However, the consultation paper provides some signposting as to the regulatory outcomes it is aiming for in relation to cryptoasset trading venues, custodians, lending platforms and intermediaries. These give an idea of the key authorisation triggers and criteria, as well as the types of rules the FCA might focus on in particular. Many of these reflect the outcomes that are expected of similar activities in traditional finance but there is a recognition that those rules may need to be adjusted to accommodate the new asset class. 

Issuance and disclosures

Where issuers of cryptoassets want to admit them to trading on a trading venue or make a public offer, the proposed approach is to follow the intended reform of the UK prospectus regime, including its exemptions, with a few adaptations. These would likely give cryptoasset trading venues greater responsibility for setting requirements for admission and disclosure documents in accordance with principles set by the FCA, as well as for due diligence. The FCA will also consider whether ongoing disclosures should be required once a cryptoasset starts trading.

Market abuse

The government is also considering a market abuse regime for cryptoassets. This would be based on elements of the Market Abuse Regulation and make it an offence for any person to commit market abuse in relation to a cryptoasset admitted to trading on a UK trading venue. This is another area where trading venues would be subject to additional obligations, including to have systems and controls to prevent, detect and disrupt abusive behaviour, and to cooperate with other trading venues for this purpose.

Practical advice

Anyone engaged in cryptoassets that touches the UK should be considering whether what they do will potentially fall within scope of the proposed regulated and designated activities. They may wish to respond to the consultation and give views on how those activities should be defined and watch out for the future FCA consultations on how it will adapt its rules to accommodate those activities. Such persons should also prepare for likely authorisation or variations of permission and the potential need to have a UK presence if they do not already have it. Cryptoasset exchanges, in particular, may also need to consider the viability of vertical integration of different functions within their operating models. This thinking should be done in the context of similar requirements being introduced in other countries. Regardless of questions on scope and detailed rules, regulators around the world expect all businesses under their supervision to be run in accordance with appropriate governance, client and asset protection and market integrity, so any improvements to these aspects will not be wasted when more detailed requirements become clearer in due course. 

This was first published by Thomson Reuters Regulatory Intelligence on 14 February 2023.