On 1 February 2023, HM Treasury (HMT) announced its proposals for the future financial services regulatory regime for cryptoassets (the proposals). The announcement comes in the wake of recent high-profile collapses of some of the world's largest cryptoasset exchanges. While work has begun on regulating certain types of cryptoassets (namely stablecoins), recent failures and the associated turbulence of crypto markets has reinforced the move centrally to establish a proportionate, clear regulatory framework. The proposals seek to enable firms to innovate at pace, while maintaining financial stability and protecting consumers. In this insight, Sushil Kuner explores key aspects of the proposals and sets out next steps.

Phased approach to regulation of cryptoassets

The Government and financial services regulators have already taken a number of steps to harness innovation and mitigate some of the key risks associated with cryptoassets. In particular, since January 2020, cryptoasset exchanges and wallet providers have been subject to the UK Anti-Money Laundering and Counter Terrorist Financing Regime. Legislation will shortly be introduced to require the regulation of promotions of cryptoassets by the Financial Conduct Authority (FCA) to ensure cryptoasset promotions are clear, fair and not misleading. The Government is also legislating to introduce a regime that will allow for the regulation of fiat-backed stablecoins, which are used for payments given their potential to become widely used as a form of payment.

The proposals represent the next phase of the Government's plans to regulate the cryptoasset sector, introducing a regime to regulate broader cryptoasset activities. This adopts a proportionate approach by focusing on areas associated with a higher degree of risk from a consumer and overall market perspective, and provides greater opportunities to support the UK's growth agenda. As such, while not all cryptoasset activities will be caught by the proposals (e.g. mining, validating transactions or operating a node on the blockchain), the Government has made it clear that it will keep market developments under review to inform future phases of work.

Expanding the definition of 'specified investments' to include cryptoassets

Under the proposals, HMT intends to create a number of new regulated or designated activities tailored to the cryptoasset market where these activities seek to mirror, or closely resemble, regulated activities performed in traditional financial services. Following this approach it will include, for example, centralised cryptoasset exchanges within scope of financial services regulation, as well as activities such as custody, lending, dealing in cryptoassets as principal or agent, and arranging deals in cryptoassets. There are also some novel cryptoasset activities for which existing regulatory frameworks would not provide a suitable basis.

Moreover, the proposals make clear that it is the activity being conducted by cryptoasset businesses that will be regulated, rather than the cryptoasset itself. Therefore, tokens that currently sit outside the regulatory perimeter, such as non-fungible tokens (NFTs) and utility tokens, would have the potential to be included in the future regulatory perimeter, depending on the nature of the activity being conducted in relation to them.

Where a person is engaged in those newly regulated activities by way of business, they will be expected to be authorised by the FCA before conducting those activities and comply with detailed rules relating to those activities. Notably, HMT recognises that many cryptoasset businesses are located offshore and so the proposals include capturing "cryptoasset activities provided in or to the UK" to take into account those activities provided by UK firms to persons based in the UK or overseas, as well as those provided by overseas firms to UK persons. This would likely fill the gap that would otherwise exist if only those activities conducted in the UK were to be in scope, and helps avoid a situation where firms move offshore to evade UK regulations.

However, the proposals suggest there may be some exemptions to this general rule, for example reverse solicitation for certain cryptoasset activities (e.g. if a UK customer accesses a cryptoasset service purely at their own initiative, without any solicitation from the overseas firm). HMT has also made clear that it intends to pursue equivalence type arrangements, whereby firms authorised in third countries can provide services in the UK without needing a UK presence, provided they are subject to equivalent standards and there are suitable cooperation mechanisms to help make this work. This is perhaps an attempt to create a proportionate framework that enables the UK to remain competitive for the cryptoasset sector.

Vertically integrated business models that offer a multitude of cryptoasset services would be expected to be authorised for each regulated activity and follow rules relevant to each activity. HMT has highlighted some business models may combine a number of regulated activities that may present conflicts of interest, as well as complex risk profiles, referring to recent cryptoasset exchange collapses. As with traditional financial institutions with multiple services and business lines, the proposals consider that these business models should be subject to similar prudential and conduct regulation, which may require firms to ensure particular functions are segregated.

Other key aspects of the proposals

  • Establishing an issuance and disclosures regime for cryptoassets, generally following the principles of the intended reform of the UK prospectus regime – the Public Offer and Admissions to Trading Regime. Through this, the Government is seeking:
    • minimum standards of information regarding cryptoassets being made available to investors to enable them to make informed decisions;
    • appropriate liability and compensation for untrue or misleading statements made in disclosure or admission documents;
    • an appropriate level of due diligence;
    • appropriate levels of investor protection around marketing materials and advertisements; and
    • controls or procedures to prevent harmful offers from being made (e.g. to detect fraud).
  • In relation to cryptoasset exchanges, establishing a regulatory framework based on existing regulated activities in respect of regulated trading venues, including the operation of a Multilateral Trading Facility, to ensure orderly, open and resilient conditions for trading on cryptoasset trading venues. Persons carrying out these activities would be subject to prudential rules and various consumer protection, operational resilience and data reporting requirements. Given the opacity in cryptoasset markets, the proposals require cyptoasset exchanges to keep, and make available at all times, accurate and comprehensive data related to trading on their exchanges. This data could be valuable to authorities for both market abuse and systemic risk monitoring purposes.
  • Recognising the 'significant evidence in cryptoasset markets' of "pump and dump" and "trash and cash" schemes – which resemble price manipulation strategies carried out on equity instruments – introducing a cryptoassets market abuse regime based on elements of the UK's Market Abuse Regime (MAR) for financial instruments. The offences against market abuse would apply to all persons committing market abuse on a cryptoasset that is requested to be admitted to trading on a UK trading venue. This will apply regardless of where the person is based, or where the trading takes place, and would entail obligations for certain market participants; in particular cryptoasset exchanges, which would be expected to detect, deter and disrupt market abusive behaviours.

Key considerations and next steps

While the UK continues to strengthen its position as a world-leader in FinTech, it is clear the UK will only welcome those businesses that can meet high regulatory standards. If cryptoasset businesses are to thrive, they need to secure trust and confidence from market participants, institutional investors and consumers alike. As such, the proposals will represent a welcome move from the FCA in trying to restore order to the cryptoasset sector and encourage innovation, while protecting consumers and ensuring market stability.

The Government is inviting all stakeholders to provide responses to the questions set out in its consultation paper and to share any other views on the proposed approach to regulating cryptoassets.

The consultation will close on 30 April 2023 and responses can be sent direct to cryptoasset.consultation@hmtreasury.gov.uk

If you think you may be impacted by the proposals and would like to discuss, please contact Sushil Kuner.