Yesterday, HM Treasury published its much anticipated vision for the future of the financial services regulatory regime for cryptoassets. Comprehensive, detailed, and 82 pages long, this consultation paper and call for evidence brings some coherence to an historically fragmented regulatory approach.
There is a lot to unpack, and we look forward to delving into the detail of the consultation in the coming weeks. For now, here are some high-level thoughts.
Levelling the playing field between crypto and traditional finance
A clear theme that emerges from the consultation is HM Treasury's desire to deliver a level playing field between crypto and traditional financial services firms conducting the same activity, where possible.
In order to achieve this goal, HM Treasury intends to introduce a number of new regulated or designated activities tailored to the cryptoasset market into the existing regime in the Financial Services and Markets Act 2000 ("FSMA") where these activities seek to mirror, or closely resemble, regulated activities performed in traditional financial services. This would mean that a wide-range of cryptoasset activities, like operating a cryptoasset trading venue or dealing in cryptoassets as principal or agent, would fall within regulatory framework in FSMA on a wholesale basis. A separate bespoke regime has been discounted as failing to achieve regulatory symmetry between crypto and traditional financial services firms.
The consultation acknowledges that there are limitations to this 'levelling' approach, as there are contexts in which analogies between crypto and traditional finance start to unravel. Crypto activities for which there is no close analogue to traditional financial services activities, like mining and validation, have been deferred to future phases of regulatory thought. In the context of market abuse, HM Treasury observes that "the underlying structure of cryptoasset markets limits the ability of UK authorities to achieve the outcome of offering market integrity or protecting consumers to the same degree as in traditional securities markets". And, as might have been predicted, DeFi is identified as an area which presents particular challenges for regulators, as explored in a call for evidence that accompanies the consultation. Nevertheless, the beating heart of this paper is that great leveller, the mantra: "same risk, same regulatory outcome".
Waving goodbye to the MLR registration regime
Significantly, this absorption of cryptoasset activities within FSMA heralds the phasing-out of the parallel pseudo-authorisation regime that currently exists for cryptoasset exchange providers and custodian wallet providers under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). Such firms will ultimately be funnelled into FSMA authorisation. While another regulatory hill to climb for those firms that are already MLR-registered, HM Treasury notes that the supervisory history of businesses will be taken into account during a "proportionate" authorisation process, and that ultimately a single-authorisation process will bring regulatory clarity and support supervisory and enforcement processes. Certainly, from a practitioner's perspective, this is a welcome step towards a more coherent regulatory regime.
Location, location, location
If HM Treasury's proposals go ahead, broad swathes of crypto firms will, for the first time, need to consider whether they need to be authorised under FSMA, and what the consequences of that will be for them. As part of this analysis, a key question will be where the activities in question are carried out. This, of course, can be a complicated question to answer in the context of a digital ecosystem which does not necessarily take heed of borders. Seeking to meet this challenge head on, HM Treasury is proposing to capture cryptoasset activities provided in or to the United Kingdom. Here is a table which illustrates just how expansive this proposal is.
|Customer located in the UK||Customer located overseas|
|Provider located in the UK||In scope||In scope|
|Provider located overseas||In scope||Out of scope|
This approach may be subject to certain exemptions, such as where a UK customer accesses a particular cryptoasset service entirely at their own initiative from an overseas firm, and that firm does not otherwise solicit (known as 'reverse solicitation'). However, even subject to certain proposed equivalence measures, the broad geographical reach of the proposed regime for cryptoassets remains striking, particularly its expansion of the registration regime under the MLRs (which applies only to firms with a UK presence).
As might be expected, the spectre of FTX's collapse in 2022 looms large in HM Treasury's imagination. In particular, it informs an interesting discussion of the fact that integrated business models are rife in crypto markets. For example, in practice many cryptoasset exchanges combine a number of financial activities such as custody, post-trade activities, prop trading, lending and issuing native coins. As demonstrated by FTX's failure, this can result in complex and sometimes reinforcing risk profiles, as well as potential conflicts of interest. Thought is to be given as to whether existing controls on combinations of activity in traditional finance could help here, and these questions will become all the more pressing should cryptoasset markets or entities become (or be likely to become) systemic.
There is much, much more to be drawn from this paper beyond these points. To name just a few examples, there is:
- a proposal for a market abuse regime based on elements of the MAR for financial instruments,
- a proposed issuance and disclosure regime for cryptoassets grounded in the intended reform of the UK prospectus regime, and,
- helpful for the legal practitioner, there is clarification to be found on how the Financial Services and Markets Bill will integrate stablecoins within the regulatory regime.
Catching our breath, it is immediately clear that most actors in the crypto ecosystem will have to sit up and take notice of this consultation— HM Treasury is on the move. The paper opens with a bold statement that the government’s firm ambition is for the UK to be home to the most open, well-regulated, and technologically advanced capital markets in the world. Perhaps, finally, we are seeing the inklings of a regulatory regime that might support the sentiments in that statement.
For more information on this consultation and call for evidence, see our Financial Regulation Weekly Bulletin.