The UK cryptoassets regulatory regime starts to emerge
Christopher Woolard CBE
Partner at EY, Chair EY Global Regulatory Network, EMEIA FS Regulatory Lead, UK FS Consulting Markets Leader. Trustee at Which?
This week HM Treasury have published their consultation on the ‘Future financial services regulatory regime for cyptoassets’. The paper outlines a phased introduction of regulation. Phase 1 covers fiat-backed stablecoins used as a means of payment - digital settlement assets (DSAs) - which is being introduced through the Financial Services and Markets (FSM) Bill. Phase 2 focuses on the regulation of other (e.g. investment) cryptoassets. The paper makes clear that there is a potential for future phases depending on market evolution. The UK looks set to take a broad approach to regulation that can adapt with market developments over time.
For firms currently operating in the cryptoassets space the paper provides new detail on what will be regulated and approach to how that regulation will be set. It makes clear that Government wants to develop a regime which will make the UK an attractive home for cryptoasset firms, by treating them the same way they do existing financial services firms around risk and outcome. Continued policy momentum clearly reflects the desire of UK policymakers to build from the opportunities that new technology presents. Even those firms without current digital asset activities should consider applying a medium term strategic lens to how these technologies may re-shape the market and lay foundations for new propositions.
What are the proposals?
HM Treasury intends to use a broad definition of cryptoassets, similar to that used in the EU Markets in Crypto Assets Regulation (MiCA), which expected to come into force from Q3 2024 at the earliest. The proposed approach focuses on regulating the activities involved in the market rather than the individual assets. All activities within scope provided in or into the UK, which will include overseas firms marketing to UK consumers, will be captured by the new regulatory regime. Focusing on activities is the key here. It will provide the FCA with a clear hook on which to apply regulation.
At this stage the regulatory regime focuses on five broad activities:
Each activity will have a regulatory approach tailored to the specifics of the activity. For firms operating across a number of activities, such as crypto exchanges, this could create a fairly complex web of regulations that they will need to carefully manage. The consultation makes clear that HM Treasury is still giving further consideration as to whether further controls are needed for firms offering a combination of activities, as seen in other areas of financial services.
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How are they proposing to regulate?
Where possible, the consultation sets out a desire for the FCA to mirror existing regulatory regimes. This requires alignment with current principle of the same risk and desired regulatory outcome. In practice, this is likely to be simpler in some areas than others. Several of the more granular sub-activities within the five broad activities, such as custody of cryptoassets, have features unique to cryptoassets, which will force the FCA to develop an entirely new approach. HM Treasury is also proposing a cryptoassets market abuse regime based on elements of the UK Market Abuse Regulation. For firms, explaining exactly what they do, and the risks presented, will be essential over the coming months to ensure that FCA fully understands the risks presented and can develop a regime that delivers to the spirit of regulation outlined in the consultation.
The consultation also gives further insight into where HM Treasury plan to go next, with Chapters 11 to 13 calling for evidence on how they should approach Decentralised Finance, other cryptoasset activities (such as advice) and sustainability.
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When can we expect regulation to commence?
The consultation runs until 30 April 2023. HM Treasury will then lay secondary legislation to enact the changes to the regulatory perimeter and give the FCA the powers to regulate. This will be followed by FCA consultations on the regulatory rules and guidance for firms and arrangements for authorising newly in scope firms, possibly including a temporary authorisation regime. It is unlikely that any regime for the Phase 2 cryptoasset activities will be in place before 2024.?
Work on the regulation of the digital settlement assets included in Phase 1 is further ahead.?However, once the FSM Bill receives Royal Assent, secondary legislation and regulatory consultations will still be required before the new regime comes into effect. By contrast, firms should expect the new cryptoasset financial promotions regime to be brought in fairly quickly once the Bill comes onto force.
What should firms do now?
Firms conducting cryptoasset activities will need to ensure that they have the policies, processes, systems and controls in place ready for authorisation. On top of the rules discussed in the consultation, firms will be expected to be ready for the Consumer Duty from day one, so should be prepping now for this. While the regulatory hurdles are significant, the relative alignment with existing regulation and the EU approach will help many firms comply more easily, leveraging off existing processes. Firms may be required to have a physical presence in the UK, and those acting as a cryptoasset trading venue, in particular, are likely to require a subsidiary operating from the UK given their critical role in the value chain. Firms will also face new prudential requirements and a robust client assets (CASS) regime. The business model implications for an established digital asset firm are significant.
The scale of incoming change makes preparation vital. Firms should keep a close eye on all developments and starting to work through the implications now will make applications for authorisation easier. Firms should note that of the applications FCA received for registration for AML/CTF from cryptoasset firms 74% were either refused or withdrew their application. The consultation and data is clear, authorisation is not guaranteed, and even for authorised firms that will only require a variation of their existing permission, applications will not be automatically granted.