Last month, HM Treasury published its consultation on the future regulatory regime for cryptoassets. Regulation in this area has been anticipated for several years, however, regardless of the details of the final regulatory position, this will be a substantial change for unregulated crypto businesses with operations or customers in the UK, say Kate Troup, partner and Ottilia Csoti, associate, Fladgate LLP.
HM Treasury is proposing to expand the current scope of the UK's regulatory activity regime to include activities carried out in relation to cryptoassets. The regulatory regime in the UK is determined by the rules set out in the Financial Services and Markets Act 2000, which is amended from time to time when changes are made to the UK's regulatory environment.
Bringing cryptoassets within the scope of mainstream financial services regulation means that the proposed new regime will feel familiar to financial services firms with existing regulatory permissions but will be a huge change for cryptoasset firms whose activities have so far been unregulated.
Unregulated crypto firms will be required to obtain authorisation by the Financial Conduct Authority (FCA) before they are able to legally carry on their cryptoasset activities. Crypto firms will also be required to comply with detailed rules that prescribe how certain aspects of their businesses must be run, and how they communicate with their customers.
At present, certain cryptoasset firms in and connected to the UK are required to register with the FCA for anti-money laundering supervision. This requirement has been in place since 2020 and many crypto firms found obtaining this limited regulatory registration difficult.
In the FCA's annual perimeter report in 2022, the regulator noted that they had registered just 34 firms for anti-money laundering supervision and that 80 per cent of applications for registration were refused or withdrawn following submission to the regulator. A number of firms in the crypto ecosystem have relocated their operations to more crypto friendly jurisdictions as a result of this supervision and registration requirement.
Firms based outside of the UK have continued to do business with UK based customers on a cross-border basis and customers are buying, trading and holding crypto assets on platforms and using wallet providers registered across the world.
Interestingly, HM Treasury's proposed regulations have a greater geographical scope than might have been anticipated and it is proposed that UK regulations will extend to cover overseas firms providing services to UK based customers. The extended geographical scope means that some overseas firms will have to apply to the FCA for an authorisation to carry on certain activities where they have UK customers but no corporate presence in the UK.
The result of this may be that some international crypto firms choose to no longer offer services to UK customers to avoid this regulatory hurdle, or some small-scale operators may continue to do so without approval assuming that they are unlikely to be on the radar for, or face enforcement action from, the regulator.
The current regime for financial services firms generally requires that these firms have a physical presence in the UK if they are going to be authorised by the FCA to provide services to UK customers.
This is undoubtedly to ensure that the activities of these firms can be adequately supervised and investigated, and that any enforcement proceedings are effective.
However, if the Treasury paper is suggesting that this may not be necessary in relation to cryptoasset firms, this will be of interest to financial services firms who have not been able to continue to provide services to UK customers under the passporting regime since Brexit, but may wish to do so if a physical presence were no longer required for authorisation.
This could be a change that is very welcome to more traditional financial services providers, who will also likely approve of the proposed plans to impose stricter regulation on crypto businesses. HM Treasury also writes that they intend to pursue "equivalence type arrangements" in relation to crypto firms authorised in other countries may be able to provide services to UK customers, provided they are subject to equivalent standards in their registered jurisdiction.
Financial promotions regime amendments are also under consultation to bring promotions of crypto assets within the scope of the existing financial promotions regime. This change is designed to address the risk of consumers being misled by crypto asset promotions and the promotions will be subject to rules requiring risk warnings and a prescribed consumer journey in the same way as other financial promotions do.
This should, in theory, improve consumer understanding around crypto assets and prevent consumers from buying crypto assets on the basis of a misleading celebrity promotion.
The regulation of activities in relation to cryptoassets should provide some protection to consumers, however, due to the opaque nature of much of the cryptomarket, there is little protection for consumers from market abuse or market manipulation.
Market manipulation behaviours have been reported in the crypto ecosystem, and similar tactics and strategies to give false signals to markets and distort pricing are used as for traditional securities.
However, due to the different structures of these markets and crypto specific problems such as not having clearly identifiable "issuers", inside information can be being held by various market participants and manipulation will be harder to detect.
The Treasury paper rightly points out that effective market abuse regulation will require international standards and cooperation, until that time, there will likely continue to be instances of market abuse that affect crypto trading in the UK.
The Treasury proposals, if adopted, would be transformative for the crypto ecosystem in the UK and will undoubtedly be welcomed by financial services firms. Crypto firms will probably feel differently.
By Kate Troup, Partner and Ottilia Csoti, Associate, Fladgate LLP.
