Introduction

On 1 February 2023, HM Treasury issued its latest proposals concerning the regulation of cryptoassets. These proposals build on HM Treasury’s previous work which focused on stablecoins and the financial promotion of cryptoassets. They deliver on the government’s announcement last April setting out plans for the UK to become a global hub for cryptoasset technology. The government has already started to lay the legislative foundations to bring stablecoins and cryptoassets into financial services regulation via the Financial Services and Markets Bill (FS&M Bill).

The government reports that both retail and institutional participation in the cryptoasset sector continues to grow. On the retail side, the government finds that most recent surveys show that 5-10% of UK adults now own cryptoassets, an increase of more than 100% over the past 1-2 years. Institutional participation has been limited but is also growing.

In this article we cover HM Treasury’s consultation for the UK financial services regime for cryptoassets and its consultation on cryptoassets promotions.

Proposals for the UK’s financial services regime for cryptoassets

HM Treasury has issued a consultation and call for evidence regarding the future financial services regulatory regime for cryptoassets.

The consultation builds on previous HM Treasury papers on cryptoassets, in particular its publications last April on the UK regulatory approach to cryptoassets, stablecoins and distributed ledger technology (DLT). In addition, the Financial Conduct Authority (FCA) and Bank of England have issued a number of discussion papers, consultation papers, policy statements and regulatory guidance notes on cryptoassets, including the FCA’s consultation paper on financial promotions for cryptoassets (published in January 2022).

The consultation focuses on the future regulatory framework for cryptoassets used within financial services rather than the wider application of DLT in financial services or the use of cryptoassets outside financial services. With these proposals HM Treasury is pursuing a number of policy objectives including protecting UK financial stability and market integrity. As with its previous consultations the proposals are guided by three core design principles – (1) same risk, same regulatory outcome, (2) proportionate and focused and (3) agile and flexible. The approach to regulating cryptoassets in the UK will also be in phases. Further information on the phases is set out in Figure 1.B on page 12.

Scope and legislative approach

The definition of “cryptoasset” in the FS&M Bill is broad so as to capture all current types of cryptoasset. In terms of scope and legislative approach (chapter 2), on page 16 of the consultation HM Treasury sets out Box 2.A which lists those cryptoassets that could in the future be subject to financial services regulation where they are being used for financial services activities (see below). These include exchange tokens, utility tokens, security tokens, stablecoins, crypto-backed tokens and algorithmic tokens. HM Treasury proposes to expand the list of “specified investments” in Part III of the Financial Services and Markets Act 2000 (FSMA) (Regulated Activities) Order 2001 (RAO) to include cryptoassets. However, it does not currently intend to expand the definition of “financial instrument” in Part 1 of Schedule 2 to the RAO to include presently unregulated cryptoassets. HM Treasury also intends to use the Designated Activities Regime (being legislated for in the FS&M Bill) to legislate for certain cryptoasset activities.

Current regulatory landscape

In terms of the current regulatory landscape for cryptoassets (chapter 3), the key messages from HM Treasury include:

• Activities relating to security tokens and other specified investments – HM Treasury expects that the current treatment of those cryptoassets that already qualify as specified investments will continue, though there may be some amendments over time (e.g. updating custody obligations in the Client Assets Sourcebook for security tokens).
• Anti-money laundering / countering terrorist financing regime – When the broader cryptoasset regulatory regime being consulted on becomes effective, HM Treasury expects firms undertaking regulated cryptoasset activities to adhere to the same financial crime standards and rules under FSMA that apply to equivalent or similar traditional financial services activities. In addition, crypto firms that are already registered under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs 2017) and carrying out activities that would come within the RAO would be required to seek authorisation under the new FSMA-based regime. Firms that seek authorisation to perform regulated cryptoassets business would not then also need to seek registration under the MLRs 2017 to act as registered cryptoassets firms. Authorised firms would need to apply for a variation of permission for cryptoassets permissions.
• Fiat-backed stablecoins which are used for payment – A phased approach is proposed, further information is set out on page 23.

Cryptoasset activities and territorial scope

In chapter 4, HM Treasury has set out in Table 4.A (pages 27 and 28) an illustrative list of  cryptoasset activities that it proposes to bring into the regulatory perimeter. These are: issuance activities, payment activities, exchange activities, investment and risk management activities, lending, borrowing and leverage activities, safeguarding and/or administration (custody) activities, and validation and governance activities. At present, mining activities are not in scope and validation, node operation and governance-related activities are not currently in scope too.

It also describes the geographical scope of the regulatory perimeter. Whilst stating that the government may wish to consider certain exceptions, the perimeter would capture activities provided by UK firms to persons based in the UK or overseas (natural and legal), as well as those provided by overseas firms to UK persons (natural or legal). There is, however, the possibility of a formal reverse solicitation exemption for overseas providers.

Among other things, HM Treasury states that whether firms would be required to have a physical presence in the UK in order to obtain authorisation is under consideration and for the FCA to determine at the point at which firms apply for authorisation. It also adds that firms operating cryptoasset trading venues would be likely to require subsidiarisation in the UK since they play a critical role in the cryptoasset value chain.

Cryptoasset issuance and disclosures

In chapter 5, HM Treasury discusses regulatory outcomes for cryptoasset issuance and disclosures. Among other things it proposes to establish an issuance and disclosures regime for cryptoassets grounded in the intended reform of the UK prospectus regime – the Public Offer and Admissions to Trading Regime – and tailored to the specific attributes of cryptoassets. This is not dissimilar to the regime set out in the EU Regulation in Markets in Crypro-Assets (MiCA). In addition, for admission of cryptoassets to a UK cryptoasset trading venue, the government is proposing to adapt the multilateral trading facility (MTF) model from the intended reform of the UK prospectus regime.

Cryptoasset trading venues

Whilst acknowledging that cryptoasset trading venues are still at a relatively early stage of development compared to traditional financial market infrastructures, the government is mindful that the proliferation of cryptoasset trading venues across the globe has heightened challenges around monitoring trading venue activity and protecting consumers. In light of this when discussing regulatory outcomes for operating a cryptoasset trading venue (chapter 6) HM Treasury proposes to

establish a regulatory framework which is based on existing RAO activities of regulated trading venues – including the operation of an MTF. Further details are set out in Table 6.A (pages 42 to 44).

Cryptoasset intermediation activities

In chapter 6, HM Treasury states that the activities of cryptoasset intermediaries have much in common with regulated activities such as “arranging deals in investments” and “making arrangements with a view to transactions in investments” set out in Article 25 of the RAO. Given this HM Treasury is proposing that requirements applying to analogous regulated activities – such as “arranging deals in investments” and “making arrangements with a view to transactions in investments” set out in Article 25 of the RAO – would be used and adapted for cryptoasset market intermediation activities. HM Treasury sets out the proposed design features for the cryptoasset market intermediation regime in Table 7.A (pages 46 to 48).

Cryptoasset custody

HM Treasury notes that currently there is no regime for cryptoasset custody in the UK and industry feedback has highlighted that there is a wide variance of  cryptoasset custody business models and practices. With this in mind HM Treasury proposes in chapter 7 that the same custody requirements be adopted for all types of cryptoassets as they come into regulation.  The existing framework for traditional finance custodians under Article 40 of the RAO will be adapted for cryptoasset custody activities. For cryptoassets that already meet the definition of a specified investment (security tokens), the existing regulatory framework that currently applies will be replaced by the new custody regime. The FCA expects to run a separate consultation on this. HM Treasury sets out the proposed design features for the cryptoasset custody regime in Table 8.A (pages 51 to 53).

Market abuse

HM Treasury believes that there is a strong case for including a market abuse regime in the proposed crypto regulatory framework. In chapter 7, HM Treasury proposes a cryptoassets market abuse regime based on elements of the market abuse regime 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. It would entail obligations for certain market participations, in particular cryptoasset trading venues who would be expected to detect, deter, and disrupt market abusive behaviours. HM Treasury sets out the proposed design features for the cryptoasset market abuse regime in Table 9.A (pages 58 to 59).

Operating a cryptoasset lending platform

The government is mindful that lending and borrowing makes up a significant amount of activity in the cryptoasset and decentralised finance (DeFi) market and there are regulatory challenges and prudential risks associated with cryptoasset lending. In chapter 10, HM Treasury proposes to require cryptoasset lending platforms to disclose important information to customers, such as the terms of legal ownership, collateral, and margin calls. However, the proposed approach does not pursue all of the same outcomes delivered by traditional lending and borrowing regulations. HM Treasury sets out the proposed design features for the cryptoasset lending and borrowing regime in Table 10.A (pages 63 to 65).

Call for evidence

In chapters 11 to 13 HM Treasury sets out calls for evidence for DeFI, other cryptoasset activities and sustainability.

Next steps

The deadline for responding to the consultation and calls for evidence is 30 April 2023.

Following the deadline the government will consider feedback and work to set out its consultation response. Once legislation is laid, the FCA will consult on its detailed rules for the sector.

Cryptoasset promotions

HM Treasury has also issued a policy statement on its approach to the regulation of cryptoasset financial promotions. This follows a consultation in 2020 on plans to legislate to bring certain cryptoassets into the scope of financial promotion rules. The policy statement outlines plans to introduce a temporary, bespoke exemption from the financial promotion restriction in section 21 of FSMA for certain cryptoasset promotions.

Since it published its consultation response in January 2022, the government has received feedback highlighting growing industry concern that the proposals it consulted on would significantly restrict or effectively ban cryptoasset financial promotions. Industry stakeholders flagged that most crypto firms are not FCA authorised, meaning that they could not communicate their own promotions under the proposed rules, and noted evidence of a lack of suitable authorised persons in the market willing and able to approve crypto promotions.

The planned exemption

Under section 21 of FSMA, a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity or claims management activity. This restriction will not apply in certain circumstances, including where the communication is made or approved by an authorised person.

The government is proposing a bespoke exemption to section 21 of FSMA to enable cryptoasset businesses registered with the FCA under the MLRs 2017, which are not otherwise authorised persons, to communicate their own financial promotions relating to qualifying cryptoassets. The exemption is intended to ensure that a cryptoasset business that is registered with the FCA for anti-money laundering purposes is able to issue their own promotions while the broader cryptoasset regulatory regime is being introduced.

Firms making use of the exemption will be subject to the same financial promotion rules as other firms issuing cryptoasset promotions.

Next steps

The government plans to introduce the statutory instrument (SI) giving effect to the planned cryptoasset financial promotions regime, including the bespoke exemption, “as Parliamentary time allows”. The measure will have a reduced implementation period of 4 months (rather than 6 months) from the date the SI is made in Parliament. The detailed rules for the regime will be set independently by the FCA.  

The exemption announced by the government is intended to be time limited and will be reviewed alongside the future regulatory approach to cryptoassets.

Conclusion

Perhaps the key takeaway from both consultations is that a number of these measures have been trailed – expansion of the financial promotions regime, measures to tackle market abuse etc. – but this proposed phase of regulation marks a significant shift in the UK’s regulatory policy with respect to cryptoassets. For the first time, we have clarity that there will be a material extension of FSMA (we are not going down the standalone regime as with MiCA) to address key activities across the crypto ecosystem, which will cause many to have to seek authorisation with the FCA in order to carry on their business. There is also an expansion in the territorial effect of the regime to cover firms both operating in and providing services to customers in the UK, thereby capturing a range of overseas firms, with the expectation that a number of them (such as those operating exchanges) will subsidiarise in the UK. Interesting times ahead indeed.