How proposed UK regulation could impact cryptocurrency businesses

by Max Savoie and Martin Dowdall of Sidley Austin

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With the UK government launching a second phase consultation on the future of cryptoassets, Max Savoie and Martin Dowdall of Sidley Austin examine what this means for firms.

HM Treasury (HMT) published its consultation on the future financial services regulatory regime for cryptoassets on 1 February. This follows the April 2022 consultation on the regulation of fiat-linked stablecoins, referred to as phase one. The latest consultation proposes rules to regulate other categories of cryptoassets, referred to as phase two. This includes:

  • Extending the existing authorisation regime for financial services under the Financial Services and Markets Act 2000 (FSMA) to cover a range of cryptoasset services;
  • Using the Designated Activity Regime (DAR), a new regime under the Financial Services and Markets Bill (FSM Bill), to impose requirements on cryptoasset firms without requiring full authorisation;
  • Imposing prospectus and disclosure requirements on cryptoasset issuers and trading venue operators; and
  • Extending the UK’s market abuse framework to exchange-traded cryptoassets.

The UK is taking an iterative approach to the regulation of cryptoassets. This contrasts with the EU’s regulatory regime for cryptoassets under the Markets in Cryptoassets Regulation (MiCA), expected to be adopted during 2023. Although the UK proposals and MiCA overlap significantly, there are important differences.

Apart from authorisation requirements, in-scope firms would be subject to regulatory requirements on, among others, own funds, liquidity management, governance, operational resilience, data reporting, consumer protection, and conduct of business.

Firms already authorised under FSMA (such as banks and investment firms) intending to undertake cryptoasset activities would need to apply for a variation of permission, which will not be granted automatically. MiCA allows certain authorised firms, like banks, to conduct cryptoasset activities under their existing authorisations – albeit subject to other requirements.

Firms will need to carefully consider the impact of these proposals on their businesses. Those that provide services in the UK and the EU will need to consider how they will structure their organisation to comply with both the UK regime and MiCA.

Scope of phase 2 proposal

The treasury’s consultation document notes that there is no universal definition of a cryptoasset, digital asset or virtual asset. However, to avoid future ambiguity, the treasury has proposed its own definition of a crypto asset.

As such, the consultation defines a cryptoasset as: “Any cryptographically secured digital representation of value or contractual rights that – (a) can be transferred, stored or traded electronically, and (b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology).”

This is a broad definition and means that a large range of cryptoassets that are currently unregulated will be brought within the scope of regulation for the first time.

The consultation provides the following non-exhaustive list of cryptoassets that could fall within regulation under phase two:

  • Exchange tokens;
  • Utility tokens;
  • Non-fungible tokens (NFTs);
  • Asset-referenced tokens;
  • Commodity-linked tokens;
  • Crypto-backed tokens;
  • Algorithmic tokens;
  • Governance tokens; and
  • Fan tokens.

The scope of MiCA and the proposed UK regime differ.

MiCA imposes unique requirements on asset-referenced tokens (such as, in relation to establishing and managing reserves), whereas the UK proposal does not.

NFTs in principle fall within phase two, whereas they generally fall outside of MiCA.

Firms providing services in both the UK and EU will need to carefully consider whether they are in scope of both or just one of these regimes; and some may need to obtain UK and EU licences going forward.

In-scope cryptoasset activities

The consultation proposes imposing authorisation requirements under phase two on, among others, the following types of activities relating to cryptoassets:

  • Operating a cryptoasset trading venue;
  • Dealing in cryptoassets as principal or agent;
  • Arranging (bringing about) deals in cryptoassets;
  • Making arrangements with a view to transactions in cryptoassets;
  • Safeguarding, or arranging the safeguarding, and/or administering, of cryptoassets other than fiat-backed stablecoins and/or means of access to the cryptoassets; and
  • Operating a cryptoasset lending platform – another difference from MiCA, which does not address lending activities.

This will likely bring a broad range of currently unregulated businesses within the scope of regulation meaning such firms will need to be authorised to continue to provide these services.

The UK does not currently propose to regulate portfolio management or investment advice in relation to cryptoassets under phase one or two. This differs from the approach under MiCA which will regulate these services. Firms providing services in the UK and the EU will need to carefully consider which requirements apply to them in each jurisdiction.

Territorial scope will capture offshore firms providing UK services

The UK proposes to regulate cryptoasset activities provided “in or to” the UK. On this basis, non-UK providers would generally be subject to the new requirements where they provide services to UK customers from outside the UK.

HMT proposes an exemption for non-UK firms providing services to UK customers from outside the country on a reverse solicitation basis. However, it notes that any such exemption would be defined so as to prevent misuse and regulatory arbitrage, which suggests the exemption will be narrow.

The Treasury intends to pursue equivalence arrangements whereby firms authorised in other jurisdictions could provide services in the UK if the other jurisdictions have equivalent standards and cooperation mechanisms with the country.

DAR could catch firms outside the scope of cryptoasset proposals

HMT is also proposing to include other cryptoasset activities under the Designated Activity Regime (DAR). As such, and despite falling outside the authorisation regime, direct requirements, or even bans, could be imposed on firms conducting activities such as requiring that certain public offers of cryptoassets be conducted via a regulated trading platform.

Response to consultation on cryptoasset promotions

On the same day as the consultation opened, HMT proposed to introduce an exemption to the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, which would allow some cryptoasset businesses to promote their own services. This would only apply to firms registered with the FCA under the UK Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (but not authorised under FSMA).

This exemption will apply until the UK’s broader cryptoasset regulatory regime is introduced.

The consultation on cryptoassets closes on 30 April. The Payment Association will be submitting a response and member firms can get involved by sharing their views with the head of policy, Riccardo Tordera.

Max Savoie is a partner and Martin Dowdall is a senior managing associate at Sidley Austin.

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