In early February, the UK released a consultation which will help to inform the construction of its future regulatory approach to cryptoassets. The consultation, titled ‘Future financial services regulatory regime for cryptoassets,’ explores how to bring cryptoassets used for financial purposes into the UK’s regulatory regime. It covers everything from definitions to DeFi, and asks for feedback on its proposals by April 30.
TRM’s policy team took a look at the consultation to highlight the key points and what they could mean for the industry.
What does the consultation address?
The consultation proposes a comprehensive approach to regulating the financial uses of cryptoassets. It does this by borrowing from the pre-existing financial regulation regime under the Financial Services and Markets Act (which is currently being amended), and by introducing some bespoke elements.
It starts by laying out a non-exhaustive list of definitions which will be used to help inform the framework, and goes on to explore the ‘phased’ approach that the government plans to take when building regulations.
The first phase will deal with issues that offer the greatest opportunities and/or highest risks, such as stablecoins used for payments, while the second phase will deal with a broader array of cryptoasset activities.
The range of activities within this second phase, which will be directly informed by this consultation, includes:
- Issuance activities
- Exchange activities
- Investment and risk management
- Lending, borrowing and leverage activities
- Safeguarding and/or administration activities
There are additional considerations for firms who choose to have vertically integrated business models, all activities related to “unbacked cryptoassets’ and for algorithmic stablecoins which are also viewed as unbacked cryptoassets.
Finally, the proposal carves out NFTs – writing that if they are not used for financial services activities, then they would not fall within the scope of this framework, exemplifying the government's overall approach to regulate the activity taking place rather than the underlying technology.
At the core of this consultation, the UK government is seeking to gauge how to best balance the need for innovation with the need to control risk.
Themes to watch
Consumer and investor protections are a big focus of the consultation, which was to be expected given the scandals that plagued 2022.
To try and prevent similar events from occurring in the future, the government lays out a number of controls, namely:
- Creating a dedicated Cryptoasset Abuse Regime (CAR): The proposal acknowledges that key differences in the traditional and crypto markets mean that a bespoke crypto regulatory regime is appropriate.
- For consumers, the proposal suggests making Financial Services Compensation Scheme (FSCS) protections –akin to FDIC insurance in the U.S.– available in some circumstances. The framework also suggests making changes to the financial promotions regime allowing firms authorized under money laundering controls to approve their own promotion.
The consultation also highlights the various regulatory challenges presented by DeFi including the borderless nature of DeFi and operational resilience. Bearing in mind the benefits that DeFi can offer society, the UK will take its time in considering the best regulatory approach.
How does it compare with MiCA?
Many comparisons will be made between what the UK is suggesting and the regulatory framework on the other side of the channel in the EU – the Markets in Cryptoassets Regulation (MiCA).
The main difference between the two is that the UK’s potential framework includes guardrails for “crypto asset lending platforms.”
The consultation notes that lending firms were responsible for several of the major scandals in 2022, and thus need to be brought under the purview of regulation. This will require such firms to have adequate risk warnings for consumer lending, for platforms to have adequate financial resources, and to have clear contractual terms on ownership of funds. On the other hand, MiCA does not include such a provision.
Another difference is in the approach to definitions. The UK has opted for a greater number of defined terms than MiCA, and also uses the term “Asset Reference Token” in a different way, which could eventually cause friction between the two regimes. The proposed UK framework provides greater clarity on NFTs, stating that if an NFT is not being used as a financial instrument then it does not come under the regulation.
Differences aside, the consultation importantly includes language on “equivalence” for third party countries. It reads, “HM Treasury intends to pursue equivalence type arrangements whereby firms authorised in third countries can provide services in the UK without needing a UK presence, provided they are subject to equivalent standards and there are suitable cooperation mechanisms to help make this work.”
This could mean that operating in both the EU and UK market could be streamlined in the future.
Although the consultation gives a good indication of the government’s intentions for the crypto industry, it is in no way a done deal. The final shape of the regime will be formed from the feedback to the consultation as well as additional industry engagement over the next few months.
This consultation is also only the first of several which we expect in the coming months. There will also be consultations on the design and use cases of Central Bank Digital Currencies (CBDCs) and taxation from HMRC.
Given the timeline and statements from regulators over the last several months, we are not likely to see actual regulations until mid-late 2024.
There is also other ongoing work that will continue to shape the UK’s crypto landscape. The Financial Markets Infrastructure Sandbox will offer the opportunity for financial services firms to experiment with using DLT technology. In September, the Travel Rule will come into force, meaning that firms authorized under the Money Laundering Regulations will have to collect information on the sender and beneficiary of crypto asset transactions. More broadly in the economic crime space, UK law enforcement will receive greater powers to seize illicit cryptoassets when the Economic Crime and Corporate Transparency Bill II ascends into law sometime this year.
All in all, the UK is hard at work constructing the “robust, transparent, and fair standards” that it hopes will place the UK firmly on the cryptoasset map.
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