The UK has published a set of papers that could shape its regulatory framework for cryptoassets for years to come.
The first set of papers lays out the government’s response to a lengthy consultation published in early 2023 on the Future Regulatory Framework for Cryptoassets. The paper provides the basic shape of the UK’s future framework and a potential timeframe for implementation. Alongside this paper, the government published an update to its plans for the treatment of Fiat-Backed Stablecoins and a paper on Managing the failure of systemic Digital Settlement Asset (including stablecoin) firms.
Closely following this first set of papers, the FCA and the Bank of England published two further discussion papers on the imminent regulation of fiat-backed stablecoins for payments which will aim to “regulate stablecoins…to protect consumers, prevent money laundering with a robust set of rules and to safeguard financial stability.” In short, there are a lot of papers to unpack.
Future Regulatory Framework for Cryptoassets
So does this new framework, articulated in the first paper, make the UK, what City Minister Andrew Griffeth calls, “the obvious choice for starting and scaling a cryptoasset business?”
First things first, it certainly provides legal and regulatory clarity on key issues. The Financial Services and Markets Act (FSMA) will be the primary piece of legislation that applies to financial activity – issuance, exchange, investment, risk management, lending, borrowing and the provision of custody – for cryptoassets. The framework covers any entity undertaking a regulated activity as a business in the UK.
What about other key regulatory areas?
TLDR - Position on Key Regulatory Areas
- Authorizations - details on the authorization process will be provided in 2024, current authorizations will not equal an automatic authorisation under the new regime;
- Disclosures - should provide consistent information and be in line with international standards, further details will follow;
- Custody - new laws will be created to cope with the nuances of cryptoasset custody and the various custodian types;
- Market Abuse - The pre-existing market abuse regime will be adopted for cryptoassets and will require information sharing in the sector;
- NFTs - if an NFT is clearly not a financial product then it does not fall under the FSMA regime;
- Lending - the UK recognises the difference between lending and staking. Lending will be covered under new rules which will be tailored to retail and institutional products;
- Staking - the government is accelerating its work on staking by finding a clear definition for the activity and establishing a taxonomy of different business models;
- Mining - The government will not be regulating mining at this time
- DeFi - The UK does not intend to ban DeFi or regulate it at this time and will continue to work in international foras to find a regulatory solution;
- Fiat-backed stablecoins - Under phase 1 of the government’s plan, rules for bringing fiat-backed stablecoins for payments are prioritized (see below).
The consultation report contains very little detail on what the new authorization process will look like for firms engaged in cryptoasset activities. We know that current authorization under the Money Laundering Regulation will not equal an automatic authorization under the new regime. Firms already authorized under Part 4A of FSMA will also not receive automatic approval and will have to apply for a Variation of Permissions to undertake newly regulated activities. The government plans to provide additional legislation in 2024 which would provide needed detail on what the authorization process will look like.
The future framework will address vertical integration by requiring firms to follow the relevant regulatory rules for each regulated activity undertaken.
The government would like to see disclosure documents for all cryptoassets so that consistent information is available to all consumers. Cryptoasset trading venues will have to disclose information set out by the FCA, informed by the IOSCO standards, on cryptoasset disclosures. That information will likely have to include “information about a token’s underlying code, vulnerabilities, risks and dependencies.” Under the UK framework, trading venues would not be liable for all consumer losses as long as they take reasonable care. This is in contrast to the EU approach which holds firms fully accountable.
The new regime will define custody as i) safeguarding ii) safeguarding and administration, or iii) the arranging of safeguarding or safeguarding and administration of a cryptoassets. Self-hosted wallets, according to the new regime, would not fall under the custody definition.
The new rules essentially apply the current market abuse regime to cryptoasset activity but will rely on greater information sharing within the sector.
The government takes the position that “NFTs of themselves are more akin to (for instance) digital collectibles or artwork than a financial services product,” and thus would not fall under this regime. If an NFT is being used for financial activity, however, then it will be regulated under this regime. The report gives useful examples of where NFT use would fall outside of the regime such as when used in games outside of financial marketplaces.
The government intends to create a newly defined regulated activity of “operating a crypto asset lending platform” which will be split between retail and wholesale products with priority given to the creation of the retail regime. These firms will have the same requirements as those defined under cryptoasset intermediation and custody regimes. The government makes it clear that cryptoasset staking is not covered by lending services and requires a specific regime. The government commits to accelerating its work on staking seeking to provide a clear definition and taxonomy of the activity. MiCA does not include cryptoasset lending or staking.
“In line with the government’s innovation-forward approach, the government does not intend to ban DeFi.” The government recognizes that it would be premature to regulate DeF at this current moment and will instead continue to engage with international standard setting bodies on their work in this area.
“HM Treasury agrees with respondents that a spectrum of decentralization needs to be recognised within the DeFi ecosystem rather than a binary between centralized or decentralized.” This approach is consistent with the EU which also left DeFi outside of the scope of MiCA and will continue to monitor developments in the technology.
Fiat-backed stablecoins - what’s the latest?
In the remaining reports and discussion papers, the government sets out its imminent plans for fiat-backed stablecoins which it defines as, “a cryptoasset that seeks or purports to maintain a stable value by reference to a fiat currency and by holding fiat currency, in whole or in part, as backing.” This definition intentionally excludes crypto-backed and algorithmic stablecoins which remain outside of the scope of future regulation for the time being and so will peer-to-peer transfers. For MICA-philes you will notice that this definition differs from the EU’s which splits stablecoins into two groups - Asset Reference Tokens (ARTs) and Electronic Money Tokens (EMTs) and instead opts for a single class of assets.
The UK will regulate fiat-backed stablecoins in two ways:
- Regulating the use of fiat-backed stablecoins in payment chains; and,
- Regulating the activities of issuance and custody of fiat-backed stablecoins when issued in or from the UK regardless of their use.
The FCA, the Payment Services Regulator (PSR) and the Bank of England will all have a role in supervising fiat-backed stablecoins. The FCA will be the primary regulator and in their discussion paper set out potential rules for how the issuance, custody and organizational requirements for firms involved in fiat-backed stablecoin payments will work. Systemic payment systems that use fiat-backed stablecoins, sterling based or otherwise, will fall under the Bank of England who in their discussion paper set out further requirements for issuance and backing of systemic assets, as well as, the AML/CFT requirements that would be placed on issuers.
Both UK issued and non-UK issued stablecoins are intended to be covered by this regime. Marking a stark departure from the EU’s approach, the UK hopes to reach a stage where it will allow non-UK issued stablecoins to be used in the UK as long as the “payment arranger” meets UK standards. Unlike the EU, it appears that the UK won’t issue transaction limits if UK standards are met.
Clarity on the timeline for the regulation of fiat-backed stablecoins for payment is also provided. Feedback on the discussion papers will close in February 2024, when the FCA and Bank of England will then use it to inform a final consultation on the rules leading to regulation in 2025.
Overall the proposed regimes for fiat-backed stablecoins and broader cryptoassets shows that UK policymakers intend to provide a clear regulatory framework and rules of the road for an industry hungry clarity. Sounds like the UK’s crypto hub ambitions might come true.
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