Regulatory landscapes across the globe are changing rapidly. In the U.S., regulators are cracking down on unregistered digital asset players, with industry giants like Binance and Coinbase (NASDAQ: COIN) feeling the sting. Meanwhile, the European Union’s sweeping Markets in Crypto Assets (MiCA) legislation received final approval in April; when it comes into force in 2024, it will be the most comprehensive regime specifically tailored to digital assets.
The U.K. has been relatively late to this party, with digital assets remaining largely unregulated to this day, and only recently has the government introduced rules that address digital assets directly.
However, efforts to regulate the space have been ramped up by the collapses and scandals of 2022, notably, Terraform Labs and FTX, and the digital asset landscape in the U.K. is changing.
“I think the effects of 2022 and some of the early systemic incidents that we saw across the market were a catalyst for regulation,” says Albert Weatherill, Partner at Norton Rose Fulbright London, where he focuses on financial services regulation, fintech, and payments.
Speaking with CoinGeek, Weatherill explains the current state of play in U.K. digital currency regulation:
“At the moment, the crypto regime is slightly fragmented, and flows out of our other existing regimes…we’ve had a bit more clarity in recent times with the implementation of the FCA’s crypto assets service provider registration regime, which means those who do custody, and provide crypto exchange services, have had to go through the process of becoming registered.”
As it stands, this is the most significant part of the “fragmented” regime. Any firm or sole practitioner involved in exchanging ‘cryptoassets’ and/or operating a machine that utilizes automated processes to exchange ‘cryptoassets’ (such as a digital asset ATM) must register with the Financial Conduct Authority (FCA), as these activities fall within the scope of money laundering regulations.
On January 10, 2020, the U.K. transposed the EU’s 5th anti–money laundering directive (5AMLD) into law via the Money Laundering and Terrorist Financing (Amendment) 2019 regulations. This updated 2017 regulations and extended the scope of persons subject to anti-money laundering (AML) laws to include Virtual Currency Exchange Platforms and Custodian Wallet Providers.
These digital asset players were required by the AML regulation to comply with customer due diligence (CDD) obligations; assess money laundering and terrorist financing risks; report any suspicious transactions; and, from January 10, 2020, submit an application to register with the FCA.
This requirement to register has acted as a quasi-licensing regime, but the regulatory oversight only covers AML-related activities and checks.
In June, long-mooted digital asset advertising rules were also introduced, including a ban on referral bonuses and a ‘cooling-off’ period for first-time investors. Together with the registration regime, this began filling what Weatherall calls “a bit of a vacuum” in U.K. digital asset regulation.
This patched-together state of affairs looked set for a major overhaul when the U.K. Treasury released a consultation paper in February, proposing a more comprehensive integration of digital assets into the U.K.’s financial regulatory framework.
The February consultation
The Treasury’s proposals, as outlined in the consultation paper, were “informed by recent market events – including the failure of FTX,” and thus the driving force was to mitigate the most significant risks associated with digital asset businesses operating within financial services, without negatively impacting job creation and investment in the digital assets space.
“Unlike the EU—which has gone down a separate regime with MiCA, a new regime that effectively borrows different components of financial services regulation—the Treasury decided that the appropriate mechanism is to essentially amend what we already have,” Weatherill says. “The Financial Services and Markets Act 2000 (FSMA) is well known, people understand it, there’s significant FCA guidance for how to interpret it. So the plan is therefore to utilize and to amend the regime.”
The FSMA is the core legislative framework for financial services oversight in the U.K., which sets out the parameters for activities and entities that fall within the scope of U.K. financial services regulation. These activities are then regulated and supervised by the FCA and the Prudential Regulation Authority (PRA).
The Treasury’s February consultation proposed to work within the FSMA, adapting it where necessary to digital assets. The core proposals in question included:
- Expanding the definition of activities subject to authorization by the U.K. Financial Conduct Authority (FCA) in order to regulate certain activities involving digital assets, including payment activities; exchange activities; investment and risk management activities; lending, borrowing, and leverage activities; safeguarding activities; and validation and governance activities.
- Establishing an “issuance and disclosure” regime tailored to ‘cryptoassets.’
- Strengthening the rules that apply to financial intermediaries and custodians of ‘cryptoassets,’ including in relation to conflicts of interest, governance, capital and liquidity, and segregation of client assets.
- Adopting a bespoke, crypto-specific market abuse regime.
The Treasury consultation ended in April and was by all accounts very well responded to, meaning it could be a while before any solid decisions are made. As Weatherill suggests:
“We’re thinking probably we won’t see an operational regime until 2025. It will take the Treasury time to digest and figure out what the industry is saying.”
However, this move by U.K. lawmakers to bring the country’s regulation more in line with international trends was rudely interrupted in May when the Treasury Select Committee threw a colossal cat amongst the pigeons, strongly urging the Treasury to regulate unbacked digital assets as gambling.
Gambling curve ball
The Treasury Committee is not to be confused with the Treasury itself (which published the February Consultation). The former, also known as the House of Commons Treasury Committee, is responsible for scrutinizing the policies and actions of the Treasury, which is the government department in charge of economic and financial matters in the U.K.
The Committee’s May 17 report, titled “Regulating Crypto,” suggested that consumer speculation in unbacked digital assets, such as BTC and Ethereum, is an area of particular concern and that “the Government needs to take a different approach in order to better protect consumers from harm.” The report also came with a fairly damning assessment of digital assets:
“Unbacked cryptoassets have no intrinsic value, and their price volatility exposes consumers to the potential for substantial gains or losses, while serving no useful social purpose. These characteristics more closely resemble gambling than a financial service, an impression reinforced by the evidence we have received of consumer behavior.”
Much like the Treasury’s February consultation paper, this is clearly a reaction to the events of 2022. Still, while the consultation reacted in line with global regulatory trends, the Treasury Committee zagged hard in another direction.
“You have this body of thought and global movement with general acceptance that financial services is the most appropriate route forward for the regulation of crypto assets. Yet you have a Treasury Committee report, which seems to be pulling against the rising tide. It’s quite disparate to where most of the conventional thought in the space has been leading towards for numerous years,” Weatherill notes.
He goes on to suggest that what made the report all the more baffling is that the Committee’s conclusions were reached after talking to numerous fintech and regulatory experts, as well as industry executives, including Susan Friedman, Head of Policy at Ripple; Ian Taylor, Executive Director of CryptoUK; Daniel Trinder, Vice President Government Affairs for Europe and MENA, at Binance; and Tim Grant, Head of EMEA at Galaxy Digital.
The pervasive influence of 2022 events, and possibly some digital currency skeptics amongst the Committee’s witnesses, seems to be the only explanation for a report that flies in the face of current regulatory trends, ending up with a completely novel solution to digital asset regulation—one which is not adopted anywhere else in the world.
“The suggestion that crypto assets have no purpose, no intrinsic value, that they’re completely worthless, that they’re the sole domain of criminals and hackers, and holding them is effectively equivalent to walking into a casino and putting all your money on red at the roulette table, is to my mind wrong and a significant oversimplification of the developments in the industry in the last decade,” Weatherill states.
He also hints at the contradictory nature of the Committee’s recommendation. Logically, if the Committee had decided that unbacked digital assets were of no intrinsic value, to the point where trading and investing in them amounted to gambling, then surely only the most stringent, secure, and well-resourced regulatory oversight would suffice.
This is not, says Weatherill, a description of the U.K. Gambling Commission—who would theoretically be in charge of digital assets if the recommendation was taken up:
“Some market observers may query why the UK gambling regulatory framework and the Gambling Commission in and of itself would be the appropriate steward for regulation of retail, crypto assets, trading and investment activity in the UK. It’s a trillion-dollar asset class with related financial services activities.”
Weatherill says this is an opinion people in the industry seem to share, who see it as “very difficult to extricate crypto assets from financial services. You are buying and selling, you are interacting with people across the market, people are holding your assets – all of these things are financial services activities.”
For its part, the gambling commission has yet to voice an official statement on whether it would be ready and prepared to take over regulatory control of digital assets.
When contacted by CoinGeek for comment, the commission simply said:
“The buying and/or selling of crypto currencies is not classified as gambling by the Gambling Act and any changes to the Act would rightly be a matter for Government.”
Fortunately for the Gambling Commission, it might never need to prepare an official position on the Treasury Committee’s ‘out there’ recommendations, as the response from the industry and politicians alike was quick and unanimously dismissive.
Not a gamble worth taking
Immediately after the report was published, trade body CryptoUK released a statement saying it “strongly disagrees with the Treasury Select Committee’s conclusion, and we are both concerned and disappointed by these claims which are unhelpful, false, fundamentally flawed and unsubstantiated.”
Ian Taylor, Board Advisor at CryptoUK, acted as a witness for the Committee in preparing the report and was keen to distance himself from its conclusions. He stated that regulating digital assets as gambling “is in direct conflict” with previous Treasury proposals to bring the industry’s activities into the “existing financial regulatory perimeter.”
Luckily for Taylor, who must have been regretting his decision to assist the Treasury Committee in the first place, in early June (two weeks after the report was published), an All Party Parliamentary Group (APPG) for digital assets, made up of 15 members of Parliament and Lords (from the upper chamber), released its own report backing the government and Treasury’s February consultation.
“The APPG supports the position of HM Treasury that cryptocurrency and digital assets are best regulated, in so far as is possible and appropriate, within existing and new financial services regulations, which has a track record in mitigating risks to consumers and investors,” said the APPG.
This is the view shared by Weatherill, who suggests that if the Treasury consultation is largely adopted, some people will surely still lose money investing in digital assets, but that financial services regulation is nevertheless the best route to a safer industry:
“Is a market leading financial services regulatory framework that we have in the UK—one which we think is appropriate to regulate commerce, systemic financial institutions, that touch almost every aspect of our daily lives—the appropriate mechanisms to try and protect consumers, to root out malpractice and ensure more efficient outcomes for the market and its participants? In my view, yes.”
The future of regulation in the UK
So it seems, for now at least, that the Treasury Committee’s flirtation with a gambling classification for digital assets amounted to nothing more than ships passing in the night, but perhaps it can serve to tell us something about the struggle some lawmakers continue to have with digital assets.
“The Treasury Committee paper to me emphasizes more than anything that there’s still debate and still divergent views on some of the core fundamental questions that relate to crypto assets, there probably always will be. This paper is just a reminder that there is precious little middle ground when it comes to how people perceive crypto assets,” says Weatherill, who suggests that despite the divisive nature of the assets, there is general agreement about one thing: “There are very few people now beating the drum for less regulation. If anything, they want certainty.”
It’s hoped the outcome of the Treasury’s February consultation, once it’s had a chance to take in all the responses, could provide this improved regulation and certainty for the market—and there are early signs that this is happening. The FCA’s introduction of stricter rules around digital asset promotion in June, which places ‘cryptoassets’ in the high-risk financial product category, seems to be evidence that a financial services regulatory route will be the way forward in the United Kingdom.
A further sign pointing in this direction came June 19, when the Financial Services and Markets Bill (FSMB), a bill that seeks to extend FSMA banking rules to stablecoins and digital assets, passed through the upper house of Parliament and will now enter its final stages before it’s passed into law. The FSMB was originally introduced in July 2022 to take advantage of Brexit freedoms and give regulators more power over the U.K. financial system.
While the original bill included a proposal to regulate stablecoins under the U.K.’s payments rules, amendments to treat all digital assets as a regulated activity and measures to supervise digital asset promotions were added later as the bill progressed through Parliament.
Crucially, the FSMB would give regulators the powers they need to set the digital asset rules on which the Treasury has been consulting. The bill’s smooth passage through the upper house is perhaps the clearest sign yet that financial service regulation, and the Treasury’s February consultation proposals specifically, are the future for digital assets in the country.
As Weatherill sums up: “There’s obviously room for flex and change, but I don’t envisage a future where we depart from what we’ve currently laid out as our roadmap for the UK regulation of cryptoassets…,which is aligned with global standards and our peers internationally, and is aligned with our existing financial services regulatory framework.”
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