In February, HM Treasury published a long-awaited consultation paper on its proposals for a new regulatory regime for cryptoassets. Further regulation in this area has been expected for many years, and, if the proposed rules are to be implemented, this could transform the crypto asset ecosystem in the UK. The millions of UK consumers who hold cryptoassets could see substantial changes if these rules are adopted.
The changes being considered will include bringing activities carried out in relation to cryptoassets within the scope of mainstream financial services regulation. This means that to those in traditional financial services or banking sectors, the new rules will feel familiar, but it will be a huge change for cryptoasset firms where their activities have been largely unregulated.
Under the new regime, unregulated cryptoasset firms will be required to obtain authorisation by the Financial Conduct Authority, before they are legally permitted to carry on their cryptoasset activities. The proposed regime will also require cryptoasset firms to comply with detailed rules familiar to other financial services firms on how their businesses are run and how they communicate with their customers.
Limited regulatory regime
Since 2020, the limited regulatory regime for cryptoasset firms in the UK required firms doing business in the UK to register with the FCA for supervision of their anti-money laundering processes and controls. Many crypto firms did not successfully obtain this more limited registration and the FCA noted in 2022 that around 80% of applications to register were either withdrawn or refused following submission. This led to a number of crypto firms relocating operations to countries with more crypto-friendly rules (or no rules). These firms have continued to do business with UK customers on a cross-border basis and UK customers are holding, trading and buying cryptoassets using crypto firms registered around the world.
Extending the geographic scope of regulation
The Treasury’s proposed rules will extend the geographic scope of the regulation and will apply to crypto firms providing services to UK based customers. This will mean overseas crypto firms will have to apply to the FCA for an authorisation to provide services to UK customers even if they have no other presence in the UK.
Some international firms may cease to provide services to UK customers to avoid the requirement to obtain regulatory authorisation, others may continue to carry on their activities without approval assuming that it will be hard for the FCA to track this and take enforcement action against them.
Requiring a firm to have a physical presence in the UK is undoubtedly to ensure that the activities of these firms can be adequately supervised and investigated, and that any enforcement proceedings are effective. However, if the Treasury paper is suggesting that this may not be necessary in relation to cryptoasset firms, this will be of interest to financial services firms who have not been able to provide services to UK customers since Brexit.
If a physical presence were no longer required for authorisation, this may be very welcome to more traditional financial services providers hoping to resume operations in the UK too. The Treasury paper states they intend to pursue “equivalence type arrangements” in relation to crypto firms authorised in other countries may be able to provide services to UK customers provided they are subject to equivalent standards in their registered jurisdiction. It will be interesting to see whether this is adopted, and whether this thinking will be extended to other financial services firms in due course.
Improving consumer understanding, reducing misleading promotions
Crypto firms will also be required to comply with the financial promotions regime and these changes will likely be welcomed by consumers and traditional financial services firms, as they are designed to address the risk of misleading cryptoasset promotions causing harm to customers. The proposed rules should, in theory, improve consumer understanding and change the way in which promotions are communicated and prescribe risk warnings which must be included, hopefully reducing the instances of misleading promotions and resulting financial harm to consumers. The Treasury also addresses the risk of market abuse and market manipulation schemes seen in the crypto ecosystem such as “pumping and dumping” which often involves social media promotions of cryptoassets by celebrities and influencers.
There is currently little protection for consumers from market abuse in crypto and manipulation is harder to detect than in traditional securities markets which have a clearer picture of the “issuer” and control of inside information. However, as noted by the Treasury effective regulation in this area will require international standards and cooperation.
This sentiment really applies to all crypto regulation, though improving consumer knowledge and understanding of cryptoassets and including cryptoassets within mainstream regulation will likely be welcomed by financial services firms, it will be interesting to see whether enforcement proceedings for non-compliant crypto firms can be effective.
Kate Troup is a partner at Fladgate LLP
Ottilia Csoti is an associate at Fladgate LLP