On 29 October 2018, the Cryptoassets Taskforce (consisting of HM Treasury, the FCA and the Bank of England) issued its final report setting out the UK’s policy and regulatory approach to crypto assets and distributed ledger technology (“DLT”). The report:
- assesses the benefits and risks of cryptoassets and DLT;
- describes the existing regulatory perimeter and how/to what extent cryptoassets are currently regulated; and
- sets out the measures that the authorities intend to take to mitigate risks to consumers and market integrity; to prevent the use of cryptoassets for illicit activity; to guard against potential future risks to financial stability; and to encourage responsible development of cryptoassets and DLT-related activity in the UK.
1. Crypto assets
The Taskforce considers there to be three broad types of cryptoassets (i.e. exchange tokens, security tokens and utility tokens) which in its view are mainly used as a means of exchange, for investment, and as a capital raising tool.
The Taskforce makes some important general observations. It emphasises the need for businesses to assess carefully on a case-by-case basis if/to what extent a particular cryptoassets instrument or activity falls to be regulated under existing rules and legislation, including with regards to aspects of general contract law, consumer law and advertising standards. The Taskforce also reminds regulated firms of the applicability of certain FCA rules and principles to unregulated activity – for example, FCA may hold regulated firms and senior management responsible for breaches relating to systems and control requirements, financial resources or financial promotion rules where such firms engage in unregulated cryptoassets activities.
The Taskforce considers that evolving business models and use cases for cryptoassets were not anticipated at the time the regulatory perimeter was defined and that, therefore, existing regulations need to be reassessed and amended as appropriate.
Against this background, the Taskforce has set out a range of specific measures which the authorities intend to take. These are summarised below:
- Preventing financial crime – The authorities will take strong anti-money laundering and counter-terrorist financing (“AML/CTF”) measures to address any illicit use of cryptoassets. The government intends to go beyond the requirements of the EU’s Fifth Anti-Money Laundering Directive (“5MLD”) and bring fiat-to-crypto exchange firms and custodian wallet providers within scope of regulation. There will be a consultation on various issues including the role of exchange services, cryptoasset ATMs and peer-to-peer crypto exchange platforms and non-custodian wallet providers. The government is also considering whether to require non-UK firms to comply with these regulations when dealing with UK consumers.
- Regulating financial instruments that reference crypto assets – The FCA is aware of harm caused by certain cryptoassets derivative products such as contracts for difference (“CFDs”) referencing cryptoassets. The FCA will therefore consult on a prohibition of the sale to retail clients of all derivatives referencing exchange tokens (e.g. Bitcoin) such as CFDs, futures, options and transferable securities. This measure is not intended to capture derivatives referencing cryptoassets that qualify as securities. The FCA intends to refuse the listing of a transferable security on exchange or of a fund that references exchange tokens, unless it has confidence in the integrity of the underlying market and is satisfied that all regulatory criteria for fund authorisation have been met.
- Clarifying the regulation of security tokens – The Taskforce recognises that, due to the complexity, opacity and particular structure of many cryptoassets, it is often difficult to determine if they fall into the regulatory perimeter; there is also insufficient consistency in the regulatory treatment of such assets. To provide clarity, the FCA will consult on perimeter guidance by the end of 2018. For now, prospective token issuers and market participants are advised to consider if their activities require authorisation.
- Consulting on extending the regulatory perimeter for ICOs – The Taskforce takes the view that the issuance of cryptoassets through ICOs which have the characteristics of specified investments should be subject to regulation. In early 2019 the government will consult with the industry on whether such cryptoassets exist in the UK market and the merits of extending the regulatory perimeter to ICOs.
- Addressing the risks of exchange tokens – Exchange tokens, investment/trading activities relating to exchange tokens and custody aspects are viewed as creating new challenges for existing regulation, not least because there is an inherent need for a consistent international approach. Again, the government intends to consult in early 2019 to re-evaluate the regulatory approach and means for effective regulation.
- Ensuring a coordinated international approach – The UK authorities remain committed to international co-operation (such as through the G20, the G7, the Financial Action Task Force, the FCA’s Global Financial Innovation Network) to ensure global regulatory coherence and co-ordination.
- Improving consumer awareness – Following various measures by the FCA to increase public awareness of the risks associated with cryptoassets, the Taskforce expressly warns consumers to be cautious when purchasing cryptoassets and to be prepared to lose money. The authorities will continue to actively warn consumers of associated risks.
- Maintaining financial stability – The Bank of England will continue to monitor any potential implications of cryptoassets on financial stability and financial market infrastructures (“FMIs”). A cryptoasset which gains wide usage will be subject to current financial stability standards, and FMIs proposing to use cryptoassets or DLT in their clearing, payments or settlement systems will need to demonstrate relevant regulatory requirements are met.
Whilst the Taskforce acknowledges that DLT has the potential to deliver significant benefits in financial services and other sectors, it recognises that DLT is still in its infancy. There are various hurdles before its wider adoption. These include the need to ensure interoperability between systems, competition concerns, legal challenges (particularly with respect to civil law and data protection), and governance issues.
In its report, the Taskforce concludes that there are no regulatory hurdles in the further adoption and development of DLT. The FCA takes a ‘technology neutral’ approach to regulation and has issued a Discussion Paper on DLT concluding that no regulatory changes are required. It is therefore anticipated that the continual growth of DLT will enjoy strong support from the UK government and authorities.
The report demonstrates the UK authorities’ commitment to their respective objectives and a desire to enable and support innovation as a thought leader of future regulation. In that regard, the report sets out the direction of travel for the UK’s regulatory approach based on existing findings and work undertaken to date. Some of the proposed measures will likely be welcome by the industry – for example, the intention to consult on guidance on how existing regulation applies to security tokens and if/to what extent cryptoassets with characteristics similar to specified investments are, or should be, regulated. Other measures, such as a possible ban on retail sales of cyrptoasset derivatives, will be more controversial although they are similar to the intervention measures taken by ESMA in relation to CFDs and binary options offered to retail clients.
In any event, upcoming consultations will be an opportunity for (regulated and unregulated) businesses who are already embracing cryptoassets and DLT, or intending to do so going forward, to shape and influence future regulation.
For further information on the timing and next steps to be taken by the authorities, please refer to Table 5.A of the report.
Co-authored by Yan Lim.