Changes to crypto regulation on the horizon

On 20 July 2022, the Financial Services and Markets Bill (the Bill) was introduced into Parliament. The Bill is the largest piece of financial services legislation for over two decades and covers a wide range of topics. At that time, we published an article which mentioned that the Bill contains very few surprises because all of its main proposals have been anticipated for some time. However, as the Bill is discussed by Parliament, there have recently been some interesting developments in relation to the regulation of cryptocurrencies.

What was stated in the original version of the Bill in relation to cryptocurrencies?

Following on from the Government’s consultation on the UK’s approach to the regulation of cryptoassets, the original version of the Bill brought activities facilitating the use of certain stablecoins within the regulatory perimeter, where they are used as a means of payment. The Bill confirms that this will be done primarily via amendments to the existing electronic money and payment system regulatory frameworks. The Bill introduces a definition of ‘digital settlement asset’ and gives HMT a power to amend the definition to ensure it keeps pace with developments.

The Bill also puts in place a regime that allows for the clear identification of the applicable regulatory requirements (for example, in relation to prudential rules) where a payment system using digital settlement assets or a digital settlement asset service provider is recognised as being systemic by HMT. The Government has sought to reflect the Financial Stability Board’s recommendations on the regulation of global stablecoin arrangements and the CPMI-IOSCO consultation report on the application of the Principles for Financial Market Infrastructures to stablecoin arrangements, and will leave room to update the regulatory framework as international standards are developed.

What has recently changed in relation to cryptocurrencies?

On 25th October 2022, the Bill was discussed in the House of Commons and the Financial Secretary to the Treasury, Andrew Griffith, stated that “cryptoassets and blockchain could have a profound impact across all forms of the financial services sector”. Mr Griffiths’ then referred to the Government's recent work in this area and stated the following:

“Following engagement with industry, the Government recognise the need to move ahead with regulating a broader set of crypto activities beyond stablecoins [as outlined earlier in this article]; that includes activities relating to the trading and investment of cryptoassets such as Bitcoin and Ethereum. Through the Bill, we want to ensure that HM Treasury has the necessary powers to deliver that. The Government believe that creating an effective comprehensive regulatory framework for cryptoassets has the potential to unlock innovation in the UK’s crypto sector and to boost growth.”

To reflect this, an amendment to the Bill has been proposed that will bring “cryptoassets” (as defined below) within the scope of the regulatory perimeter in the Financial Services and Markets Act 2000 (FSMA). In short, this would mean that cryptoassets are regulated in a similar way to more traditional securities such as shares and bonds. If implemented this would therefore lead to a significant change in the regulation of cryptoassets in the UK.

Which “cryptoassets” would now be within scope of the Bill?

The Bill proposes adding the following new definition of a “cryptoasset” to FSMA:

“cryptoasset” means any cryptographically secured digital representation of value or contractual rights that—

(a) can be transferred, stored or traded electronically, and

(b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology)”

One initial point to note is that the above definition is wider than the current definition of a “cryptoasset” that falls within the UK anti-money laundering regime, where the definition of a “cryptoasset” instead refers to “cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”. This is because the new FSMA definition refers to technology that may include distributed ledger technology but is not required to do so, whereas the anti-money laundering definition only applies to distributed ledger technology. This difference is intentional and was noted by Mr Griffith in the House of Commons debate that “The intention is clearly to allow sufficient flexibility to broaden the perimeter”. In addition, HMT would have the power to amend and update the “cryptoasset” definition in the future.

What could this mean in practice?

As mentioned above, the UK Government is proposing to regulate cryptoassets in a similar way to more traditional securities such as shares and bonds. This means that firms that are, for example, providing investment advice, arranging deals or providing custody services in relation to cryptoassets are likely to need to be authorised by the FCA under FSMA. In relation to firms that may already be registered with the FCA under the anti-money laundering regime, this would be a separate application process as it involves a separate authorisation.

In addition, being an authorised firm under FSMA is also likely to mean that the rules set out in the FCA Handbook will also apply, which is not currently the case for firms that are registered under the anti-money laundering regime only.

What happens next?

There is no indication of when the Bill will complete its passage through both Houses of Parliament. To get an insight into potential timescales, we note that from the introduction of The Financial Services Bill 20219-21 into Parliament in October 2021, it took over six months to receive Royal Assent. Further, Mr Griffith stated that government are committed to consult on the issue before the end of the year. The progress of the Bill is tracked on this UK Parliament webpage.

Both HMT and Bank of England (BoE) intend to consult further in this space. Responding to the rise in popularity of cryptoassets, HMT stated in its April 2022 consultation response that it will consult later in 2022 on proposals for the regulation of a wider set of cryptoasset activities beyond those mentioned in this article. HMT stated that the impending consultation will reflect ESG commitments.

Further, in a speech made by BoE Deputy Governor Sam Woods, Mr Woods confirmed the BoE and PRA are progressing to create a regulatory framework for systemic stablecoins to allow non-banks and PRA-regulated banks to innovate in this area. BoE will consult on this in 2023.

What should firms do now?

While firms have some time before these changes would enter into force, they could have a significant impact on firms and their businesses. Any firms that are involved in crypto assets should therefore track these developments closely to determine the extent of their application and the steps that should be taken.