The UK regulatory landscape: what’s the current state of play?
An initial observation was made that over the last five years or so, the UK digital assets space has transitioned from a burgeoning industry comprised primarily of smaller FinTech start-ups, to one in which there are now a large number of players (including both FinTechs and more established financial institutions) with a range of different products and business models. However, over the same period, the UK regulatory architecture relating specifically to digital assets has changed very little. That being said, there has recently been more activity and more is on the horizon, with recent HM Treasury consultations concerning stablecoins and the promotion of cryptoassets, as well as the new Financial Services and Markets Bill, which purports to create a new regulatory regime applying to ‘digital settlement assets’. The panellists agreed on the need for new regulation in the sector and that the recent focus by the government and by the regulators is welcome.
UK vs Europe: Who’s Ahead?
With the current state of play in the UK in mind, the panellists moved onto a discussion of how the UK’s current approach stacks up against that of its closest neighbour, the EU 27. It was mentioned that, now that political agreement had been reached on the Markets in Cryptoassets Regulation (“MiCAR”), a new regime relating to cryptoassets in the EU was well on the way to entering into force. The panellists agreed that the EU 27 was ahead of much of the rest of the world in creating a fully comprehensive cryptoasset regime for the EU 27 and that many jurisdictions (the UK included) would be watching closely to see which parts work and which parts could benefit from improvement.
By contrast, it was observed that the UK has a less developed approach to cryptoassets at present. However, one panellist highlighted the fact that the Financial Conduct Authority (the “FCA”) had been a leader in helping to develop the discussion around the taxonomy of the digital assets space, helping to establish the different ‘buckets’ for cryptoassets (such as security tokens, exchange tokens, and utility tokens) which are widely used in multiple jurisdictions today.
MiCAR: A Welcome Change?
Looking at MiCAR a little more closely, some panellists expressed the view that whilst it makes for a good start – providing a relatively level playing field and regulatory certainty to market participants –the new regime will not be perfect. For instance, one panellist observed that MiCAR focuses quite heavily on products like stablecoins, whilst potentially paying less attention to certain other areas including decentralised finance (“DeFi”) and non-fungible tokens (“NFTs”). The view was expressed that this structure in the regime could play to the strengths of certain types of player in the digital assets space (who might be subject to fewer rules), whilst placing a greater regulatory burden on others. It was observed that this is likely a product of the long lead time for MiCAR and the fact that certain technologies or products that are now relatively well established were nascent at the time that MiCAR was being developed. One of the panellists predicted that these ‘imbalances’ would likely be rectified in time, with a ‘MiCAR 2.0’ reportedly already being tentatively discussed at the European Commission.
What’s the future for the UK?
Turning again to the UK regulatory landscape, the panellists discussed the fact that in recent years it had become apparent that a general consensus had emerged among legislative and regulatory decision-makers that a holistic approach like MiCAR is not the way forward for the UK. Rather, in view of the novel nature of the industry and the products it is ushering into the market, the UK has been somewhat more reactive in its approach. This is exemplified by the approach to stablecoins. With the announcement of stablecoin Libra/Diem by Facebook (now Meta) in 2019, which raised the prospect of powerful non-governmental entities issuing their own means of exchange, UK policymakers reacted quickly in an aligned manner to develop a proposed regime to regulate these kinds of digital assets. One panellist acknowledged the need for regulation and consumer protection in relation to these kinds of assets, which purport to be stable, but which frequently are not, as illustrated by the collapse of Terra (Luna) in 2022.
However, one panellist expressed the view that the UK (along with other jurisdictions like the US) are likely to be moving away from this kind of ‘wait and see’ approach to regulating cryptoassets in light of the recent bankruptcy of FTX and the associated reports of the appropriation of customer funds by the exchange. This panellist predicted that the UK and US would now likely expedite their decision making on addressing the risks posed by cryptoassets and those offering services in relation to them.
What should the regulators focus on?
Noting the statutory objectives for the FCA of ensuring consumer protection whilst also encouraging competition, the moderator invited views on what should be key areas of focus for the regulators in developing their approach to digital assets. One panellist stated that there should be a focus on ensuring proportionality of regulations and ensuring an appropriate split between the approach to retail and wholesale services. It was observed that whilst there should be a more flexible approach for wholesale firms, who are able to look after their own interests, high standards for retail services are important. The panellists observed the increasing popularity of cryptoassets as an investment choice for retail customers, noting that risky behaviours have been emerging (such as individuals re-mortgaging their primary residences in order to purchase cryptoassets). There was a broad consensus that consumer protection should be a top priority for the regulators in developing their approach.
One panellist highlighted the fact that part of what attracts or repels firms to a jurisdiction is their likely relationship with the regulator. The panellists engaged in an interesting discussion on what kind of an image the FCA is currently projecting in that regard. On one hand, the panellists acknowledged that the FCA is taking positive steps on this, for example by collaborating with market participants in its recent ‘Crypto Sprint’. However, it was also observed that there have been issues in relation to the FCA’s administration of the new AML regime for virtual asset service providers (“VASPs”), with the FCA often keeping applicants under the new regime waiting for up to twelve months without any updates and, in some cases, rejecting applicants without providing reasoning. The panellists agreed that it would be crucial for the FCA to keep an open dialogue with market participants to ensure that the UK is viewed as an attractive destination for investment by firms operating in the digital assets space.
Regulatory developments concerning blockchain in an FMI context
Moving away from a discussion of the regulation of digital assets as an asset class, the panellists discussed regulatory developments concerning the deployment of blockchain technology more broadly. It was observed that blockchain technology could be leveraged in the financial markets to automate certain back end processes, for example by providing the regulator with an up-to-date ledger showing market transactions and thereby negating the need for transaction reporting. The panellists expressed their hope that the financial market infrastructure (“FMI”) sandboxes in the EU and UK would try to unpick some of the issues that arise in the deployment of distributed ledger technology in an FMI context, such as the interaction between distributed ledger-based trading platforms and central securities depositaries.
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Authored by Michael Thomas and Mark Orton.
