On 7 January 2021, HM Treasury published the “UK regulatory approach to cryptoassets and stablecoins: Consultation and call for evidence” (the Paper).
This publication was borne out of the Chancellor’s March 2020 budget where, in response to the rapid growth of cryptoasset markets in recent years, the Chancellor committed to:
- consulting on bringing cryptoassets within the scope of financial promotions regulations; and
- consulting on broader regulatory approaches to cryptoassets and stablecoins.
Earlier this year, HMT published the consultation paper on cryptoasset promotions which concluded on 25 October 2020. This Paper now addresses the second commitment.
The Paper is made up of two parts. The first is the consultation paper, which discusses the current regulatory landscape for cryptoassets, and puts forward a policy with specific proposals regarding the regulation of cryptoassets for payments purposes. The second is a call for evidence covering a broad range of questions in relation to cryptoassets.
John Salmon, Technology Partner and Global Head of Blockchain at Hogan Lovells, comments:
“This consultation paper is a very welcome step. Stablecoins have grown in prominence over the last 18 months or so, and regulatory uncertainty has been hindering its application. The EU published the draft regulation for Markets in Crypto-assets (MiCA) and this has been broadly well received, although there are a number of issues which will need to be overcome. Similarly, this Paper will represent an important opportunity to provide clarity in this space, especially in light of Diem’s plans to launch stablecoins that are backed by single fiat currencies (as part of its rebrand) by 2021.”
Lavan Thasarathakumar, Consultant at Hogan Lovells, says:
“It is encouraging to see the UK calling for evidence on a number of emerging areas in the crypto space. In particular, DLT-based financial market infrastructures has huge potential in the UK. We have already seen the proposal of a pilot regime in Europe, albeit on a restricted scale. In a similar vein, this Paper will help to pull together evidence for how DLT can be used to enhance the relevant systems in the UK and, given the maturity of the UK’s financial markets, whether a more ambitious approach can be taken in the UK. Additionally, one of the most hotly discussed topics currently in this space is DeFi—notably, MiCA has been criticised for not delivering a solution for truly decentralised projects. HM Treasury can take this opportunity to develop a regime which can attract such ambitious DeFi projects to the UK.”
HM Treasury’s proposed approach will see future legislation in this area define the objectives and scope of the regulatory perimeter, as opposed to mandating specific requirements. On this, John Salmon further comments:
“Given the speed at which the industry is developing, such an approach is welcome—it will allow independent regulators to develop standards that are more agile and, therefore, more able to keep up with innovations and novel business models.”
The Consultation Paper
The consultation paper proposes:
- a policy approach; and
- an expansion of the regulatory perimeter.
The suggested approach will involve specific requirements being implemented by independent regulators (e.g., via rules or codes of practice) within a wider framework of objectives and considerations set out by HM Treasury. HM Treasury currently seeks to define the scope, objectives and principles of the regulatory approach, rather than pinning down precise requirements.
The Paper identifies the following key objectives:
- protecting financial stability and market integrity;
- delivering robust consumer protections to the same level as other regulated instruments used for the same purposes (e.g. payments); and
- promoting competition and innovation in the UK.
Additionally, the Paper suggests a number of guiding principles including:
- ensuring a level playing field (i.e. applying the concept of “same risk, same regulatory outcome” and of technology-neutrality);
- maintaining the delineation of UK regulator responsibilities and applying existing regulations where appropriate;
- taking a proportionate approach and focusing on urgent risks and opportunities;
- taking an agile approach that is able to reflect international discussions and standards.
The Paper requests feedback regarding the approach, objectives and principles as outlined above, as well as views on the extent to which the UK’s approach should be in line with other jurisdictions.
Expansion of regulatory perimeter and new regime for “stable tokens”
Under the proposed approach, activities associated with unregulated tokens primarily used for speculative investment purposes will remain outside the perimeter of conduct and prudential regulation. However, such activities will be subject to financial promotions regulations and AML/CTF requirements. Utility tokens will also remain outside the scope of conduct and prudential regulations.
The Paper further sets out a regulatory framework for “stable tokens” (i.e., tokens which maintain a stable value by referencing asset(s)). The regime would seek to draw on existing e-money and payments legislation.
In terms of scope, the proposed regime intends to cover tokens which can reliably be used for retail or wholesale transactions by being linked to or collateralised by stable reference assets. Algorithmic stablecoins will not be covered.
It is proposed that the Financial Conduct Authority will authorise and supervise relevant entities (e.g., issuers, exchanges and custodian wallets) carrying out certain activities in the UK, and the CP suggests a list of activities and high level requirements. A number of activities and requirements bear similarities to those under existing payments regulation (such as the activity of transmitting funds, and requirements relating to risk management and financial crime). However the list also sets out activities and requirements which are more specific to stable tokens. These include, in particular, activities involving issuance, creation and destruction of tokens, value stabilisation and reserve management; and requirements in relation to quality of reserve assets, safeguarding of tokens and private keys, and custody of client assets.
Where stable token arrangements function similarly to a payments system, it would also be subject to regulation by the Payment Systems Regulator. Furthermore, in a stable token arrangement, issuers and system operators which reach systemic status and critical service providers as defined under the Banking Act 2009 would be regulated by the Bank of England and by enhanced requirements (which would be grounded in the Principles for Financial Market Infrastructures). Other core entities within the stable token chain (e.g. wallets) may also fall within scope of systemic regulation.
The proposed regime may additionally impose location requirements on entities which actively market to UK customers (e.g. obligation to have a UK establishment).
The Paper requests feedback on the proposed framework for stable tokens, including:
- whether existing payments regulation should be used as a basis for regulating stable tokens, and if the listed functions and requirements are sufficiently comprehensive;
- the extent to which “single-fiat tokens” (i.e. where the value is linked to a single fiat currency) should be subject to requirements under the Electronic Money Regulations 2011;
- the classification of unbacked tokens which seek to maintain a stable value through the use of algorithms;
- views on proposed location requirements; and
- the application of existing legislation relating to e-money, payment systems and systemic payments systems.
Call for Evidence
HM Treasury has also issued a call for evidence which specifically looks into:
- the application of existing regulation to security and investment tokens;
- DLT-based financial market infrastructures, including the potential benefits of adopting DLT for trading, clearing and settlement, and the adequacy of existing legislation;
- the extent to which other unregulated tokens and Decentralised Finance (DeFi) should be brought within the regulatory perimeter, and the risks and opportunities presented by DeFi.
The deadline for responding to the CP is 21 March 2021. HM Treasury will additionally undertake a programme of stakeholder engagement (e.g., roundtables and workshops) before setting out a final response.
Authored by John Salmon and Lavan Thasarathakumar