The HM Treasury published a paper titled “Future financial services regulatory regime for crypto-assets,” on which it is seeking consultation from the audience and is calling for evidence this week.
In the February 2023 consultation paper, Andrew Griffith MP, Economic Secretary to the Treasury, said that it is the government’s firm ambition for the UK to be home to the most open, well-regulated, and technologically advanced capital markets in the world, which means taking proactive steps to harness the opportunities of new financial technologies.
“By capitalizing on the potential benefits offered by crypto, we can strengthen our position as a world leader in fintech, unlock growth and boost innovation,” said Griffith.
The consultation is open for feedback until 30 April 2023 from stakeholders, including crypto-asset firms, financial institutions, technology firms, other businesses impacted by crypto-asset regulation, representative bodies, academics, trade associations, legal firms, and consumer groups.
In total, the paper has asked stakeholders 52 questions revolving around regulatory proposals, fiat-backed stablecoins, algorithmic stablecoins, NFTs, and DeFi, among other areas, to bring crypto asset activities into the UK regulatory perimeter.
Clear & Timely Regulatory Framework
While the crypto asset market continues to develop with increasing pace and complexity, the MP said, it continues to be a nascent sector that brings both risk and opportunity. However, the government doesn’t aim to stifle risk but rather manages this “desirable part of the cycle of innovation.”
Griffith mentioned the FTX implosion having widespread implications for global crypto-asset markets and investors, which he said “reinforces the case for clear, effective, timely regulation” that will enable crypto service providers to thrive in the UK and people and businesses to invest with confidence.
For this, they are working on the Financial Services and Markets Bill (FSM), which lays the legislative foundations to bring stablecoins and crypto assets into financial services regulation. The government is also exploring just how digital ledger technology (DLT) “could offer benefits to financial market infrastructures and the UK’s sovereign debt management.”
This document, according to Griffith, marks the next step in providing a clear regulatory framework for the sector, which sets out proposals for delivering a broader financial services regulatory regime for crypto assets as well as bringing centralized crypto asset exchanges into financial services regulation for the first time along with other core activities like custody and lending.
A Phased Approach
On Wednesday, in its consultation paper, Britain’s finance ministry established a regulatory framework for crypto assets in the UK to encourage growth innovation and competition, enable consumers to make well-informed decisions, and protect UK financial stability and market integrity.
For this, HMT will use a set of core design principles to guide its decisions on regulation. These principles are based on the idea of “same risk, same regulatory outcome,” under which the government intends to take an activities-based approach to regulation. However, there may be specific cases where systemic risk may warrant further regulation.
The government further intends to avoid applying disproportionate or overly burdensome regulation on entities while remaining agile and flexible to accommodate evolving markets and products.
In line with these principles, the government will continue to push for a phased approach to regulating crypto assets, prioritizing areas with the greatest risk and opportunity.
In Phase 1, which has been ongoing since last year, the UK-based crypto exchange or custody wallet service providers must comply with Anti-Money Laundering and Counter-Terrorist Financing (AML/CTF) registration regime.
The government is also working on the FSM Bill to regulate fiat-backed stablecoins when used for payments as they can become widely used as a form of payment, stated the consultation document.
In Phase 2, the government plans to roll out a set of regulations for broader activities, like trading and investing in crypto assets. Here the goal is to target activity areas with a higher degree of risk and greater opportunities to support the UK’s growth agenda. So not all crypto asset activities will be part of this Phase.
Legislative Approach
The consultation paper provides a glossary of commonly used terms for different types of crypto assets, which, it said, could be subject to financial services regulation in the future. These include “exchange, utility, and security tokens, NFTs, stablecoins, asset-referenced tokens, commodity-linked tokens, crypto-backed tokens, algorithmic tokens, governance tokens, and fan tokens.”
According to the document, these crypto assets can be subject to financial services regulation when used for the purpose of issuance, payment, exchange, investment risk management, lending, borrowing and leverage, safeguarding, and validation.
The proposed crypto asset activities mentioned above seek to incorporate all activities that currently require registration under the MLR (Money Laundering Regulations) into the regulatory perimeter of FSMA. This would include a specific authorization process for firms carrying out crypto asset activities. Although HM Treasury and the FCA both strongly prefer a single authorization process and register, they concede that this is time-consuming, given the phased approach for regulating crypto assets.
The government further plans to bring crypto assets within the regulatory framework established by FSMA. This will give HM Treasury the power to make secondary legislation bringing activities into the regulatory perimeter. It is also proposed that the list of “specified investments” be expanded to include crypto assets. As for those not covered under it, HMT proposes using the new regime set out in the FSM Bill that will either prohibit the activity entirely or set direct requirements.
The UK’s financial watchdog has confirmed that when the new crypto asset regulatory regime comes into effect, businesses will need to adhere to the same financial crime standards as traditional financial firms.
This is because the financial crime rules under FSMA are broader than those in the MLR. The FCA (Financial Conduct Authority) will also consider whether to update the financial crime rules to apply to new crypto asset activities.
Regulatory Outcomes
In its latest paper, the UK government has proposed to create a new set of rules and regulations for crypto assets, which will be based on the existing framework for stock markets and tailored to the unique characteristics of crypto assets.
When it comes to the issuance and disclosures of crypto assets, the government proposes to follow a similar regulatory approach to securities when a virtual asset will be traded on a regulated crypto trading venue as it becomes exchangeable for fiat currency or subject to a public offer. And in line with the approach applied to securities, HM Treasury does not intend to regulate the “creation” of unbacked crypto assets directly.
For admission of crypto assets to a UK crypto trading platform, the government proposes using the MTF model from the reformed UK prospectus regime.
The government is considering whether public offerings of crypto assets, including initial coin offerings (ICOs), where a company creates new tokens and sells them to investors, could be considered securities offerings. If these public offerings of crypto assets are considered securities token offerings (STO), then the intended Public Offers and Admissions to Trading Regime may provide an adequate regulatory framework for this activity.
As for those who do not fit within the STO definition, the government is considering an alternative route. The Designated Activities Regime (DAR), or similar legislative mechanism, is suggested to prohibit these offers unless they were conducted via a regulated platform.
HM Treasury has also proposed establishing a regulatory framework for trading venues, subject to various requirements, including prudential rules, consumer protection, operational resilience, and data reporting. The consultation further seeks views on proposals for requirements applying to crypto asset market intermediation activities and custody activities.
The paper then goes out to propose a new set of rules to crack down on financial crimes in the cryptocurrency market. The proposed regulations would make it a crime to commit market abuse on any digital asset traded on a UK-based exchange, regardless of where they are based or where the trading occurs. The regulations would also require certain market participants, like cryptocurrency exchanges, to take measures to detect, deter, and disrupt market manipulation.
As for crypto lending and borrowing activities, the government has plans to apply and adapt existing regulatory activities while making suitable modifications to accommodate unique crypto asset features.
Call for Evidence
In regards to DeFi, the regulator believes the same regulatory outcomes and objectives should apply to crypto assets regardless of the technology, infrastructure, or governance mechanisms that are being used.
“However, due to the rapidly evolving and novel nature of the DeFi sector, DeFi presents complex and unique challenges for policymakers and regulators,” said the UK’s HM Treasury in its consultation paper, noting that codes, DAOs, and governance tokens may not be undertaking financial services activities by way of business.
As such, the regulator says a few components of the value chain may be impractical to regulate, for instance, if the underlying protocol truly becomes decentralized over time. According to the paper, the focus of regulatory responsibility for mitigating risks could be on centralized on and off-ramps like exchanges, as well as interface providers such as aggregators and other consumer “front ends.”
As for those wondering about NFTs, they will not be in the scope of the crypto assets financial promotions regime because they can represent a wide array of different assets which might constitute non-financial services products, stated the paper.
However, financial services activities related to NFTs or utility tokens will be regulated rather than the asset itself. So, as long as an NFT or utility token is not used in such a way, it would not fall into the scope of financial services regulation unless the structure and characteristics of the NFT constitute a specified investment and the activities carried on corresponding to the token constitute regulated activities that fall within the existing perimeter.
According to HMT, the work of international organizations is essential when it comes to this topic. They don’t want to get ahead of them by creating a framework that would need to be changed when international approaches and standards are decided.
However, it proposes defining a set of DeFi-specific activities like “establishing or operating a protocol” so that those carrying out these activities would be required to obtain authorization. The FCA can also design a bespoke regime around these regulated activities, giving the agency more flexibility in regulating DeFi.
In its call for evidence, HMT has asked respondents whether mining or validation activities should also be subject to regulation and should staking be regulated in phase 2 of its plans.
In the end, the government reiterated its firm commitment to position the UK as a competitive location for sustainable finance.
The post The United Kingdom Publishes Draft Regulations for Crypto-Assets appeared first on Securities.io.
