In October 2018, the UK’s Cryptoasset Taskforce published its final report[1], setting out proposals for the UK’s regulatory approach to cryptoassets and distributed ledger technology (‘DLT’) in financial services.
The Taskforce was created in March 2018 as part of the UK government’s Fintech Strategy, comprising of individuals from the Bank of England, the Financial Conduct Authority (‘FCA’) and HM Treasury.
The Report considers benefits and risks of cryptoassets and DLT, outlines the current regulatory perimeter and how cryptoassets are currently regulated; it sets out the Taskforce’s steps plan to develop the regulation of cryptoassets – while mitigating risks to consumers and encouraging responsible development of cryptoassets and DLT-related activity in the UK.
Cryptoasset Regulation – Where are we now?
The Taskforce identify three different types of cryptoassets:
- Exchange Tokens – these are not backed or issued by a central body, they do not provide rights or access like Security Tokens or Utility Tokens but are used as a means of exchange or for investment
- Security Tokens –these can infer a right of ownership or share of future profits, they fall within current UK regulatory perimeters (FSMA) and could also fall within scope of MiFID II[2]
- Utility Tokens – these are used to access a specific product or service on a DLT platform, a utility token could also be used as a capital raising tool although it has more limited appeal for investors.
From a regulatory perspective, it’s clear the Taskforce has a focus on activities associated with cryptoassets, as well as the categorisation of specific types of cryptoassets – the Report includes an overview of common cryptoassets uses and where these sit in the UK’s current regulatory perimeter.
- A means of exchange – exchange tokens can be used to buy and sell goods; but the Taskforce don’t necessarily categorise them as ‘currency’ or ‘money’. Utility tokens could be considered e-money if structured in certain ways, bringing them in the remit of the Payment Services Regulation (‘PSR’)
- To facilitate regulated payment services – these sorts of services may be regulated as money remittance under the PSR, but will not necessarily include the cryptoasset element itself, rather the activity
- Direct investment – this falls outside the current regulatory perimeter unless the cryptoasset is a security token or is made via a regulated entity
- Indirect investment – a financial instrument referencing a cryptoasset will likely fall within existing regulatory perimeters, either under FSMA or MiFID II. These could include: Contracts for Difference (CFDs), options, futures
- Capital raising or Project support – a security token will fall within existing regulatory perimeters; however, a utility token will not.
Taskforce concerns
The Report accepts that cryptoassets and DLT have a place in the world of financial services, but the Taskforce’s priority is to mitigate risks associated with the current generation of cryptoassets, to allow better development and scaling of projects which can really benefit the industry. The Taskforce outlines four risk areas:
- Risk of financial crime – cryptoassets could be used for illicit activity – however, regulation and implementation of systems and controls such as KYC/AML can help to mitigate this;
- Potential threat to financial stability – the cryptoassets market is still in its infancy, so this is unlikely to be a major risk. However, we can’t predict how the market will grow;
- Risks to consumers – cryptoassets and DLT is a technical area. There is a risk that consumers will buy unsuitable products, exposing themselves to unexpected financial risk. However, the market is developing, access to wallets and exchanges is gradually becoming easier and more transparent – appropriate measures need to be in place to mitigate this risk; and
- Market integrity – market abuse strategies, for example: caused by manipulation and lack of regulation, may lead to consumer loss and damage sector confidence.
Next steps
Global interest in cryptoassets and DLT is growing, as the financial service sector and other industries start to recognise benefits and explore new technological offerings.
The FCA Regulatory Sandbox is a good example – the fourth cohort included 29 businesses, with around 40% focusing on DLT based services[3]. Applications for the fifth cohort closed on 30 November 2018, details of successful businesses will be published in 2019.
The Report identifies several action points to further develop the UK’s regulatory approach to cryptoassets and DLT. By end of 2018, the Taskforce will:
- Consult on current FCA perimeter guidance (PERG), considering which cryptoassets activities fall within the existing framework
- Consult on a potential prohibition of the sale to retail consumers of derivative products incorporating certain cryptoassets
- Continue to consult on and establish a timeframe for the Bank of England’s renewed Real-Time Gross Settlement service.
By early 2019, the Taskforce will:
- Consult on developing the existing regulatory perimeter to include broader cryptoassets, including exchange tokens
- Seek to implement the fifth Anti-Money Laundering Directive, which may broaden the scope of the AML regime to cover the cryptoassets sector
- Issue revised guidance on tax treatment of cryptoassets.
Members of the Capital Law team will be attending FCA Innovate 2019 in London on Thursday 24 January 2019. The event includes talks and workshops on the FCA’s approach to regulation of cryptoassets. Watch this space for a further report.
Capital Law is one of only a handful of firms with regulatory expertise in the DLT/blockchain and cryptoasset sector. We are experienced in advising on the regulatory issues arising, our work includes verifying white papers and private placement memoranda ensuring they comply with the financial promotion regulations, giving written advice on categorisation of specific projects – security, utility and exchange tokens, and drafting seed/sale documentation for ICOs or STOs.
Details of our blockchain work across the firm can be found here.
[1] https://www.gov.uk/government/publications/cryptoassets-taskforce
[2] MiFID II – the Markets in Financial Instruments Directive II is the underlying European legislation that seeks to increase financial transparency across the EU and standardise regulatory requirements of financial markets.
[3] https://www.fca.org.uk/firms/regulatory-sandbox/regulatory-sandbox-cohort-4-businesses
