The world of cryptoassets is rapidly evolving, and regulatory frameworks are adapting to keep pace. In the UK, a series of regulatory changes have been proposed and introduced with the intention of providing greater clarity and oversight in the cryptoasset space.
This article outlines some of the key regulatory areas that UK-based cryptoasset businesses (and, in some cases, overseas businesses with UK customers) should be aware of.
(a) Anti Money Laundering Registration
Firms providing certain cryptoasset services by way of business in the UK must register with the Financial Conduct Authority (FCA) under the anti-money laundering (AML) and counter-terrorism financing (CTF) regime.
The cryptoasset services that the registration requirement will apply to include:
Cryptoasset exchange providers – including businesses that exchange, arrange, or make arrangements with a view to the exchange of (i) cryptoassets for money or money for cryptoassets; and/or (ii) one cryptoasset for another. It also includes firms operating cryptoasset ATMs.
Custodian wallet providers – this includes businesses that safeguard (and/or administer) cryptoassets on behalf of customers (or private cryptographic keys on behalf of customers in order to hold, store and transfer cryptoassets).
The registration process is onerous and requires a firm to provide detailed information about its operations, compliance procedures, and AML risk assessments. Registered firms must comply with ongoing regulatory obligations, for example, in relation to customer due diligence, reporting and record keeping.
As at 1 October 2023, the FCA had only registered 43 (14%) of the 310 applications received to date (with 73% of applications being withdrawn and 14% either rejected or refused).
The FCA has shown a willingness to take enforcement action against businesses that fail to register or to otherwise meet their AML/CTF obligations (criminal sanctions are also possible). Businesses engaging in cryptoasset activity should therefore consider (1) whether they need to register under this regime; and (2) if registered, whether they are complying with applicable AML/CTF requirements.
(b) Change in control regime
Another significant change for cryptoasset businesses has been the expansion of the FCA’s change in control regime. A person or firm wishing to acquire or increase (direct or indirect) “control” of a cryptoasset firm registered with the FCA under the MLRs must now submit a change in control notification to the FCA and await their approval before completing the transaction. Failure to obtain this approval is a criminal offence.
Notably, the expansion of this regime gives the FCA the power to assess the “fitness and propriety” of the person or firm wishing to acquire or increase control of an FCA-registered cryptoasset firm. It also gives the FCA the ability to object to the transaction going ahead, and if an objection is made, to make its reasons for objecting public.
Changes made by the Financial Services and Markets Act 2023
(c) The Regulated Activities regime
One significant development in the crypto space has been the introduction of the Financial Services and Markets Act 2023 (FSMA 2023). Having come into force on 29 August 2023, FSMA 2023 has the effect of bringing cryptoassets within the scope of the existing financial services regulatory regime.
Under the Regulated Activities regime, certain activities (for example, advising or managing) cannot be carried on in the UK in relation to certain investments (for example, shares or bonds – otherwise known as “specified investments”) without appropriate authorisation or exemption.
FSMA 2023 has extended the definition of investments to include “any asset, right or interest that is, or comprises or represents, a cryptoasset”. Whilst cryptoassets are not yet included in the list of “specified investments” in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO), the UK government recently announced its intention to move forward with the expansion of this list to cryptoassets in a response to its consultation released in October 2023.
In this response, the UK government stated that:
that, “subject to parliamentary time”, it intends to effect the inclusion of cryptoassets within the list of “specified investments” in 2024. Once this happens, businesses carrying on activities involving cryptoassets will therefore need to ensure that they have the appropriate authorisation and are following the relevant rules and requirements; and
FCA authorisation will not be automatically granted to firms that are registered with the FCA under the AML and CTF regime.
The UK government has referred to this as the regulation of ‘phase 2’ activities, with the ‘phase 1’ activities that it intends to regulate relating solely to fiat-back stablecoins (see below).
(d) Regulation of digital settlement assets (including stablecoin)
FSMA 2023 has also introduced provisions that enable increased regulatory control of digital settlement assets (DSA). DSAs include stablecoins, as well as wider forms of digital assets used for payment and settlement.
Notably, FSMA 2023 enables the UK government to introduce regulation in relation to: (i) recognised payment systems that include arrangements using DSAs; (ii) recognised DSA service providers, and (iii) service providers connected with, or providing services in relation to, these payment systems and DSA service providers.
In May 2022, the UK government released a consultation setting out proposals to adapt the Financial Market Infrastructure Special Administration Regime (FMI SAR) to apply to DSA firms. In its response to this consultation, the UK government confirmed that overall, respondents were broadly supportive of the proposals in its consultations, and that next steps will include: (i) the Bank of England considering whether further guidance on the operation of the FMI SAR is necessary; and (ii) updating stakeholders. Businesses dealing with stablecoins or other forms of DSAs should therefore keep a watchful eye on developments in this area.
FSMA 2023 also has had the effect of bringing DSAs and DSA service providers into the scope of recognised payment systems (which currently fall under the remit of the Bank of England). We note that this follows a consultation released in February 2023 setting out the case for a new digital pound (see our article on this topic here).
An arguably more notable development is that, in October 2023, the UK government released a response to its earlier consultation announcing its intentions to regulate ‘phase 1’ activities relating to fiat-backed stablecoins. Similarly to the ‘phase 2’ activities listed above, this is stated to involve bringing these activities within the scope of the UK’s existing regulatory regimes by:
bringing the use of fiat-backed stablecoins in payment chains into the Payment Services Regulations 2017; and
bringing the activities of issuance and custody of fiat-backed stablecoins (where the coin is issued in or from the UK) within the existing regulatory perimeter of the RAO.
The UK government has stated that it intends to effect these changes as soon as possible, and by early 2024 (again, “subject to parliamentary time”).
(e) The Financial Promotions regime
New rules have recently come into effect imposing restrictions on the promotion of “qualifying cryptoassets” to UK consumers. The key takeaways of these new rules have been summarised in our article here. All UK and overseas firms marketing cryptoassets to UK customers must understand (and comply with) these new rules.
The FCA have said it will be taking robust action against anyone who falls foul of these new rules, and issued 146 alerts about cryptoasset promotions on the first day of the new regime.
(f) The Designated Activities regime
FSMA 2023 also introduced a new Designated Activities Regime (DAR) for the regulation of certain “designated” financial markets activities. This new regime applies to “investments”, which, under FSMA 2023, now includes cryptoassets.
Persons carrying out designated activities will not need to be FCA-authorised or meet threshold conditions, but they will be required to follow the regulators’ rules in relation to the specific designated activity itself. This may include, for example, requirements relating to reporting, trade-related restrictions, or public disclosures.
At present, no activities have been designated in relation to cryptoassets. However, in a consultation released in February 2023, the UK government expressed its intention to create new designated activities tailored to the cryptoasset market. It will therefore be important for cryptoasset businesses to stay updated with developments in relation to this regime.
(g) The existing regulatory regime
As always, cryptoasset businesses should consider whether their activities may be caught under other regulatory frameworks, not strictly designed with cryptoassets in mind. For example, certain cryptoassets or tokens may have the characteristics of electronic money, or securities, or other financial instruments; or the structure of a specific arrangement may mean that a cryptoasset business is operating a collective investment scheme or providing some other kind of regulated investment service.
(h) Digital Securities Sandbox
In a consultation released in July 2023, the UK government proposed the establishment of a Digital Securities Sandbox (DSS) aimed at facilitating the testing and adoption of digital securities across financial markets. FSMA 2023 now provides for the establishment of this type of FMI sandbox.
Challenges for cryptoasset businesses
These developments pose many challenges for cryptoasset businesses, including in relation to:
How cryptoassets are regulated – should the UK government make good on its stated intentions to bring activities relating to stablecoins and other cryptoassets into the scope of the UK’s existing regulatory regime (rather than a new bespoke regime designed specifically with the relevant technology in mind).
How cryptoassets are defined – one of the key issues we see arising for cryptoasset businesses is determining which rules or regimes are applicable. As the definition of what type of cryptoasset is caught differs between the regulatory initiatives listed above, businesses may find themselves in a position where they need to comply with some rules and not others. For example, NFTs do not appear to be a “qualifying cryptoasset” in scope of the financial promotions regime, but may trigger the requirement to register for AML, and may fall within the wider definition of “cryptoasset” set out in regulated and designated activities regimes.
How cryptoasset businesses can be acquired – businesses looking to acquire or increase their ownership of cryptoasset firms in the UK need to be aware of (and comply with) the requirements to obtain FCA approval before doing so.
Broadened geographical scope – whilst the remit of the UK regulation ordinarily only encapsulates businesses based in the UK, the UK’s regulatory scope in relation to cryptoassets may extend to overseas businesses as well (see, for example, the financial promotions regime referenced above).
Fast pace of development – As is evident by the developments noted above, the regulatory landscape in the UK is rapidly evolving to keep pace with changes in the cryptoasset industry. Whilst likely to be time-consuming, keeping up to date with all of these changes will be important. Firms carrying on various crypto-related activities activities may find themselves in a position as early as 2024 where they need to be properly authorised to do so.
Consequences of non-compliance – non-compliance with relevant regulations may lead to criminal, civil or regulatory penalties. This may include criminal prosecution, contracts being deemed void, voidable or unenforceable, fines being issued against businesses and individuals, and/or the FCA using its wide-ranging enforcement powers to prescribe, restrict or suspend the activities of businesses.
If you would like more information on any of the above, please get in touch with a member of the Fox Williams team.
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