PRIMER: UK Crypto Regulation
Following Boris Johnson’s resignation along with key cabinet members, market participants expect delays to the agenda but no major policy changes
The UK has taken a piecemeal approach to crypto regulation, with separate proposals for anti-money laundering (AML) mechanisms, consumer protection and financial stability. In this edition of its primer series, IFLR unpicks existing and pending regulation for cryptoassets.
The state of play can be summarised by a tension between an ambitious government, with key figures such as Rishi Sunak and John Glen setting intentions to make the UK a crypto hub before their resignation, and a much more tentative Financial Conduct Authority (FCA) that has faced resourcing issues.
“Everyone thinks regulation is necessary to give consumers the protection and confidence and bring cryptoassets into the mainstream,” said Nick Price, partner at Osborne Clarke. “The FCA is reluctant to regulate cryptoassets due to a lack of sufficient funding and experienced staff to regulate it appropriately without restricting competition and innovation.”
See also: EU agrees on MICA regulation
However, market participants expect the regulator to pick up the pace due to the recent crypto winter that saw stablecoin Terra and sister token Luna crash, and crypto valuations drop significantly as a result.
“Regulators need to get on with the job of bringing the use of crypto technologies in finance within the regulatory perimeter,” said John Cunliffe, deputy general for financial stability at the Bank of England, in a speech this week. “To put it the other way around, the lesson we should not take from the crypto winter is that crypto is somehow over and we do not need to be concerned about it anymore.”
Relevant rules include the Fifth Money Laundering Directive (MLD5) as implemented pre-Brexit, the financial promotions regime, which is currently under consultation, and the Financial Services and Markets Bill, which includes stablecoin regulation.
The UK’s money laundering regime requires cryptoasset firms set up in the UK to register with the FCA. Only firms with appropriate Know Your Customer (KYC), source of funds and proof of funds checks, can be registered to ensure that no illicit money is coming through the system.
“The objective is sound, but the way they’ve gone about it is not,” said Bradley Rice, partner at Ashurst. “If you’re not in the UK, the laws don’t apply so the regime doesn’t protect consumers – it just forces them to go to offshore providers that local UK regulators have no authority to take action against.”
A major concern in the industry is that the AML registration regime is encouraging firms to set up abroad due to the very high bar that has been set for firms looking to register with the FCA. As it stands, over 150 crypto firms applied for registration but only 35 were approved.
Many market participants put this down to the FCA’s reluctance to regulate these entities. “I’m sure the 35 firms that got through have gold-plated money laundering policies and procedures,” said Osborne Clarke’s Price. “I’m not certain that all of those who withdrew their application or were denied authorisation didn't have very good AML policies and procedures.”
As well as a high rate of firms being encouraged to withdraw applications or being rejected from the register, long delays to the approval process have been an issue.
“The FCA has only approved a handful of firms to the cryptoasset register this year,” said Eva Lawrence, COO at Arcane Crypto. “Companies are looking at around 18 months to be assigned a case officer and have their applications reviewed. This makes it difficult and unattractive for new firms that are not currently on the temporary registration list – which only includes one firm right now – to launch a cryptoasset business in the UK".
This points to an obvious tension between government ambitions and regulators’ reluctance to follow through.
However, market participants expect this to be less of an ordeal going forward. “The resourcing and education issues haven’t gone away,” said Ian Taylor, CEO at CryptoUK. “But now we’ve gone through this registration process once, it’s going to be less painful for the regulator and the industry next time.”
The Financial Services and Markets Bill is set to include proposals on how to regulate stablecoins as e-money. Market participants have been broadly happy with this approach but have expressed concerns over how to tackle stablecoins used for investment purposes, and over transferring coins abroad.
“The government is approaching stablecoins by amending the electronic money and the payment services regulations,” said Ashurst’s Rice. “This is absolutely the right way to go about it. It's a very sensible approach of adjusting existing laws to achieve their goals.”
Regulators have laid out their views to bring stablecoin providers more in line with expectations on banks. “Our intention is to apply the ‘same risk, same regulatory outcome’ approach in the UK,” said the Bank of England’s Cunliffe. “We hope to issue a consultation document on the regulatory policy framework later this year. Taken as a whole, the UK authorities have made clear that they are prepared to see stablecoins operate in the UK, provided these are properly regulated and supervised.”
It is uncertain when exactly the legislation will go through parliament. “The bill is expected when parliamentary time allows,” added Rice. “MPs have a lot to deal with – not least the cost-of-living crisis, the Ukraine war and everything else. Trying to get crypto regulation on the statute books won’t be priority number one or two.”
The review of the financial promotions regime is another key issue and is expected to bring cryptoassets in line with other financial products. Here again, market participants worry about the practical implications this would involve.
The proposals class cryptoassets as a high-risk investment, meaning firms looking to mass-market such services would have to get all advertisement approved by a third-party firm licensed under the Financial Services and Markets Act (FSMA).
Finding such a firm could prove a challenge for many entities operating in the cryptoasset space.
“By cutting off the ability to mass-market, regulators will achieve their objective of stamping out harm to consumers,” said Rice. “But they will also stymie innovation significantly, which is a problem.”
For Rice, this regulation has the potential to completely undermine the government’s ambition to make the UK a cryptoasset hub.
It’s also unclear whether there will be enough external firms willing to take on the added risk and approve the promotions.
“There are serious commercial considerations,” said Konstantinos Adamos, senior legal counsel at Revolut. “Clearly, it won’t be commercially viable for a small crypto firm to seek external advice every time it wishes to post something on Instagram.”
Despite these manifold concerns, industry participants are broadly optimistic on what’s next for the UK crypto industry. The FCA’s CryptoSprints, which have enabled industry engagement on many areas of crypto regulation, have also been positively viewed by many.
“If the FCA takes on board industry feedback from industry participants at the sprints, hopefully we’ll see that come through as the policies develop,” said Rice.
With a new prime minister and cabinet expected to be in place by September 5, more certainty on this should emerge by year-end.