We are now over halfway through 2020, which by many accounts, has been, shall we say, unusual. Coronovirus’s all encompassing impacts aside, we are in the midst of even greater engagement from policy makers looking to bring our nascent industry into the broader regulatory perimeter.
We’ve long anticipated that greater regulatory clarity could finally trigger a tsunami of institutional interest to engage in our sector, propelling both adoption and growth. This past week we’ve seen major announcements from the likes of the U.S. OCC and Mastercard, both of which could fuel business opportunities for crypto exchanges, custodians and traditionals banks. Are we now experiencing the serendipitous moment that we will reflect upon in the future as the catalyst for major development for our industry?
Policy makers around the world are becoming increasingly focused on whether crypto-assets should be regulated. And if so, which regime would they fall into? Many in the industry see security tokens as naturally slotting into existing frameworks such as the Financial Services and Markets Act (FSMA) and Markets in Financial Instruments Directive (MiFID). However, where does that leave payment and utility tokens? Do they even fit into an existing regime? Should lawmakers consider a new bespoke regime and if so what will this look like?
The UK and Brussels
On 20 July, HM Treasury released a long anticipated public consultation for cryptoasset promotions, seeking industry views on the government’s proposal to bring the promotion of certain types of cryptoassets within the scope of the UK existing financial promotions regulation. The measure is intended to enhance consumer protection, while continuing to promote responsible innovation.
What is driving this new regulation? We know that the UK has a good rule of law and an advanced, competent authority (FCA), who oversee and supervise the financial sector, and who’s primary priority is to protect consumers. It is not a coincidence that just a few weeks prior to the release of the consultation, the FCA published their Cryptoasset Consumer Research Note, a quantitative study assessing the size of the market, consumer profiles and their attitudes towards cryptoassets.
The FCA’s findings focussed on increased adoption of crypto in the UK over the past year (since their initial study in 2019), with holders of cryptoassets increasing from 3.5% to 5.35% or 1.5 million to 2.6 million people, and specifically, the importance of advertising in driving consumer behaviour. In particular, the report noted that advertising regarding cryptoassets, which is often targeted at retail investors, is not typically fair or clear and can be misleading. Furthermore, the report highlighted that unsophisticated crypto investors were more likely to be influenced by adverts and held incorrect assumptions about the levels of regulatory and consumer protection available to them in today’s current regulatory landscape.
The Government’s Cryptoasset Promotions consultation proposes to strengthen the FCA’s ability to establish and enforce a regulatory ‘gateway’, by which an unauthorised firm must pass through to undertake cryptoasset promotions, requiring them to seek review and approval of their promotions by an authorised person within a FSMA authorised firm before they are communicated. Within the proposal, failure to obtain such approval would be considered a regulatory breach and a criminal offence on the part of the unauthorised person.
In October 2015, as part of the UK’s ongoing commitment to The Financial Action Task Force (FATF), the government issued the first National Risk Assessment (NRA) for money laundering (ML) and terrorist financing (TF) to identify, understand and assess the money laundering and terrorist financing risks faced by the UK. While this assessment was not relied upon in isolation, the increased understanding it provided assisted the government, law enforcement agencies, and the private sector in targeting resources at the areas of highest risk, intended to enable a risk-based and proportionate approach to preventing financial crime in the U.K.
Within the initial 2015 NRA report, the government determined that money laundering and terrorist financing risks associated with cryptoassets was low. This determination was confirmed again in their second NRA assessment in 2017.
However, this year we experienced a significant change to the U.K. Government’s approach to mitigating risks associated with financial crime, with the EU’s Fifth Anti-Money Laundering Directive (AMLD5) coming into force in January. Under the fifth directive, the scope of persons subject to the earlier regulations (AMLD4 in 2017) was expanded to include cryptoasset exchange providers, custodian wallet providers and cryptoasset automated teller machines.
We also know that the Treasury has been working on updating the NRA, and the industry expects the report will be released in September. Based on the increased adoption mentioned earlier and the new compliance requirements proposed, the big question is whether the NRA will upgrade the current money laundering and terrorist financing risks posed by cryptoassets from low to medium.
The European Commission (EC) issued a public consultation on a framework for markets in cryptoassets in December 2019, which concluded in March 2020. The consultation paper was followed by a detailed due diligence report on virtual currencies by the European Parliament. Since, the EC have subsequently issued 2 non-papers, one in May and another in July, seeking to test the proposed new laws with each member and gain political buy-in before a final proposal is issued.
CryptoUK was pleased to see that the commission has broadly listened to the industry and is proposing a bespoke regime for non-security tokens (payment & utility), and also that the commission is not considering stablecoins as a form of e-money. For crypto-assets which do not qualify as financial instruments, such as utility tokens and asset-backed cryptoassets, the Commission will propose an all encompassing bespoke regime – the Markets in Crypto-Assets Regulation (MiCA). The regulation will introduce requirements for cryptoasset issuers, stablecoin issuers and cryptoasset service providers. In particular, significant asset-backed cryptoassets will be subject to additional requirements, such as capital requirements, third party audits & clear and not misleading whitepapers. The question as to whether the new regulations for stablecoins will be more demanding than the e-money regime remains.
There is an interesting difference between the two non-papers – the removal of the proposed opt-in regime. This type of regime has previously been used in other member states and allows for services to be “passported” across the Eurozone. However, this “two-speed regime” is difficult to adopt EU wide. It would require the country’s supervising agency (ie.BaFin) to run their own national regulatory regime as well as an additional (and potentially vastly different) regime for those who opt-in to the EU regime, thus requiring a great amount of resource, possibly unavailable or unaffordable to smaller member states.
As the opt-in regime was not discussed in the second non-paper, we speculate that a fully harmonised regime for crypto-asset issuers and service providers, as mentioned in the earlier non-paper, may be the EU’s preferred regulatory path.
Whatever your view of Brexit, the UK has now left the EU and is in the transition period and will commence a new relationship with the EU on 1st Jan 2021. Unfortunately due to the pandemic, the UK Cryptoasset Task Force has postponed its upcoming consultation on the UK’s broader regulatory approach to cryptoassets to late 2020 or early 2021. We await to see whether this results in the UK consultation aligning to those of the EU.
The EU seems to have laid its regulatory path – a fully harmonised bespoke regime. The question now is whether the UK government will divert from Brussels and adopt a more friendly approach, thus attracting increased investment in the UK. Or, will the UK government forge a similar path aligned to EU legislation to maintain a level playing field and reduce opportunities for regulatory arbitrage to continue? Whatever comes to pass, we believe we will likely look back on 2020 as the year regulatory clarity influenced the future opportunity for crypto and innovation.
Author’s Credit: Ian is the Chair of CryptoUK, the U.K. trade body driving policy development between digital asset industry participants and policymakers to educate and nurture an environment that fosters innovation, job creation and investment. He is also an investment banker and crypto enthusiast.