UK government publishes consultation on future financial services regulation of cryptoassets

Without warning, overnight on 31 January, HM Treasury published a Consultation Paper entitled  the "Future financial services regulatory regime for cryptoassets". The paper was not mentioned as part of the Edinburgh Reforms announced in December 2022, but nevertheless marks the start of the journey for UK cryptoassets regulation. 

The consultation paper itself sets out the preliminary thinking by the Treasury and Financial Conduct Authority, and calls for evidence from any interested party through asking some high-level questions on the proposed approach the Treasury is seeking to take. 

The closing date for responding to the consultation is 30 April 2023. There are no firm timelines for subsequent next steps, although the Treasury has stated that more specific consultations with stakeholders will also be forthcoming. The UK remains behind the European Union on cryptoassets regulation, as the proposed Markets in Cryptoassets legislation is already in draft form and making its way through the European Union legislative process.

Proposals made in consultation paper

In summary, the paper sets out that cryptoasset-related activities ought to be regulated under the Financial Services and Markets Act 2000 (FSMA), and therefore where possible, should follow a similar pattern of regulation as for the majority of the existing UK regulated financial services sector. This means  that activities will be regulated rather than the underlying asset itself, although the list of "specified assets" under FSMA will be expanded to include "cryptoassets". The approach to fitting cryptoassets regulation into the existing regime is described as being "same risk, same regulatory outcome". 

There is a proposed definition of "cryptoasset" which is already in draft form in the Financial Services and Markets Bill going through Parliament. This definition is deliberately drawn widely, and is wider than the current definition under the Money Laundering Regulations. The paper also states that the definition of cryptoassets in this context could include non-fungible tokens (NFTs), and therefore certain activities in relation to NFTs have the potential to be caught. 

There is a recognition, however, that there are some inherent differences between traditional financial services and cryptoassets, and therefore that regulation may have to work differently.

From a territorial perspective, the new regime would apply to firms operating in the UK or providing services into  the UK – due to the globalised nature of cryptoassets, there is an understanding that overseas-based firms should be regulated in the UK in order to provide services to UK customers. However, firms operating cryptoasset exchange venues may be required to subsidiarise and have an establishment in the UK. The consultation paper also demonstrates that the UK authorities have further thinking to do as to how best regulate participants in cryptoassets systems, such as validators, oracles or decentralised autonomous organisations.

The activities that are proposed to be regulated: cryptoasset issuance, payment-related activities, exchange activities, investment & risk management, custody, and lending/borrowing. The paper takes each of these activities in turn, setting out the Treasury's preliminary thinking as to how best to regulate such activities, together with identified risks requiring regulation and difficulties there may be in trying to impose a regulatory regime on each activity.  

The paper proposes that there will be a phased approach to the implementation of UK regulation, with activities in relation to fiat-backed stablecoins to be regulated in a "Phase 1", with all other cryptoasset-related activity to be regulated in a "Phase 2". No timing for these phases is given.

Osborne Clarke comment

While the consultation paper marks a significant first step on the road to UK cryptoassets regulation, it is very much a first step. There is a long way to go before we see the UK regulation of cryptoassets, and stakeholders have the opportunity to help shape what that future regime will look like.