This Reed Smith commentary describes the approaches of key global regulators in their quest to develop responsible frameworks that properly balance the benefits of cryptocurrencies with clear regulatory standards for consumer protection, fair market conduct, financial inclusion, financial stability, efficient retail and interbank transfers and payments, data privacy and security, appropriate taxation and more.
As the cross-border paradigm of cryptocurrencies evolves, an abiding tenet across jurisdictions is close coordination among global financial regulators. The purpose of increasingly close coordination is to foster adoption of tailored oversight frameworks that monitor and shape cryptocurrency regulation taking into account the particular characteristics and use cases of cryptocurrencies. Overall, financial regulators appear to see value in working together toward aligning the policy foundation of regulatory standards for a digital financial services world.
I. U.S. Crypto Policy
U.S. policy with respect to digital assets is to take strong steps to reduce the risks digital assets could pose to consumers, investors and businesses, financial stability, crime prevention, national security, human rights, financial inclusion and climate change. The new U.S. Executive Order focuses on a myriad of risks in the digital asset space that have been high priority issues for the Biden administration, including affordable domestic and cross border funds transfers and payments, financial inclusion and equity, cybersecurity, money laundering, sanctions evasion and environmental risks.
The U.S. Executive Order on digital assets adopts the level playing field principle “same business, same risks, same rules” and an incremental approach to applying regulatory and supervisory standards that govern traditional market infrastructures and financial firms. To carry out U.S. policy and objectives, the U.S. Executive Order establishes six priorities for government oversight of cryptocurrencies:
- consumer and investor protection
- financial stability
- mitigation of illicit finance
- U.S. leadership in the global financial system and economic competitiveness
- financial inclusion, and
- responsible innovation.
Recognizing that sovereign money is at the core of a well-functioning financial system that supports economic growth, the U.S. Executive Order places the “highest urgency” on efforts to design and deploy options for a U.S. central bank digital currency (“CBDC”). The U.S. Executive Order directs the Department of the Treasury (“Treasury”), together with other executive branch agencies and the federal banking agencies, to issue a report and recommendations to the President on the implications of a U.S. CBDC and the future of sovereign and privately produced money for the financial system and democracy. The Board of Governors of the Federal Reserve System is encouraged to continue its research into CBDCs and to develop a strategic plan for adopting a U.S. CBDC considering its effect on monetary policy.
Although the U.S. Executive Order establishes a whole-of-government strategy with respect to digital assets, U.S. government agencies have been actively addressing many of the issues and priorities articulated in the Executive Order for several years. For example, the Treasury, Financial Crimes Enforcement Network (“FinCEN”) determined in 2013 that exchangers and administrators of convertible virtual currencies are money services businesses subject to the Bank Secrecy Act and must register with FinCEN. Further, the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission have taken a number of digital assets-based enforcement actions against individuals and entities since 2018.
Digital assets continue to draw regulatory and legislative scrutiny. While the pace of government rules, guidances and enforcement actions has been increasing recently, it may accelerate further once the research, studies and reports directed by the U.S. Executive Order have been completed and there is greater clarity around the direction of U.S. crypto rules. In the past few months, for example, regulators and legislators have taken the following actions, and we expect an increasing number of actions going forward:
- FinCEN extended the due date for comments in January 2021 on a notice of proposed rulemaking requiring money service businesses to submit reports, keep records, and verify the identity of customers in relation to transactions above certain thresholds involving hosted and unhosted wallets in certain jurisdictions identified by FinCEN.
- The Infrastructure Investment and Jobs Act enacted in November 2021 requires filing of currency transaction reports whenever a person receives digital assets in excess of $10,000-USD and requires digital asset brokers to report a taxpayer’s trades and transfers of digital assets.
- The federal banking agencies issued an inter-agency roadmap of crypto engagement in November 2021 that focuses on how banks could store crypto assets safely, settle and execute crypto trades, lend taking crypto as collateral, activities involving facilitation of customer purchases and sales of crypto and payments, including stablecoins, and activities that could result in holding crypto on a bank’s balance sheet.
- The Treasury, Financial Stability Oversight Council, in December 2021, published its 2021 annual report identifying the rapid growth of digital assets as a primary risk to the U.S. financial system.
- The SEC issued a proposed regulation amendment in January 2022 to expand coverage of Regulations ATS and SCI to U.S. Treasury securities alternative trading systems that raises the possibility of subjecting crypto trading and other platforms to regulation as "communication protocol systems."
- The Federal Reserve Board issued Money and Payments: The U.S. Dollar in the Age of Digital Transformation describing considerations related to potential issuance of a U.S. CBDC, and an International Finance Discussion Paper, Stablecoins: Growth Potential and Impact on Banking, both in January 2022.
- The Treasury issued a study in February 2022 on money laundering in the art trade, as required by the Anti-Money Laundering Act of 2020, which identified nonfungible tokens as an area of potential concern.
- The Federal Bureau of Investigation announced the formation of the Virtual Asset Exploitation Unit in February 2022, a specialized team dedicated exclusively to cryptocurrency, blockchain analysis and virtual asset seizure.
II. European Commission Crypto Policy
Recently, the European Commission and the European Parliament further discussed a draft regulation on crypto-assets. The so-called Markets in Crypto-Assets Regulation (“MiCA”) is intended to ensure unambiguous handling of cryptocurrencies and regulate crypto-asset services and crypto-assets which are not already subject to existing European regulation. The current patchy legal framework in different European countries makes it difficult for companies to start a business in this still new area. In addition, the different national regulations create unequal opportunities for market participants.
Generally, MiCA will have the greatest impact on issuers, service providers, and trading venues. Crypto issuers, in particular, will be required to comply with an information obligation and publish a white paper on their products which must be submitted to the relevant financial supervisory authority. Further, MiCA determines that crypto service providers, such as crypto-asset custodians and operators of trading venues, must have a registered office in a Member State if they want to offer their products and services in the European Union. For smaller companies and financial technology companies, the regulation could cause certain disadvantages. In Member States where the market has been virtually unregulated to date, companies face high costs due to, for example, the acquisition of licenses or the costs incurred in connection with reporting requirements or a secure IT infrastructure.
After completion of the legislative process, MiCA is expected to come into force at the end of 2022. On a separate note, Germany is a frontrunner in Europe in relation to crypto market regulation and has implemented certain items covered by MiCA already.
III. United Kingdom Crypto Policy
Despite numerous references to the risky nature of cryptoassets in its 2021/22 business plan, the United Kingdom (“UK”) Financial Conduct Authority (“FCA”) or other UK financial regulators have been a fence-sitter when it comes to bringing cryptoassets universally into the UK financial regulatory perimeter.
In 2019, the FCA published its guidance on which categories of cryptoassets would fit within existing FCA regulation. The guidance re-asserted the “technology neutral” character of the current regulatory framework under the UK Financial Services and Markets Act 2000 (“FSMA”) meaning that each type of cryptoasset would be considered within the financial regulatory perimeter in the same way as other financial activity.
In January 2021, the UK government published a consultation paper and a call for evidence on the UK regulatory approach to cryptoassets, with the near-term priority of introducing a regulatory framework supporting the safe us of stablecoins.
Since then, cryptoassets have been subject to piecemeal, risk-specific regulation.
In January 2020, UK crypto businesses were made subject to stringent anti-money laundering regulations under the Money Laundering Regulations 2017, including a requirement to register with the FCA.
More recently in January 2022, the FCA brought the promotion of crypoassets within the scope of financial promotions legislation in the same way that stocks, shares and insurance products are. This is set to be achieved through secondary legislation to amend the scope of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. The current order sets out the investments and activities to which the financial promotion regime applies. Under FSMA, a business cannot promote a financial product unless they are authorised to do so (either by the FCA or the Prudential Regulation Authority), or the content of the promotion is approved by a firm which is itself authorised. The promotion of such products must be fair, clear, and not misleading.
The UK Government’s Treasury function and the Bank of England are continuing to evaluate the possible opportunities and risks associated with the introducing a UK CBDC, which has included looking at CBDC initiatives elsewhere. The UK is taking a leading role in exploring this topic to understand the wide-ranging opportunities and challenges it could bring.
IV. Asia-Pacific Crypto Policy
In the Asia-Pacific region, Singapore and Hong Kong stand out as financial centres that have sought to pursue policy objectives comparable to those outlined in the new U.S. Executive Order. Singapore and Hong Kong authorities have struck a balance between countering the risks arising from crypto-related activities and acknowledging the potential of the crypto sector to foster innovation.
In Singapore, “digital payment token” services are regulated under the Payment Services Act 2019, which is designed to provide for regulatory certainty and consumer safeguards while encouraging innovation and growth of payment services and financial technology.
Between 2016 and 2020, the Monetary Authority of Singapore (“MAS”), in collaboration with private-sector firms and other central banks, trialled various use cases for a blockchain-based wholesale CBDC. This project, known as Project Ubin, spanned a number of phases exploring areas such as tokenisation of the Singapore dollar, delivery-versus-payment scenarios, domestic and cross-border interbank settlement and cross-currency settlement. In 2021 the MAS published a paper outlining how a retail CBDC might be implemented in Singapore, although given the already pervasive use of electronic payments in this jurisdiction, the policy position is that there is no strong case for a retail CBDC at present.
In Hong Kong, the Financial Services and Treasury Bureau has consulted on the introduction of a licensing framework for virtual asset service providers who operate virtual asset trading platforms, which is intended to harness opportunities presented by financial innovation while ensuring the healthy and orderly development of the market.
In 2017, the Hong Kong Monetary Authority (“HKMA”) began researching on the application of CBDC in handling large-value payments and delivery-versus-payment settlement and has since then expanded its scope with 3 central banks in the region on international payment. In October 2021, a whitepaper on retail application of CBDC was issued, which was claimed to be the first among similar papers published by central banks to unveil a technical architecture that includes a ground breaking privacy preservation arrangement that allows transaction traceability in a privacy-amicable manner.
In 2014, the People's Bank of China (“PBoC”) began its study on its CBDC: e-CNY. In 2019, PBOC announced the use of e-CNY in 4 pilot cities. In 2020, the number of cities using e-CNY increased to 10. In spring 2022, e-CNY began its use in the Beijing Winter Olymics area. As of March 2022, e-CNY is used in 20 cities. It is expected that e-CNY application will be available for use in Hong Kong soon as the HKMA discusses with the PBoC the last phase of the technical testing, including the involvement of more banks in Hong Kong and using the Faster Payment System to top up e-CNY wallets.
V. Middle East Crypto Policy
There has been slow progress with regard to the development of crypto regulations in the Middle East. Crypto-assets are deemed risky and there is a lack of protection or rights relating to their use. Clear regulations are largely yet to be developed. Bahrain and the United Arab Emirates (“UAE”) are two of the countries that have newly developed regulations governing cryptoassets – the effects of which will play out in the coming years.
In 2019, the Central Bank of Bahrain issued regulations to govern and license regulated cryptoasset services within the country. These regulations cover areas such as licensing, minimum capital requirements, notification requirements and measures to safeguard customers. Licences apply to anyone operating within the country and are granted on a scale depending on licensees level of involvement with cryptoassets.
The UAE, including the Abu Dhabi Global Market (“ADGM”) and the Dubai International Financial Centre (“DIFC”), is working to develop its regulatory regime of cryptoassets in order to attract new forms of business to the region.
This month, the regulator of the DIFC (the Dubai Financial Services Authority (“DFSA”)) issued a consultation paper aiming to bring the cryptoassets, and those who conduct specified activities in respect of them, within the DFSA’s remit. These regulations aim to mitigate the risk posed by these assets by addressing issues such as financial adequacy of service providers and consumer protection. These regulations are yet to be implemented.
Similarly within the ADGM, the Financial Services Regulatory Authority has issued “Guidance on Regulation of Crypto Asset Activities in ADGM”, which covers activities conducted by exchanges, custodians and intermediaries engaged in cryptoasset related activities.
Last week, the UAE announced that a new federal law governing virtual asset has been adopted – the Dubai Virtual Asset Regulation Law (“DVARL”). The scope of the DVARL is limited to authorising the conduct of activities relating to virtual assets in the Emirate of Dubai only (excluding DFIC). The DVARL also establishes the Dubai Virtual Assets Regulatory Authority, which is said will oversee the authorisation and regulation of virtual asset service providers and regulate the sale of virtual asset. The DVARLis expected to be published soon.
Reed Smith will continue to monitor digital assets developments across jurisdictions and will publish periodic updates on significant actions. For further information, please contact any of the Reed Smith attorneys listed.
In-depth 2022-078
