Definition of cryptoassets and legislative approach

In general, the government will proceed as outlined in the Consultation. The government proposes to expand the list of ‘specified investments’ in Part III of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). This would require firms undertaking relevant activities involving cryptoassets, by way of business, to be authorised under Part 4A of the Financial Services and Markets Act 2000 (FSMA). In line with feedback received during the Consultation, the government recognises that developing a completely bespoke regime outside of the FSMA could risk creating an uneven playing field between the traditional financial sector and cryptoasset firms. This approach is also aligned with that of numerous other jurisdictions.

Significantly, however, the government has confirmed that it does not intend to expand the definition of ‘financial instruments’ in Part 1 of Schedule 2 of the RAO to include presently unregulated cryptoassets. The government agrees with the majority of respondents that retrofitting the existing financial instruments regime to cryptoassets would risk creating unsuitable and potentially onerous regulation. In order to ensure that the legislation is flexible to accommodate future developments in this rapidly evolving field, the definition of ‘cryptoasset’ has been drawn broadly to capture not only all current types of cryptoasset, but also those that may come into existence going forward.

Cryptoasset issuances and disclosures

The Consultation outlined the government’s intention to establish an issuance and disclosures regime for cryptoassets, which would be grounded in the intended reform of the UK Prospectus Regime: the Public Offers and Admissions to Trading Regime (POATR), but tailored to the specific attributes of cryptoassets. Two regulatory trigger points were proposed: (i) admitting (or seeking the admission of) a cryptoasset to a cryptoasset trading venue, and (ii) making a public offer of cryptoassets (including initial coin offerings).

In its Response, the government confirmed that it intended to proceed in accordance with the approach outlined in the Consultation. The government’s view is that there should be disclosure documents for all cryptoassets which are made available for trading on a UK cryptoasset trading venue. The key objective underlying this approach is to ensure standards of information available to consumers for all tokens used for activities within the regulatory perimeter are consistent.

Furthermore, the government will take forward the proposal for venues to define detailed content requirements for admission disclosure documents. The government also supports the idea of a central coordinating body (such as an industry association) to coordinate this effort, with FCA oversight. The government agrees, in principle, with the idea that disclosure requirements would differ and be less prescriptive for venues which only admit institutional investors.

Disclosure requirements (and exemptions from those requirements) for tokens made available through a public offer, rather than admitted to trading through a regulated platform, will likely be similar to those proposed under the new draft POATR.¹ Such exemptions would be expected to include offers of free cryptoassets (for example, via an airdrop or similar distribution mechanism).

The government highlighted the following features of the proposed regime as important to ensure that the disclosure / admission requirements would not act as a barrier to entry:

• Disclosure / admission requirements will only apply to tokens that are made available to the UK public, not to all newly created tokens.
• Certain exceptions will apply – for example, offers made for no consideration or where the value of consideration is below a certain threshold, offers made only to professional investors or to a limited number of persons or acquired solely through a consensus protocol reward mechanism.
• Disclosure / admission documents will not take the shape or form of long equity prospectus-like documents and will need to be focused and fit for purpose.
• For any prudential requirements on issuers, professional indemnity arrangements will be considered, subject to regulatory rules.

Cryptoasset trading venues

The Consultation outlined the government’s proposals to establish a regulatory framework for persons operating a cryptoasset trading venue. It was proposed that this would be based on existing RAO activities of regulated trading venues, including the operation of an MTF. Persons carrying out these activities would be subject to prudential rules and other requirements including consumer protection, data reporting and operational resilience.

In its Response, the government confirmed that it would take forward the proposed approach. However, it emphasised the need to consider specific characteristics and risks of cryptoasset trading activities. The government intends to take an activities-based approach to regulation, giving it the flexibility to accommodate different business models. Firms which operate a cryptoasset trading venue will be required to obtain FSMA authorisation for that activity. Venues will provide a crucial function in terms of admitting cryptoassets to trading on their venues and conducting necessary due diligence over these cryptoassets. The government also intends to apply the insolvency provisions from Part 24 FSMA, to provide the FCA with the same rights to protect clients of crypto firms. This will also enable the FCA to participate in standard insolvency procedures, such as administration and liquidation, giving it equivalent rights to those it has for FSMA authorised firms and payment services or e-money firms.

Cryptoasset intermediaries

The Consultation proposed that requirements in relation to analogous related activities, for example, ‘dealing in investments as agent’ or ‘dealing in investments as principal’ (under Article 25 of the RAO), could be used and adapted for cryptoasset market intermediation activities.

The Response confirms that the government will take forward the proposed approach and define a set of new regulated activities relating to the intermediation of cryptoassets, drawing from analogous activities in the existing regulatory perimeter.² The legislative approach, and subsequent rules set by the FCA, will need to consider specific aspects of crypto markets and to what extent to make use of traditional concepts used in regulation, which may not translate well from the traditional financial services sector. An example of this would be establishing the appropriate methods for defining and evaluating whether an intermediary has acted in accordance with a client’s ‘best interests’. To ensure that issuance and market abuse regimes are ‘activated’ for tokens bought and sold by UK investors, the government intends to require a disclosure / admission document to be lodged on the UK’s National Storage Mechanism (NSM) by a trading venue before any intermediary is able to deal or arrange deals in a given token.

Cryptoasset custody

The Consultation proposed to apply and adapt existing frameworks for traditional finance custodians under Article 40 of the RAO for cryptoasset custody activities, putting in place new provisions where appropriate, or making suitable modifications to accommodate unique cryptoasset features.

The Response confirms that the government will legislate to define a new regulated activity for custody to cover (i) safeguarding, (ii) safeguarding and administration, or (iii) the arranging of safeguarding or safeguarding and administration, of a cryptoasset. The existing framework under Article 40 of the RAO will be used as a basis for the regime but suitable modifications to accommodate unique cryptoasset features, or the inclusion of new provisions where appropriate, will be made. Generally speaking, the government confirmed that the activity of providing self-hosted wallet technology to a consumer is not expected to fall under the definition of ‘safeguarding’ or ‘safeguarding and administrating’ (the new regulated activity for custody). Security tokens which meet the definition of an existing specified investment will mostly continue to be regulated in accordance with existing rules and regulations (issuance, reporting and prudential rules). However, custody of security tokens will be specified by a new regulated activity to address fundamental differences in the way which cryptoasset custody operates in comparison to traditional custody arrangements. The Stablecoins Update and subsequent Phase 1 legislation will provide greater clarity on the custody regime for UK-issued fiat-backed stablecoins and security tokens.

Operating a cryptoasset lending platform

In the Consultation, the government proposed the creation of a newly defined regulated activity – ‘operating a cryptoasset lending platform’. Through this, the government proposed that lending platforms would be required to have adequate financial resources, risk warnings and clear contractual terms of ownership.

In line with broad support from industry and consumer groups, the government intends to take forward the proposal to establish a newly defined regulated activity of ‘operating a cryptoasset lending platform’. The government noted that it would not make sense to adopt a single model of traditional lending regulation for all cryptoasset lending arrangements, given the many different types of cryptoasset borrowing and lending arrangement. The government indicated that there will be differentiated regulatory treatment between cryptoasset lending and cryptoasset staking (which does not involve transfer of legal title of the asset).

Market abuse framework for cryptoassets

The Consultation discussed the introduction of a cryptoassets market abuse regime based on elements of the Market Abuse Regulation (MAR) regime.

The Response confirmed that the government will take forward the suggested scope of the regime, including the use of MAR as the basis along with the prohibitions (covering insider dealing, unlawful disclosure of inside information and market manipulation). Obligations will apply to cryptoasset trading venues and other regulated market participants. However, the government disagrees that the overall scope of the regime should be more narrowly defined, on the basis that this would not deliver adequate protection to UK consumers. In terms of obligations to manage inside information, the government will take forward proposals to require regulated cryptoasset firms to appropriately manage price sensitive information in connection with cryptoassets.

Update on plans for the regulation of fiat-backed stablecoins

HMT has confirmed its intention to bring forward secondary legislation as soon as possible, and by early 2024, subject to available parliamentary time, this update states. The legislative proposals will bring activities relating to fiat-backed stablecoins into the regulatory perimeter, enabling the FCA to regulate them.

UK stablecoins regulation

The government plans to bring the use of fiat-backed stablecoins in payment chains into the Payment Services Regulations 2017 (PSR 2017) and the activities of issuance and custody of fiat-backed stablecoins, where the coin is issued in or from the UK, within the scope of the FSMA. HMT intends to regulate activities relating to stablecoins in two ways: (i) by regulating the use of fiat-backed stablecoins in payment chains, and (ii) by regulating the activities of issuance and custody of fiat-backed stablecoins when issued in or from the UK irrespective of their uses. Other types of stablecoins or unbacked cryptoassets will still be allowed to be used in payment chains, but these transactions will remain unregulated. In addition to these activities that will be subject to FCA’s supervision, the Bank of England will have the ability to regulate systemic Digital Settlement Assets (DSA) payment systems and service providers.

FCA’s supervisory regime

HMT will bring activities relating to fiat-backed stablecoins into the FCA’s regulatory perimeter via secondary legislation. HMT expects to define a fiat-backed stablecoin as a cryptoasset that seeks or purports to maintain a stable value by reference to a fiat currency and by holding fiat currency, in whole or in part, as backing. The definition will not be limited to particular currencies or be limited to single currency stablecoins.

HMT intends to create a regulated activity under the RAO for the issuance of fiat-backed stablecoins in or from the UK. HMT intends to ensure that the FCA (and potentially the Bank of England if appropriate) has the power to require that the banking assets of fiat-backed stablecoins are held in a statutory trust. This will enable the FCA to make rules on requiring the stablecoin issuer to hold backing assets for the benefit of customers.

HMT intends to amend the PSR 2017 to extend the scope of the regulatory perimeter to cover payment chains for:

• Mixed stablecoin payments – where the on-ramp to the payment chain is from a stablecoin, but it is converted to fiat within the payment chain, and the off-ramp is in fiat.
• Pure stablecoin payments – where both the on-ramp and off-ramp in the payment chain are in stablecoin and the transfer of value occurs in stablecoin.

Response to ‘Managing the failure of systemic Digital Settlement Asset (including stablecoin) firms’

From 31 May to 2 August 2022, the government consulted on its approach to ‘managing the failure of systemic Digital Settlement Asset (including stablecoin) firms’, by applying a modified Financial Market Infrastructure Special Administration Regime (FMI SAR) to such firms. Respondents overall were broadly supportive of the government’s proposed approach. Some respondents wanted greater clarity on how the FMI SAR would be applied in practice, in particular with regard to the additional return or transfer of customer funds and custody assets objective. Some respondents also indicated that a bespoke failure regime might be better to address the challenges posed by the failure of a systemic stablecoin firm.

In its response, the government confirmed that it intends to lay regulations to implement the policy intent as described in the consultation in due course, when Parliamentary time allows. Furthermore, the government will provide greater clarity on the operation of the modified FMI SAR by making insolvency rules.

1. Public Offers and Admissions to Trading Regulations 2023 – Draft SI and Policy Note
2. For analogous activities in the existing regulatory perimeter, readers should refer to i) Article 14 of the RAO (“Buying, selling, subscribing for or underwriting….as principal); ii) Article 21 of the RAO (“Buying, selling, subscribing for or underwriting….as agent); iii) Article 25(1) of the RAO (“Making arrangements for another person (whether as principal or agent) to buy, sell, subscribe for or underwrite…”); and iv) Article 25 (2) of the RAO (“Making arrangements with a view to a person who participates in the arrangements buying, selling, subscribing for or underwriting…(whether as principal or agent)…”)

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