At a glance
- HMT has published the “Future financial services regulatory regime for cryptoassets”, which is effectively a roadmap to develop a comprehensive regulatory framework for cryptoassets. The publication sets out a tailored approach for fiat-backed stablecoins, and a separate, activity-based regime to bring key crypto players – including exchanges, custodians and lending platforms – within the UK regulatory perimeter.
- The UK’s starting point will be the existing core securities frameworks (e.g. MiFID) that apply to traditional financial products and these will need to be tailored to accommodate the unique features of cryptoassets. Crypto natives and traditional financial services firms will broadly welcome this clarity but will eagerly await further detail.
- With a consultation response and a raft of secondary legislation and FCA consultations to follow, a detailed picture of regulatory requirements will take up to three years to emerge.
- The requirement for some FCA MLR registered firms to move to a fully authorised regime will have a significant impact on crypto natives, many of whom will experience being fully regulated for the first time. These firms should use the lead time to review and upgrade risk management and governance arrangements.
On 1 February, HM Treasury (HMT) published its long-awaited next steps for developing a comprehensive regulatory framework for cryptoassets.
The publication presents a tailored approach for fiat-backed stablecoins, and a separate comprehensive, activity-based regime to bring key crypto players within the UK regulatory perimeter. HMT’s roadmap does not amount to a detailed regulatory framework – that will only come after the Financial Conduct Authority (FCA) consults on detailed firm rules. There are no specific time commitments set out in this publication, but we expect to see some clarity in the regulatory timeline grid expected to be published early this year.
However, this roadmap marks an important step in delivering the government’s vision for a competitive UK cryptoassets market, and provides much needed clarity around the broader approach to regulating crypto markets.
This blog explores the UK’s overall regulatory approach to cryptoassets, key features of its activity-based framework, and some of the initial implications for the crypto industry.
The UK’s overall regulatory approach
The “same risk, same regulatory outcome” principle underpins the approach to cryptoassets, with the regime expecting cryptoassets activities to meet the same regulatory standards expected of similar traditional FS activities. The proposed activity-based framework covers a broad suite of crypto activities, and references new powers that HMT is set to receive via the Financial Services and Markets Bill (FSMB).
The publication sets out a phased approach to cryptoassets regulation:
- Phase 1: Create a regulatory regime for fiat-backed stablecoins used for payments. At a minimum, this regime is expected to capture GBP and other fiat-backed stablecoins issued in the UK. This will not cover any other type of stablecoin other than fiat-backed.
- Phase 2: Introduce a regime to regulate broader crypto activities, including trading and investment use cases. It will focus on activities with higher risk, and greater opportunities to support the UK’s growth agenda.
Cryptoassets in scope for Phase 2
Cryptoassets are defined broadly in the FSMB , aimed at capturing all current types of cryptoassets.
This broad definition underpins the two key powers that HMT is set to receive to bring crypto activities within the regulatory perimeter, explored in the next section. This means that the full suite of cryptoassets could be caught by phase 2:
Already within regulatory perimeter
Proposals to bring within regulatory perimeter via phase 1
Potential to come within regulatory perimeter via phase 2
Under HMT’s proposals, any of the following tokens could be subject to regulation, where used for regulated activities (detailed below) .
However, in practice, HMT expects that its new powers will apply to specific groups of cryptoassets, dependent on the activity being regulated rather than by type of cryptoasset. This will become clear via secondary legislation later this year or next. As an illustrative example, exchange tokens could be in-scope for custody services, but outside the perimeter when serviced by lending platforms. The Government has already adopted this approach in other areas of crypto regulation. For example, it intends to exclude NFTs from the scope of the crypto promotions regime.
Given this uncertainty, industry will undoubtedly push for detailed secondary legislation and regulatory rules in order to develop a clear and detailed view on how specific products will be caught by UK regulation in order to support the development of risk and compliance approaches.
Activity-based approach to crypto regulation
The activity-based approach to cryptoassets draws heavily on the existing core frameworks for traditional financial products and services. If the FSMB is progressed in its current form, HMT will primarily have two avenues to regulate crypto activities:
- Via the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO): HMT has secondary legislation powers under FSMA to bring activities into the perimeter by specifying them in the RAO. The Government plans to expand the list of specified investments in the RAO to include cryptoassets. The FSMB affirms the use of the RAO to regulate cryptoassets and clarifies that firms would be performing regulated activities and require authorisation under Part 4A of FSMA.
- Via the Designated Activities Regime (DAR): HMT also has power to leverage the DAR to designate certain activities and develop tailored regulation . This includes prohibiting activities, or setting direct requirements for how they are performed. The DAR allows HMT to use this power to regulate certain activities that may not fit neatly into the RAO regime, e.g. to regulate narrow crypto-asset services provided by a large non-financial services firm, where the full authorisation requirements under FSMA may not be the optimal route to achieve the right regulatory outcome.
The table below analyses the activity-based approach proposed in the first two phases of regulation, including elements that are excluded from the perimeter for now.
Other considerations relating to the UK’s activity-based approach
While the detailed rules applying to specific crypto activities will only be fleshed out by the FCA over the next three years or so, some key features of the UK’s activity-based approach are now clearer.
Authorisations and broader implications for crypto natives
Once the new regime applies, crypto firms registered with the FCA under the UK Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) would need to seek authorisation under the new FSMA-based regime. To facilitate a smooth transition, the FCA will introduce a proportionate process, and will try to avoid asking for the same information twice.
It remains to be seen whether this will include specific accommodation for FCA-registered crypto firms to continue providing crypto services. This would certainly be welcomed by the industry. The phased approach to regulation may pose particular complications if different types of crypto activity become subject to authorisation requirements (and therefore to FCA rules) at different times. HMT specifically requests feedback on this point.
HMT is clear that financial crime obligations will increase when firms transition from being FCA-registered under the MLRs to an authorised firm under the new FSMA-based crypto regime. The financial crime rules in FSMA are broader than the MLRs, covering areas including anti-bribery and corruption, sanctions and fraud.
The challenge of complying with the UK’s future regime will be most acute for crypto natives, many of whom will come within the regulatory perimeter for the first time. They should use the lead time to get to grips with the traditional frameworks which will underpin the UK approach. This includes cross-sector frameworks such as governance and segregation of responsibilities, operational resilience, and outsourcing, all of which feature throughout HMT’s consultation.
These firms may benefit from taking some initial “no regret” actions, including upgrading governance arrangements. We expect robust governance to be a core focus area across all in-scope activities. In particular, actors should use the lead time to ensure they have a clear organisational structure with lines of responsibility, ensure that Boards and senior leadership have sufficient regulatory and compliance expertise, and review key policies and procedures, especially around client asset protection. Crypto natives may also benefit from building out regulatory engagement and second line risk and compliance functions, to engage the FCA on authorisation plans as the detailed rules take shape.
HMT proposes to generally capture crypto activities provided in or to the UK (subject to nuances for specific activities):
In practice, this means that firms servicing UK customers from another jurisdiction may need to seek authorisation, subject to certain potential exceptions. Reverse solicitation may be one exception, although HMT notes it should be defined in a way that prevents misuse and regulatory arbitrage.
If this approach is progressed, international firms will face the challenge of navigating multiple divergent frameworks (e.g. UK, home jurisdiction, and other jurisdictional regimes). Developing compliance systems and controls to comply with these frameworks and meeting multiple legal obligations will pose significant challenges. International firms could start now to build a clear view of the extent to which they wish to serve UK customers and consider the UK’s emerging regulatory approach as part of growth plans.
An important – yet open – question is whether firms captured by extra-territoriality will be required to have a physical UK presence. This is currently under consideration, and for the FCA to determine, at the point at which firms apply for authorisation. However, HMT is clear that crypto trading venue operators will likely require a subsidiary in the UK. International trading venues that serve UK customers should start preparing for this. Establishing and staffing a UK presence – with sufficient risk and compliance expertise – will likely require significant organisational change for some firms.
Separately, the UK Government confirmed its next steps regarding crypto promotions. Crypto firms registered with the FCA under the MLRs will welcome the temporary exemption that will enable them to communicate their own promotions while the broader future crypto regime is being developed, rather than needing to have them approved by an authorised firm.
After setting out its plan in regards to fiat-backed stablecoins in 2022, as part of the next wave of regulation, the Government plans to bring other key actors including exchanges and custodians within the regulatory perimeter. As expected, the UK will draw on (but tailor) existing regulatory frameworks (e.g. MiFID) that apply to traditional financial products and services.
The volume of work ahead indicates that we are unlikely to see all the details of the UK’s approach in 2023. Andrew Griffith already confirmed this last month. With a consultation response and a raft of secondary legislation and FCA consultations to follow, our estimate is that comprehensive regulatory clarity will take up to three years. Even amongst the activities targeted in phase 2, we may see a degree of prioritisation. In line with the UK’s risk-based approach, certain details – especially concerning exchanges and custodians – may emerge first.
The industry will broadly welcome the approach set out. Significant work lies ahead to flesh out the detail and fine-tune these frameworks to the nuances of the crypto industry. The ongoing challenging experience of applying current frameworks – not designed with crypto in mind – to security tokens activities highlights the importance of developing detailed rules and guidance for cryptoassets. However, there is a unique opportunity for the industry to support the policy development process and develop suitable regulatory solutions. HMT’s roadmap is a clear indication that the UK authorities are in listening mode.
Overall, the crypto ecosystem will welcome the UK Government’s clear commitment to develop a comprehensive cryptoassets framework. Once the details are fleshed out over the next few years, the UK should have a structured regime that will allow actors to determine how and where to play in the UK’s regulated crypto ecosystem.
 Any cryptographically secured digital representation of value or contractual rights that— (a) can be transferred, stored or traded electronically, and (b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology).
 These cryptoassets are taken from Box 2.A in HMT’s consultation. As HMT sets out, these are a group of commonly used terms and will not necessarily be aligned to regulatory definitions.