The UK’s Cryptoassets Task Force yesterday published its long awaited report into the state of play on UK regulation of crypto assets (available here). Overall the report continues the picture started by the Treasury Committee’s report on crypto assets of September (see our detailed review here), clearly illustrating the Government’s view of caution over crypto, but with an overall positive outlook on the sector long term.
The report provides brief views on the FCA’s existing regulatory perimeter in respect of crypto assets, an overview of the risks and benefits posed by crypto assets, a discussion on the benefits of distributed ledger technology, and closing with a summary of the next steps that the three regulators will take in this sector. In summary, the report concludes that:
- the 5th Money Laundering Directive will be implemented in the UK in 2019, and (following consultation) will be gold plated to capture more types of crypto businesses than 5MLD strictly requires.
- consultations will be launched this year and early next in respect of clarifications to the FCA’s regulatory perimeter, on so called “exchange token” regulation, on crypto-backed derivative products and their sale to retail, and on security and utility tokens.
- the application of DLT within financial services could have significant benefits and there appear to be no significant regulatory barriers currently in place in the UK.
Our overall view
As noted above, the report in our view can be considered broadly positive in respect of the crypto assets industry in the UK. Whilst the report clearly calls out a significant number of negative features of the industry (as the Treasury Committee did too of course) it also concludes with a significant number of positive next steps for the industry that many of the more legitimate players in the market will actively welcome.
It is also clear from the report that thinking is still evolving within the regulators around how to control these markets. In a move that that is extremely positive for the industry, the report does not pre-judge what much of the new law should look like now, but instead suggests a number of consultations to be launched over the coming months to chart the course of regulation, which will hopefully allow the industry to play a meaningful part in helping to shape that regulatory process.
On the regulatory perimeter
The report provides useful guidance on the FCA’s current regulatory perimeter, helping to clarify how much of a remit the FCA has over crypto. In broad terms the view described does not provide any surprises - so called “exchange tokens” (i.e. traditional cryptocurrencies) are confirmed as not currently falling within the FCA’s perimeter, as well as utility tokens, but security tokens are confirmed as being within the perimeter.
From a legal perspective this is hugely helpful guidance from the Taskforce at this stage, but at present it is a stopgap - the report suggests further that there will be a consultation launched before the end of 2018 in respect of broader perimeter guidance on crypto assets, including security tokens. In our view this cannot come quickly enough, although we would suggest that this guidance should major heavily on utility tokens as the most grey area at present.
The report splits crypto assets into three broad buckets: (1) exchange tokens (Bitcoin, Litecoin etc); (2) security tokens (tokenised forms of traditional securities); and (3) utility tokens (tokens launched primarily for the purposes of raising funds, which do not have the characteristics of a traditional regulated product).
Crypto taxonomy has almost become an industry in and of itself in recent months with many differing projects, views on nomenclature and categorisation of different assets. In our view the FCA’s taxonomy is useful as an uncomplicated model but could require refinement as the market develops. For example, it is not entirely clear how stable coins like USDC or other asset backed tokens might fall within the structure (unless the FCA considers them to be akin to traditional securities, in which case they will be security tokens). In any case, we suspect it is a good starting point to develop regulation from, with some refinement.
In line with the Treasury’s September report, the Taskforce has taken a strong line on anti-money laundering, reaffirming that the 5th Anti Money Laundering Directive (5MLD) will be implemented in the UK as soon as possible in order to bring crypto firms into scope of AML/KYC regulations.
However the Taskforce goes beyond that, stating that the UK will be seeking to sweep in not just exchanges and custodian wallet providers (as 5MLD requires) but also a number of other crypto operators including crypto ATM providers, non-custodial wallet providers, peer to peer exchanges, and firms that offer layering services.
This is a massively welcome development in our view. 5MLD as drafted is out of date - the legislation was drafted years ago (a lifetime in crypto years) and is not therefore able to reflect the state of the art in the crypto industry today. Further, many of those businesses brought into scope by 5MLD actually already perform proper KYC checks, meaning applying 5MLD as drafted would be of little benefit. The Taskforce’s suggestion here seeks to plug the gap between 5MLD and today’s crypto landscape and will hopefully give the FCA the tools it needs to clamp down on financial crime in the illegitimate parts of the industry. Expect a consultation early next year, with legislation coming into force at some point in 2019.
Initial Coin Offerings
After the relatively harsh treatment that ICOs got in the Treasury Committee’s report, it would be fair to assume a similar approach would be taken by the Taskforce. However, whilst the Taskforce does not necessarily suggest ICOs in their current form are for public good, it does mention more than once the potential future benefits that ICOs may bring to the fundraising markets.
The report does of course note the regulatory uncertainty around utility tokens and expresses concern about tokens having the hallmarks of traditional regulated products, but being designed to appear to be unregulated assets. It suggests a consultation in early 2019 on this point, and the regulation of exchange tokens more generally (see below).
One more surprising element of the report is that there is no explicit suggestion to bring pure utility tokens (i.e. tokens used for fundraising that don’t have any characteristics to make them look like securities) into scope of regulation, as the Treasury Committee report seemed to suggest. This may perhaps suggest a mild reprieve for the ICO industry if it can follow a path of creating genuine utility tokens rather than the all too common window dressing done by many to avoid regulation. The consultation in early 2019 will hopefully bring more clarity on the intentions in this area.
The Taskforce has clearly decided to take a cautious approach to what it calls exchange tokens, and has left the door open to decide how to regulate them via consultation to take place in early 2019 (the same consultation as that for the utility token issue mentioned above).
Surprising in our view is that the wording of the report could potentially allow for the regulation of exchange tokens themselves - not just the market participants that deal in exchange tokens. Regulating a decentralised asset such as exchange tokens would be a difficult ask and therefore in our view may be a bridge too far - instead more likely in our view is the regulation of market participants such as exchanges and wallet providers, in line with the Treasury Committee’s report recommendations.
Other points to note
The report discusses distributed ledger technology at length, concluding that it could have significant benefit for UK plc. Usefully the report concludes that there are currently no significant regulatory barriers to the adoption of DLT in the UK and therefore does not propose any significant action around the use of DLT at this stage.
One other interesting point from the report is around crypto-backed derivatives/ CFDs/ futures. It is clear that significant concern exists within the regulators around these types of products being sold to retail, so much so that the report suggests that we will see a consultation before the end of 2018 on a potential prohibition of sale of these products to retail.
On a similar note, the report briefly discusses listed crypto-backed products and approval of these. It makes clear that the FCA will only approve these types of product if it has “confidence in the integrity of the underlying market”, and that “granting the listing would not be detrimental to investors’ interests”. This paragraph is clearly aimed at the current moves in the US to attempt to get approval for listed ETFs, but usefully it is clear from this that an approval would be considered by the FCA, albeit it would likely be a difficult approval to obtain. Whether there are any crypto markets out there that the FCA has confidence in the integrity of at present is not stated, although the tone of the paragraph would suggest more review maybe required before that confidence can be found.
Overall the report is a welcome development for the industry in the UK. Clarity from regulators in crypto either way is always positive but on the whole the report appears to be well informed, sensible and progressive in terms of its attitude to the crypto industry. The next key development will of course be to see the content of the consultations but until then this could be seen as an excellent first step towards encouraging the right kind of crypto activity in the UK.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.