His Majesty’s Treasury (HMT) published its much-anticipated response to the consultation paper on the UK’s regulatory regime for cryptocurrencies on October 30, 2023.
The HMT confirmed its final proposals for crypto regulation in the country in no less than 94 pages, which includes a proposal to bring several crypto asset-related activities within existing financial regulation, introduce a new authorization process, and set out a new disclosure and liability regime for the asset class.
The government received a total of 141 responses from a wide range of stakeholders, including blockchain network providers, crypto exchanges, crypto compliance firms, Web3 gaming companies, crypto fund managers, traditional banks, asset managers, and payment providers.
Today we will take a closer look at some of the key aspects of the HMT’s response, which will be laid out before the UK Parliament in early 2024.
1. Bringing Cryptocurrencies Within Existing Financial Regulation
The HMT has confirmed that it plans to regulate cryptocurrencies within the existing legislative framework governing financial services in the UK. The government is working on plans to adhere to the proposals in the Consultation Paper, specifically expanding the “specified investments” list in Part III of the Financial Services and Markets Act (FSMA) 2000 Order 2005.
Crypto assets will not be included in the separate definition of “financial instruments”, which means that they would remain outside of the scope of the Markets in Financial Instruments Directive (MiFID) regime and other EU-derived crypto regulations that have been retained by the UK post-Brexit.
By incorporating crypto asset activity into the existing FSMA framework, the government is providing a level playing field between digital assets and traditional finance that aligns with recommendations by the International Organization of Securities Commissions (ISOCO) as well as the approach taken in other jurisdictions.
2. Defining Crypto Assets
HMT has clarified that cryptocurrencies should be compared to similar products or activities within traditional financial products and services. Most importantly, digital assets should not be used within financial services markets or used as an instrument, product, or investment outside the financial services regulatory regime.
3. No Temporary FSMA Authorization Process for Crypto Firms
Industry participants had requested a temporary approval regime for crypto companies, or at least a streamlined approach to authorization. However, the HMT rejected these proposals as it was against introducing a temporary permission regime, providing streamlined access to firms under the MLRs, or providing a streamlined variation of the permission process for firms already authorized under the FSMA regime.
The FCA will be responsible for developing rules on the authorization process. The financial regulator is expected to provide feedback on the quality of the applications for the new regime, contribute to regulatory clarity by engaging with the applicants’ advisors and consults, and provide data on the volume and outcomes of the applications received.
4. Extraterritorial Scope to Remain a Key Feature of the New Regulation
The UK intends to extend the territorial scope of the rules to crypto-related activities “in or to the UK”. This will exceed the territorial scope of cryptocurrencies beyond traditional financial services. The HMT intends to continue this broader approach and has stated that it does not support expanding the overseas persons exclusion (OPE) that is commonly available for traditional financial services firms that allow them to access the UK market on a cross-border basis.
HMT confirmed that it views non-fungible tokens (NFTs) as digital collectibles or artwork rather than financial products. Therefore, they will not be regulated as financial services, and most NFT-related activities would fall outside the scope of the new regulatory regime.
That said, the Treasury also acknowledges the evolving landscape of the crypto markets, in particular where tokens labeled as NFTs might possess functionalities other than collectibles. Such features may bring back NFTs under the scope of the regulatory perimeter.
6. Decisions on Decentralized Finance (DeFi)
After considering responses from industry participants, HMT acknowledged that it would be premature and ineffective for the UK to regulate DeFi activities. The Treasury sees a potential role for fully decentralized DeFi models in future financial services. However, this demands thorough risk management and international collaboration.
HMT also noted that DeFi models would be widely adopted in the future and will soon need to meet regulatory standards akin to traditional finance. This is indicative of the HMT’s understanding that DeFi has a major role to play in the crypto market.
7. Clarifying the Position on Crypto Staking
HMT noted that certain activities carried out by intermediaries in the pooled staking sector, like custody of pooled cryptocurrencies and the issuance of liquidity tokens, carry significant risks to consumers.
However, the risks of these activities may be covered by other regulatory regimes, including those for financial promotions, custody, lending, and intermediation, without the need to introduce any additional regulation.
The HMT plans to establish a regulated activity under the RAO concerning the issuance of fiat-backed stablecoins within or from the UK. The Treasury also wants to introduce regulated activity under the RAO for the custody of stablecoins issued in the UK and collaborate with the industry and the FCA before introducing legislation and regulating networks facilitating mixed tokens, and pure stablecoin payments.