Clifford Chance

INTRODUCTION

The regulatory landscape for cryptoassets is set to change in both the EU and the UK, through the introduction of new, comprehensive regulatory frameworks for cryptoasset service providers. The EU Markets in Cryptoassets Regulation (MiCA) is expected to be published in the EU Official Journal by Summer 2023 and will introduce a pan-EU regulatory framework for the issuance of, intermediating and dealing in, cryptoassets. The shape of the UK framework is still under consultation, though the UK is coming under some pressure to provide clarity on the scope of the new regime quickly, to provide firms with certainty they need and details of both regimes are yet to be fleshed out by regulators starting later this year.

THE STORY SO FAR

At present, there is no specific UK or EU-wide[1] regulatory regime for cryptoassets beyond anti-money laundering (AML) related requirements that implement international Financial Action Task Force (FATF) recommendations.

In particular, both the UK and EU have introduced registration regimes for cryptoasset exchange providers and custodian wallet providers, who are subject to ongoing AML-related obligations, such as requirements to take steps to identify and manage the risks of money laundering and terrorist financing. These include establishing appropriate policies, controls and procedures, and carrying out the requisite customer due diligence.

The UK Financial Conduct Authority (FCA) has applied a particularly high bar in vetting cryptoasset firms seeking registration for AML purposes, approving only 15% of applications submitted as of January 2023[2].

Beyond AML-related requirements, the UK’s current approach to regulating cryptoassets is articulated in the Final Guidance on Cryptoassets[3] (the Final Guidance), published by the FCA in July 2019. This approach requires a case-by- case analysis of the relevant cryptoasset’s substantive characteristics to determine whether or not it falls within the perimeter of the existing regulatory framework.

 For those types of cryptoassets that do fall within the regulatory perimeter, different regulatory rule sets may apply depending on whether the cryptoasset is characterised as a transferable security, a deposit, electronic money (e-money) or another type of regulated financial instrument.

Unregulated tokens include all other types of cryptoassets which are not treated as regulated financial instruments or products. In general, this means that firms carrying on activities relating to unregulated tokens fall outside the UK regulatory perimeter. In practice, many “cryptocurrencies” marketed to consumers currently fall within the category of unregulated tokens.

A similar approach is taken under existing EU-level regulation, to determine whether cryptoassets meet existing definitions of regulated financial instruments under the EU Markets in Financial Instruments Directive (MiFID2) or qualify as e-money under the E-Money Directive.

INTRODUCING MICA, A PAN-EU CRYPTOASSET REGULATORY FRAMEWORK

Just over two years after it was first proposed, the agreed text of MiCA was released in late 2022. MiCA aims to create an EU regulatory framework for the issuance of, intermediating and dealing in, cryptoassets. It will introduce licensing and conduct of business requirements as well as a market abuse regime with respect to cryptoassets.

MiCA applies with respect to “cryptoassets”, which are defined very broadly as “a digital representation of a value or a right that uses cryptography for security and is in the form of a coin or a token or any other digital medium which may be transferred and stored electronically, using distributed ledger technology or similar technology”, with certain specific carve-outs.

For example, MiCA does not apply to security tokens which would quality as financial instruments for the purposes of MiFID2, deposits, securitisation positions, insurance or pension products. This means that firms engaging in cryptoasset activities will still need to consider whether they will fall under the MiCA definition of “cryptoassets” or whether they are subject to another regulation.

MiCA creates a broad regulatory framework for cryptoassets in the EU which:

• regulates the issuance of, and admission to trading of, cryptoassets, including transparency and disclosure requirements;
• introduces licensing requirements for cryptoasset service providers, issuers of asset-referenced tokens (ARTs) and issuers of electronic money tokens (EMTs);
• introduces regulatory obligations applicable to issuers of ARTs and EMTs and cryptoasset service providers, including consumer protection rules for the issuance, trading, exchange and custody of cryptoassets;
• creates a market abuse regime prohibiting market manipulation and insider dealing; and
• sets out enforcement powers available to national regulators.

Many requirements under MiCA are broadly similar to requirements under the existing EU financial services regimes, including requirements relating to disclosures, governance and licensing.

For further detail on MiCA, please see the briefing “Crypto Regulation: the Introduction of MiCA into the EU Regulatory Landscape”[4].

MiCA is expected to be published in the EU Official Journal by Summer 2023. It will “enter into force” 20 days later, which will allow the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) to develop the various technical standards and guidelines envisaged under MiCA, which will flesh out the details of the rules.

 Provisions relating to ARTs and EMTs will formally start to apply from 12 months after entry into force (likely mid-2024) and remaining provisions will apply from 18 months after entry into force (likely towards the end of 2024). Firms are already starting to prepare for the implementation of MiCA, including in some cases positioning themselves to benefit from certain grandfathering and provisions that will give firms already carrying on cryptoasset activities in the EU more time to apply for authorisation under MiCA.

MiCA does not provide for a separate third country regime, so non-EU firms will have to obtain full authorisation to provide services within the EU (other than cross-border services provided on a strict reverse solicitation basis). This means that non-EU firms will need to assess whether and how their activities will be caught by MiCA and what restrictions will apply. Depending on the outcome of that assessment, firms may consider whether seeking an authorisation in an appropriate member state ahead of MiCA taking effect would be worthwhile to benefit from the transitional arrangements and to avoid post-MiCA delays. Firms that wish to do so must act swiftly as authorisations can take many months to secure.

UK’S PROPOSED COMPREHENSIVE REGULATORY REGIME FOR CRYPTOASSETS

The UK has so far lagged behind the EU in developing its cryptoasset regulatory framework. However, it is now seeking to catch up, as the Financial Services and Markets Bill (FSMB) , which is expected to become law in the Spring, will introduce new powers for HM Treasury (HMT) to bring cryptoassets within the scope of the UK financial services regulatory perimeter.

On 1 February 2023, HMT published its long-awaited consultation[5] on a comprehensive regulatory regime for cryptoassets other than fiat-referenced stablecoins. This latest consultation on regulation of wider (non-stablecoin) cryptoasset activities builds on previous discussion papers and consultations, including a January 2021 consultation[6] which focused on stablecoin regulation. It also complements other proposals in the FSMB to introduce a regime that will allow for the regulation of “digital settlement assets”, which are defined as fiat-backed stablecoins which are used for payments.

In its latest consultation, HMT indicates that it intends to create various new regulated activities relating to cryptoassets. This means that firms would need to be authorised (or exempt) under the Financial Services and Markets Act 2000 (FSMA) in order to carry on those activities by way of business in (or into) the UK. Many of these proposed activities mirror, or closely resemble, regulated activities under the existing FSMA regime, though are also some novel cryptoasset activities proposed.

HMT also indicates it may use the new “designated activities regime” (DAR) that will be introduced under the FMSB to regulate certain activities relating to cryptoassets where it is not necessarily appropriate to impose licensing requirements. Similar to MiCA, HMT’s proposals include a regime for the issuance, offering and admission to trading of in-scope cryptoassets and a cryptoassets market abuse regime, where certain rules may be introduced using the DAR.

The definition of “cryptoasset” for this purpose comes from the FSMB and is extremely broad. HMT indicates that it may introduce certain carve outs from the definition for the purpose of the new regulatory regime, but has not yet provided detail of any such carve outs.

As such, the expected scope of the new UK cryptoasset regulatory regime remains hazy.

This latest consultation forms part of “Phase 2” of the UK’s phased approach to cryptoasset regulation – with Phase 1 being implementation of the digital settlement assets regime for regulation of fiat-backed stablecoins. Once the FSMB gains Royal Assent (expected in Q2 2023) HMT will be able to make secondary legislation covering the detail of the regime. The Financial Conduct Authority (FCA) will then need to consult and make the wide range of relevant rules to bring the regulatory regime into operation.

These are expected to include minimum capital, liquidity and other prudential requirements for firms requiring authorisation under the new regime, as well as ongoing conduct of business rules for authorised firms and rules on admission and disclosure requirements where cryptoassets are traded in the UK. Firms that are already authorised under FSMA would also need to apply for a variation of their permissions to include newly regulated cryptoasset activities. However, details of how authorisation and variation of permission processes are expected to operate (and whether there would be any grandfathering for firms that have already registered under the MLRs) have not yet been published.

OTHER REGULATORY DEVELOPMENTS

• UK financial promotions regime for cryptoassets

Marketing of unregulated cryptoassets in the UK is not currently subject to FCA regulation and is overseen only by the Advertising Standards Authority (ASA). However, HMT has published draft regulations that would bring certain qualifying cryptoassets[7] into the scope of UK financial promotions restrictions.

The effect of the rules would be that, unless they are exempt, businesses that intend to make financial promotions in relation to qualifying cryptoassets would need to have their promotions approved by an authorised person under FSMA. The regime will apply even where the person communicating the financial promotion is based overseas, and regardless of how it is communicated (including online or on social media).

Due to industry feedback, HMT has proposed introducing a temporary exemption to Section 21 FSMA, which will enable cryptoasset businesses that are registered with the FCA under the MLRs (but who are not otherwise FSMA-authorised persons) to communicate their own financial promotions in relation to qualifying cryptoassets.

The FCA has also consulted on rules for the promotion of cryptoassets and other high-risk investments that will apply to authorised firms making (or approving) cryptoasset promotions. The final rules for cryptoassets have not yet been published thought FCA has indicated that those rules will closely follow the final rules for high-risk investments, which were published in August 2022 and came into force on 1 February 2023[8]. It is not yet clear exactly when the new rules will be implemented, although the FCA warned firms to start preparing now for the new regime[9] in a statement published in February 2023.

• Central bank digital currencies

Like most jurisdictions, both the UK and EU have been exploring whether and how to introduce a central bank digital currency (CBDC). Following preliminary consultations and exploratory work, the Central Bank launched an investigation in October 2021 into how a digital euro could be designed and distributed, as well as the impact it could have on the market. This investigation phase is expected to conclude in autumn 2023.

In the UK, the Bank of England and HMT launched a CBDC Taskforce in April 2021 and most recently in February 2023 published a consultation on the design of a potential UK retail CBDC. This latest consultation paper sets out analysis conducted by HMT and the Bank of England to date on the potential case for a UK retail CBDC and seeks feedback on the key features of a potential retail CBDC model.

Neither the UK nor the EU have yet taken a firm decision on whether to actually go ahead and develop a CBDC. However, if they do go ahead these would be major infrastructure projects spanning several years. Therefore, it is expected that the earliest “go-live” date for a UK or EU CBDC would be towards the end of this decade. Further phases of work would also be needed to flesh out the role of intermediaries in providing CBDC wallets or other services, and any regulatory regime that would apply to them.

• Travel rule

Both the UK and the EU have also published legislation implementing the “travel rule” set out in FATF Recommendation 16[10], requiring that cryptoasset transfers must be accompanied by certain identifiable information on the transferor and transferee. The UK has already published its implementing legislation[11], which will apply from 1 September 2023. Registered cryptoasset service providers under the MLRs will need to prepare now for its implementation. The EU has also agreed the text of its implementation of the travel rule for cryptoasset transfers and it is expected to be published in the Official Journal alongside MiCA later this year, and apply from the same time as MiCA. Again, EU cryptoasset service providers will need to prepare to comply with these new requirements.

[1] Although some EU jurisdictions such as France have introduced national

regimes for the regulation of cryptoasset service providers.

[2] See FCA webpage “Cryptoasset AML/CTF regime: feedback on good and poor quality applications” at https://www.fca.org.uk/cryptoassets-aml-ctf-regime/ feedback-good-poor-quality-applications

[3] FCA, Guidance on Cryptoassets Feedback and Final Guidance to CP19/3 (Policy Statement, PS19/22) <https://www.fca.org.uk/publication/policy/ps19-22. pdf> Accessed December 2022.

[4] https://www.cliffordchance.com/briefings/2022/12/crypto-regulation--an-

introduction-of-mica-into-the-eu-regulator.html

[5] HMT, “Future financial services regulatory regime for cryptoassets Consultation and call for evidence” https://assets.publishing.service.gov.uk/ government/uploads/system/uploads/attachment_data/file/1133404/TR_Privacy_ edits_Future_financial_services_regulatory_regime_for_cryptoassets_vP.pdf

[6] HMT, “UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: Response to the consultation and call for evidence” O-S_Stablecoins_consultation_response.pdf (publishing. service.gov.uk)

[7] HMT has indicated that it will define qualifying cryptoassets as “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable”.

[8] FCA, “Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions” PS22/10: Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions (fca.org.uk)

[9] FCA, “Cryptoasset firms marketing to UK consumers must get ready for financial promotions regime” Cryptoasset firms marketing to UK consumers must get ready for financial promotions regime

[10] See the FATF Recommendations at https://www.fatf-gafi.org/en/

publications/Fatfrecommendations/Fatf-recommendations.html

[11] The Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022, which will insert a new Part 7A MLRs setting out these requirements.

Note: This article was originally published in the International Journal of Blockchain Law.