Clifford Chance

We are delighted to have worked with leading payments platform Paysafe on an important new report:  A green future: How the crypto asset sector can embrace ESG  on the key environmental, social and governance (ESG) considerations for the cryptoasset industry.

As new technology continues to transform financial markets, ESG principles are central to responsible innovation. Building them into the foundation of new technologies and future financial ecosystems is essential. However, there is still a lack of clarity for market participants around what best practice looks like, and the specific legal and regulatory frameworks that will drive change are largely still being developed.

This report is an important addition to the ESG discussion as it captures legal, consumer and policy approaches and looks beyond the environmental impact which is often the focus in this space. We believe that clearer, more robust frameworks can be developed by policymakers to help our clients navigate the complex world of ESG considerations in the cryptoasset markets and achieve their ESG goals. The report includes five key policy recommendations to drive change and improve ESG outcomes in the crypto space. Implementing these recommendations would help the UK maintain its position as a leading hub for technology and innovation and cement its position as a leader in the development of ESG standards.

Current legal and regulatory requirements on ESG

Regulators in the UK and EU are still in the process of developing comprehensive regulatory frameworks for the crypto industry, and discussion around the appropriate level of ESG principles or requirements for the provision of cryptoasset services is ongoing. However, there are wider existing frameworks, rules and guidance that apply more generally in both the financial services sector and beyond that would need to be considered. These include the Sustainable Financial Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive in the EU and FCA guidance and the Financial Reporting Council's UK Stewardship Code 2020 in the UK. More work is needed to consider the intersection between crypto and ESG issues and propose legislation which effectively addresses the specific ESG-related challenges that the crypto industry presents, without fully disrupting the market.

Environmental challenge – energy consumption

Foremost among the ESG challenges for crypto is the predominance of energy consumption associated with use of distributed ledger technologies (DLT). There are currently no rules that specifically impose environmental requirements on cryptoasset service providers in the UK in this regard. The EU has made a step forward in the regulation of the crypto industry by requiring issuers of cryptoassets and cryptoasset services providers to provide disclosures on their ESG performances under the Markets in Crypto-Assets Regulation (MiCA Regulation) which is currently going through the final stages of the legislative process.

Social challenge –illicit activities and consumer harm

Another ESG concern facing the crypto industry is the potential for illicit activities and consumer harm resulting from crypto transactions. In this area, the UK Financial Conduct Authority (FCA) has taken some steps to protect consumers and HM Treasury has issued two consultations proposing to regulate stablecoins and cryptocurrency adverts in an initial phase of regulation, building to cover the regulation of cryptoasset service providers more generally. These are similar to the proposed rules for the EU under the MiCA Regulation, although there are some key differences.

Governance challenge – data privacy

The use of DLT also raises concerns from a data privacy perspective which governments and regulators are considering, however work remains to be done to develop coordinated legal and regulatory measures to protect consumers from these dangers.

Future legal and regulatory requirements on ESG

As the relationship between ESG and fintech is increasingly understood, a comprehensive and iterative approach to regulation is needed to ensure that policy initiatives are aligned and reinforce each other. Any future legal and regulatory framework should aim to avoid duplicating or conflicting with existing frameworks, and aim for consistency across industries and with other jurisdictions to the extent possible. As technology develops, such frameworks will need to develop alongside it. Indeed, the EU's MiCA Regulation already envisages reviews that are likely to include further ESG-focused measures that would apply to cryptoasset service providers. Regulatory sandboxes, such as the UK FMI Sandbox and the EU Pilot Regime, can be used to develop regulation alongside innovation.

Many existing regulatory approaches to ESG in the wider financial sector have centred around disclosure, highlighting the need for standardised requirements and metrics to provide investors with clear information, for example as has been seen in the SFDR and the International Financial Reporting Standards Foundation. Green taxonomies may play a central role in any new regulatory regime, providing a sector-wide standardised framework for the identification and classification of financial products and services that can be considered green or in transition. As the digital finance market continues to evolve, harmonisation of regulation in order to allow firms to identify their ESG obligations and best practices poses a challenge. As such it will be important for regulation to evolve in tandem with the crypto industry to ensure transparency and clarity for market participants and consumers. 

Download the report.