Cryptoassets Taskforce: final report
The final report of the joint HM Treasury, FCA and-Bank of England Cryptoassets Taskforce was recently published and sets out the UK’s approach to cryptoassets and distributed ledger technology (DLT) in financial services. The report provides an overview of cryptoassets and the underlying technology, assesses the associated risks and potential benefits, and sets out the path forward with respect to regulation in the UK. The Taskforce has concluded that while DLT is at an early stage of development, it has the potential to deliver significant benefits in financial services and other sectors in the future, and all three authorities will continue to support its development.
The report notes there is limited evidence of the current generation of cryptoassets delivering benefits, however, benefits may arise in the future. In contrast, there are substantial potential risks associated with cryptoassets and the highest priority for the authorities are to mitigate the risks to consumers and market integrity, and to prevent the use of cryptoassets for illicit activity. The Taskforce has concluded that strong action should be taken to address the risks associated with cryptoassets that fall within existing regulatory frameworks. Further consultation and international coordination is required for those cryptoassets that pose new challenges to traditional forms of financial regulation, and fall outside the existing regulatory framework. The authorities plan to engage with international bodies to ensure a comprehensive response.
The Taskforce’s cryptoassets framework
The Taskforce has developed a framework which takes into account the different uses of the three different types of cryptoassets (exchange tokens, security tokens and utility tokens). Cryptoassets are typically used:
as a means of exchange;
- for investment; and/or
- to support capital raising and/or the creation of decentralised networks through initial coin offerings (ICOs)
The Taskforce found that cryptoassets are not widely used as a means of exchange in the UK. Data from cryptoasset exchanges shows that trading of sterling against Bitcoin makes up just 0.33% of daily global trade volumes – however the report also notes that the pseudonymous nature of cryptoassets makes such data difficult to obtain. The Taskforce estimated that there are 56 ICO projects in the UK that have been used for capital formation, which accounts for 4.3% of the 983 projects globally.
The current regulatory perimeter
Whether and what regulation applies to a particular cryptoasset instrument or activity can only be decided on a case-by-case basis. Firms and persons involved in providing services or investments related to cryptoassets should carefully consider if their activities could involve regulated activities or the issuing of financial promotions, and must ensure they are complying with relevant legal and regulatory obligations.
The FCA has been conducting enquiries into activities of unauthorised firms that are involved in some form of cryptoassets business to determine whether they are carrying on regulated activities that require FCA authorisation. If so, the FCA may investigate and take action, identifying and determining the most serious matters which pose the greatest risk to consumers. The FCA has also been encouraging regulated firms to speak to the FCA supervisors regarding cryptoasset activities they are undertaking or considering. In addition, financial services law is not the only potentially applicable body of laws. For example, contract law, consumer law, and advertising standards may apply.
There are also broader considerations for regulated firms that carry out cryptoasset-related activities. Some regulatory provisions in the FCA’s Handbook – such as the Principles for Business, the Senior Managers and Certification Regime, the Systems and Controls Provisions, and the Financial Promotions rules – can apply to unregulated activities in certain contexts.
In addition to the Financial Promotions rules placed on regulated firms, there are also broader legislative restrictions in respect of financial promotions. Section 21 of FSMA provides that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless the promotion has been made or approved by an authorised person or it is exempt. Issuing a financial promotion in breach of Section 21 of FSMA is a criminal offence.
Security tokens and other similar products
While security tokens fall within the current regulatory perimeter and it is the responsibility of firms to determine whether their activities require authorisation, the Taskforce recognises that the complexity and opacity of many cryptoassets means it is difficult to determine whether they qualify as security tokens. Given the complexity and variety of cryptoasset products intended to function as investments, the Taskforce is concerned that there is not sufficient consistency of regulatory application in these circumstances.
While security tokens are a new form of an existing financial instrument, the Taskforce considers that exchange tokens do not meet the traditional definition of a financial instrument. These assets are unlike other financial services products, and do not fit neatly within existing definitions or financial regulatory frameworks.
Impacts of DLT
The Taskforce considers that DLT has the potential to deliver significant benefits in financial services, as well as in a broad range of other sectors. As an emerging leader in DLT, the UK should look to capitalise on these opportunities. DLT has the potential to enhance system resilience; improve the efficiency of end-to-end settlement processes and reporting, auditing and oversight; and enable greater automation. The Taskforce does not consider there to be regulatory barriers to the adoption of DLT. The PRA and FCA will continue to take a technologically neutral approach to regulation, as well as providing a platform for innovation.
Impacts of cryptoassets
Cryptoassets are not widely used in the UK, and the UK is not a major market relative to the global cryptoasset market. However, interest and activity in cryptoassets in the UK has grown over the past few years. The Taskforce has assessed a wide range of potential benefits and risks associated with cryptoassets. It has concluded that there is limited evidence of the current generation of cryptoassets delivering benefits. However, benefits may materialise in the future, for example through the use of ICOs as a capital raising tool. The Taskforce has concluded that cryptoassets pose a range of risks, notably to consumers (who may face large losses), market integrity (due to manipulation and other market-abuse style strategies) and financial crime. While cryptoassets currently pose no material risks to financial stability, this may change in the future.
The Taskforce has concluded that DLT has the potential to deliver significant benefits in both financial services and other sectors, and all three authorities will continue to support its development.
HM Treasury, the FCA and the Bank of England will take action to mitigate the risks that cryptoassets pose to consumers and market integrity; to prevent the use of cryptoassets for illicit activity; to guard against threats to financial stability that could emerge in the future; and to encourage responsible development of legitimate DLT and cryptoasset-related activity in the UK.
In order to deliver these actions, the authorities will consult on:
- implementing one of the most comprehensive responses globally to the use of cryptoassets for illicit activity
- a potential prohibition of the sale to retail consumers of derivatives referencing certain types of cryptoassets (for example, exchange tokens)1, including CFDs, options, futures and transferable securities
- guidance clarifying how certain cryptoassets already fall within the existing regulatory perimeter
- whether the regulatory perimeter requires extension in relation to cryptoassets that have comparable features to specified investments but that fall outside the perimeter
The Taskforce has also concluded that exchange tokens present new challenges to traditional forms of financial regulation. There is therefore a need to consider carefully how regulation could meaningfully and effectively address the risks posed by exchange tokens and what, if any, regulatory tools would be most appropriate. The government will issue a consultation in early 2019 to further explore whether and how exchange tokens and related firms such as exchanges and wallet providers could be regulated effectively, in the case that other measures outlined in this report do not adequately address all relevant risks.
In addition, the authorities will continue to:
- warn consumers of the risks of investing in cryptoassets
- monitor potential implications for financial stability
Ron is a partner at Cummings Fisher and heads the derivatives and documentation practice. Drawing on his work in private practice with buy-side clients and in house at investment banks, he has broad experience in providing legal advice in relation to derivatives and structured finance transactions, prime brokerage and asset custody arrangements.
If you would like to discuss any of the points we raise, please contact me or one of our other lawyers.
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