Regulation
UK is taking the right steps on cryptocurrency regulation, but needs to act faster
The UK is moving in the right direction when it comes to regulating cryptocurrencies, but the country needs to move faster, says the author of this article.
The author of this article is Brett Hillis, a partner at the law firm Reed Smithand a member of On-Chain, the firm’s crypto and digital assets group. The team has over 100 lawyers working in the United States, the United Kingdom, Europe, Asia and the Middle East.
The evolution of the cryptocurrency and digital asset space continues to be important to the wealth management industry, and we are pleased to share this information. Standard editorial disclaimers apply. Please email the editor at tom.burroughes@wealthbriefing.comIf you’d like to join the conversation, we welcome feedback from those on the front lines of this technology.
The UK government has made no secret of its ambition to make the UK a crypto hub. It is a laudable ambition, but the UK faces a crowded and competitive market internationally. There are many incentives to attract crypto and other digital asset businesses to Britain, but the UK must recognise that, in the face of competition from other jurisdictions, it cannot afford to sit back and do nothing.
However, it is worrying that UK regulators do not appear to have recognised this problem when it comes to retail investments.
It is telling that the Financial Conduct Authority (FCA) has not consulted on the sale of investment products referencing crypto assets to retail clients for five years, with the corresponding ban in place since January 2021. Since then, however, the global situation has changed dramatically. Particularly significant recent developments include the regulatory approval of bitcoin exchange-traded funds (ETFs) in the US and Hong Kong. In the European Economic Area, investors have been free to invest in bitcoin exchange-traded products (ETPs) backed by physical assets since 2019.
But the FCA’s only move has been to allow institutional investors to invest in Bitcoin and Ethereum ETPs. As a result, it is hard to escape the conclusion that the UK’s position is much more conservative when it comes to the retail market for crypto-asset-based products.
An outdated position?
The FCA’s position is aimed at protecting retail investors and this of course remains of paramount importance. But the FCA’s position assumes that, unlike institutional investors, retail investors in general will not have the ability to accurately assess the risks and value of the underlying crypto assets, regardless of the other regulatory protections put in place to protect them.
The FCA’s argument for banning retail investors from investing in ETPs is based on a number of assumptions that may well have been proven correct in 2019. But the cryptocurrency markets have matured considerably since then. Despite this, the FCA has not reassessed its position on whether the same challenges apply or whether a ban on retail investors is the best way to address them.
For example, the arguments made five years ago that cryptoassets have no intrinsic value, are vulnerable to market manipulation and financial crime, and have extremely volatile prices may not have the same force today as they did then. And even if those arguments were as true today as they were then, it does not follow that a retail ban is the best response. So if the FCA were to undertake a new consultation today, it is hard to imagine that it would reach the same conclusion.
The FCA’s approach puts UK regulation in a curious position. Cryptoassets do not fall entirely within the FCA’s regulatory scope. Most significantly, they do not fall within the FCA’s product remit, meaning that no cryptoassets have been banned by the FCA. In other words, it is not within the FCA’s remit to ban bitcoin or ethereum.
Anti-money laundering regulations have been extended to encompass cryptocurrency exchanges, brokers and custodians, which fall within the scope of the FCA’s regulatory powers, but the FCA’s role in this regard is to warn investors of the risks associated with crypto assets as an investment product rather than preventing access to them.
Therefore, with the FCA’s position unchanged, the ban on ETPs for retail investors has led the UK to regulate cryptoassets and crypto asset ETPs differently, despite the fact that the products share a similar risk profile. In fact, the banned product is arguably the less risky of the two due to the custody and custody provisions.
After that ?
Since 2021, the FCA has been given additional powers to regulate cryptoassets, with the financial promotion regime being extended to cover cryptoassets. The FCA has set out detailed requirements around the promotion or sale of these products to retail consumers – which has perhaps unsurprisingly not encouraged retail investors – and it is clear that the FCA intends to take an active approach to its enforcement responsibilities.
For example, on the first day after the introduction of a new cryptocurrency marketing regime, the FCA issued 146 alerts to firms, reminding them of their obligation to protect UK consumers from illegal promotions. In itself, this assertive approach to regulation should not necessarily be seen as a cause for concern. On the contrary, the strict approach to marketing can play an important role in educating consumers about the risks. But educating consumers about the risks is one thing, denying them the opportunity to invest is another.
This approach is also out of step with the UK’s broader approach to cryptoasset regulation as it has developed. It has not closed the market but has provided strong protections for retail investors. The FCA’s financial promotion regime for cryptoassets shows that retail investors can be permitted to purchase cryptoassets subject to a heavily regulated customer journey. It seems incongruous that a similar approach is not being taken for fully regulated products referencing these cryptoassets.
Indeed, overall, the FCA’s regulation of cryptocurrencies and digital assets deserves praise, both for the rules it has developed and its practical approach to their enforcement. The end result should be confidence in the sector.
But that confidence may well be shaken by the continued ban on retail investors, particularly in light of the reassessment of their position by other jurisdictions. It is of course essential that retail clients are protected from excessive risk exposure, but this must be done in a way that does not create unnecessary barriers to investment. For all the positive aspects of the UK regulatory regime, the FCA has also created an unnecessary barrier to retail investment and the sooner this is addressed the better.