“On the Brink of Something Important” – the UK Government’s approach to cryptoasset technology

introduction

In early April 2022, there was a flurry of announcements about cryptoasset regulation in the UK. On April 4, 2022, John Glen, Treasury Secretary for Business, delivered a keynote speech outlining the government’s plans to make the UK a “world-leading regime” for cryptoasset companies, and Rishi Sunak, Chancellor of the Exchequer, stated his ambitions for Britain into a “global hub for cryptoasset technology” and mandate the Royal Mint to produce a non-fungible token (“NFT”).

On the same day, HM Treasury published a response to its consultation on the UK regulatory approach to cryptoassets, stablecoins and distributed ledger technology (“DLT”) in financial services. The announcements follow the Treasury Department’s January announcement that financial promotions related to certain cryptoassets would be regulated and the FCA’s consultation on the rules applicable to such promotions (which ended on March 23, 2022).

In this article, we examine what these announcements say about the direction of UK cryptoasset regulation and why it is a crucial time for the industry to join the discussion.

A detailed route map

The government wants the UK to be a “global hub” and “the very best place in the world to start and scale crypto businesses.” This does not mean that the UK will lower regulatory standards in the cryptoasset business, but that the UK will seek to encourage innovation by implementing “robust and effective regulation.”

The UK Government’s plan to support the development of a “world’s best crypto ecosystem”, which includes HM Treasury’s approach (see below), will take into account:

• The need for a dynamic method of regulating all financial activities and products, including those using crypto technologies, that is “tailored and proportionate” but also “flexible and technology-neutral.”
• Regulation, or a “code of regulation” shaped by the input and advice of industry participants, as well as the Treasury and regulators working through the Cryptoassets Taskforce.

• The importance of facilitating safe, sustainable and rapid innovation.

Mr. Glen pointed out that English law, world-leading legal services and courts are a great asset. The Law Commission, which has already presented work on key issues in the crypto space, including digital assets and smart contracts, is now being asked to review the legal status of Decentralized Autonomous Organizations (“DAOs”).

In addition to financial services regulation, the UK tax regime will be examined to provide solutions to issues such as the treatment of decentralized finance (“DeFi”) credit and staking protocols. Additionally, according to Glen, the disincentives for UK fund managers adding crypto assets to their portfolios will be removed (although we note that the Financial Conduct Authority (“FCA”) will issue a reminder to regulated entities on the risks of exposure to crypto assets in March 2022). Has ).

A commitment to engage with and learn from the industry

Mr Glen spoke of the UK Government’s ability and determination to learn fast and highlighted the UK’s track record of easing regulatory sandboxes. He announced the FCA’s CryptoSprint, which will take place in May 2022 and will focus on “informing regulatory policy changes based on evolving technologies.” The CryptoSprint will consider three “issue statements” that the FCA says cover some of the key stages in the cryptoasset lifecycle:

• How should information related to cryptoasset issuance be disclosed to investors?
• How do we identify (and test) where regulatory obligations should be placed for centralized and decentralized cryptoasset models? These should allow regulators to strike a balance between capturing relevant activities that pose a risk to UK consumers and markets now and as the sector develops, while allowing useful innovation.
• What gaps need to be filled in the existing UK custody regulatory framework for crypto asset custody to help protect UK consumers and markets?

Mr Glen highlighted the joint work of the Treasury, the FCA and the Bank of England in implementing a financial markets infrastructure sandbox, as announced by Chancellor Rishi Sunak in his speech at FinTech Week 2021, to be in place by 2023. This sandbox will allow companies to explore the use of DLT in financial market infrastructure. He noted that using DLT in this way “could transform financial markets by providing greater efficiency, enhanced liquidity, enhanced transparency and greater security.” This sandbox will build on Treasury evidence gathering (see below).

The government will also set up a high-level industry group, the Cryptoasset Engagement Group, which will be chaired at ministerial level and will include senior officials from the FCA, the Bank of England and business.

government to play a leading role

In his speech, Mr Glen pointed to the UK’s structural advantage, with a central government-set regulatory framework and a small number of regulators (unlike the European Union and the United States). He described the UK government as “determined, united”, “focused” and ready to lead by example. The UK government is already developing ways to use DLT for customs and international trade, and will explore the possibility of issuing debt using the technology.

Mr Glen revealed that Chancellor Rishi Sunak had asked the Royal Mint to create an NFT by summer 2022 as a symbol of the UK’s “forward-looking approach”.

Regulatory approach to crypto assets, stablecoins and DLT in the financial markets

Stablecoin payment systems need to be regulated

Stablecoins have been in the regulatory spotlight for some time due to their potential to pose risks for consumers and markets alike. In January 2021, the Treasury Department launched a consultation and a call for evidence on the regulation of stablecoins and cryptoassets and the use of DLT in financial markets (see our summary). This concern was reinforced in March 2022 in the Bank of England’s Fiscal Policy Committee report on cryptoassets and DeFi, which focused on market stability. On April 4, 2022, the response to the January 2021 consultation was published. This answer:

• Confirms that the UK government will legislate to bring stablecoins into the UK regulatory framework where these stablecoins are used as a means of payment. This is achieved through amendments to the Electronic Money Regulations 2011 and the Payment Services Regulations 2017 (which provide a ‘robust basis’ for payment regulation in the UK).
• Sets out plans to extend the applicability of part of the Banking Act 2009 to certain stablecoin activities where risks are potentially systemic. In such cases, the Bank of England is the lead regulator for companies authorized by the FCA and recognized under the Banking Act.
• Addresses competition concerns by recognizing the need to amend relevant legislation to ensure that relevant stablecoin-based payment systems are subject to appropriate competition regulation by the payment systems regulator.

These actions aim to create an environment in which payment systems using stablecoins can function and thrive, which the Treasury Department said will “deliver a world-leading stablecoin regulatory regime.”

DLT usage in financial markets

As mentioned above, the government has been studying the potential uses of DLT in financial markets for some time and has plans for a financial market infrastructure sandbox in 2023. In its response, the Treasury noted that current financial services regulations and laws were drafted without DLT in mind and that the government intends to “support the industry to ensure that legislation and regulation can enable tokenization (e.g. of securities) and DLT in financial market infrastructures”. The knowledge gained in the sandbox is expected to feed into legislative changes.

Extension of regulation to unregulated tokens

HM Treasury confirmed it continues to evaluate the appropriate regulatory response to broader cryptoassets and will consult on its proposed approach later in 2022. DeFi has the potential to reinvent and disrupt existing financial services business models, but comes with its own specific risks (such as theft from security breaches, financial crime, governance, and liability considerations). The government intends to work together to design appropriate future regulation; This presents opportunities for the industry to help shape the future of the UK as a leader in the nascent and rapidly evolving DeFi market.

What’s next – key things to watch out for

• The legislative process regarding the extension of the existing financial support scheme to eligible cryptoassets (see our earlier briefing here), the extension of the regulatory perimeter to include stablecoins used as a means of payment and the establishment of the financial market infrastructure sandbox and secondary legislation regarding its operation.
• The results of the FCA’s consultation on the financial sponsorship rules that will apply to qualifying crypto assets.
• HM Treasury consultation on broader regulation of cryptoassets (later in 2022).
• The Legal Commission’s project on conflicting laws and new technologies, which is expected to start in the first half of 2022.
• The results of the FCA’s CryptoSprint, which will take place on 10-11 May 2022 and is expected to feed into the FCA’s regulatory approach to the sector.
• The Treasury, FCA and Bank of England Financial Markets Infrastructure sandbox implementation to be in place by 2023.
• The Royal Mint’s NFT program to be completed by Summer 2022.