For the U.K. to remain attractive to the crypto industry, it should strive to provide more clarity and certainty around compliance. Policymaking in the United Kingdom is typically reactionary, and this is no less true in the context of the crypto-asset industry. Reactionary policymaking means that the U.K.’s crypto regime is occasionally behind those of its competitors, which could ultimately cause the U.K. to become a less attractive place to conduct crypto-related business. The former Chair of CryptoUK, Iqbal Gandham, pointed out in an April 2018 letter to the U.K. Parliament’s Treasury Committee that despite the fact that “the UK holds great potential to become a global leader in cryptocurrencies,” the “absence of regulatory direction” has stifled innovation in the industry.
Indeed, it was only last year that the Financial Conduct Authority published its final “Guidance on Cryptoassets” paper, and only this year did it announce that existing businesses carrying out crypto-related activity in the U.K. must register with the FCA and any new crypto businesses established after that date will not be able to operate unless they have successfully registered. The new registration requirements were implemented following recent amendments to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, otherwise known as the MLRs. The explanatory note to the MLRs indicates that the purpose of the statutory instrument is to carry out the implementation of the European Commission’s Anti-Money Laundering Directive, or AMLD, which sets out to: Promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.
Implementation of the new amendments saw the appointment of the FCA as the official regulatory body overseeing crypto-asset activity, giving it the responsibility of carrying out the purpose of the MLRs. The obligation to register with the FCA does seem like a positive step toward providing more regulatory clarity in the U.K., but what happens beyond registration? And what can we learn from other jurisdictions?
Lessons from Japan?
Crypto-based businesses that are required to register with the FCA are subject to compliance with a broad range of ongoing obligations set under the MLRs. It is interesting to note, however, that reporting obligations under the instrument appear to be relatively vague — in contrast to the legislative position in Japan. Following the Mt. Gox scandal in 2014, the Japanese government acted swiftly when it came to developing new regulations for the crypto industry. By 2017, the Payment Services Act, or PSA, was amended, not only to provide a legal definition of cryptocurrencies but also to carry out the imposition of statutory obligations on all crypto exchange businesses.
Implementation of the new regulations obliged crypto exchanges to register with a competent local finance bureau and gave rise to supervision obligations by the Japanese Financial Services Agency, or FSA. According to the PSA, crypto businesses must keep accounting records of all cryptocurrency transactions and annual reports must be submitted to the FSA. While the MLRs appear to be slightly hazy on reporting rules for crypto businesses, the effect of the new amendments should, in theory, mean that firms engaging in crypto activities can now be defined as FCA-regulated entities. If this were indeed the case, it would not be unreasonable to suggest that FCA-registered crypto businesses should follow the already existing wide-ranging guidance available for FCA-regulated firms, which includes requirements to submit an annual financial crime report to the FCA and the obligation to report any suspicious activity.
It is crucial to note, however, that the operative word here is “guidance,” not a statutory obligation. Guidance is broadly open to interpretation and gives rise to questions about regulatory clarity, particularly when it comes to reporting obligations of crypto entities in the U.K. The ambiguous position we find ourselves in becomes more concerning, especially as we are now seeing a rise in businesses participating in crypto-based activities. In fact, a key finding from the FCA’s 2020 crypto-asset consumer research is that crypto exchanges are key market participants in the space. Thus, it becomes increasingly important that such market participants have clarity around their compliance obligations, both generally and in the context of crypto exchanges.
Security or no security? That’s another question
The requirement for crypto-based businesses to register with the FCA is an indication that the U.K. is heading toward the right regulatory direction. However, registration really only scratches the surface, particularly when crypto exchanges are involved. The FCA’s guidance on crypto assets identifies security tokens as one of three broad categories of virtual currencies. Security tokens are a class of crypto assets that may present with certain attributes, which means they provide certain rights and obligations comparable to those of financial instruments regulated by the Markets in Financial Instruments Directive, or MiFID. The current position in the U.K. is that if a crypto asset looks as if it has characteristics similar to a security, then it falls within the FCA’s regulatory parameter. If not, then it will be unregulated.
Before listing new tokens, crypto exchanges tend to require legal analysis to be carried out in order to determine whether those tokens are classed as securities. Generally, if a token isn’t legally classified as a security, then it gets given the green light for listing; if it does turn out to be a security, then a more cautious approach is taken. In any event, the degree of regulatory obligations attaching to a token will vary depending on its characteristics and is usually assessed on a case-by-case basis. We might, however, see a shift in this approach sooner rather than later. Kraken subsidiary Crypto Facilities recently registered with the FCA to operate as a multilateral trading facility, claiming to be the first U.K.-based exchange to do so. As a licensed MTF, Crypto Facilities is subject to significantly more regulations. However, it has clearer reporting obligations to the FCA, which is a contrasting position to the ambiguous approach when it comes to those crypto exchanges that may not necessarily be offering crypto securities. Two other crypto exchanges operating in the country, Archax and Gemini, got licenses a month later.
Binance, for instance, is an FCA-registered exchange and is authorized to conduct a broad range of investment-related activities, but it doesn’t have a license to operate as an MTF. Both Crypto Facilities and Binance are top exchanges with a U.K. presence, but one of the main differences between the two entities is that one has clearer reporting obligations while the other does not.
Are the U.K. rules sufficient?
We have only this year seen the implementation of the new registration rules under the MLRs — a slow reaction in comparison with the three-year head start by Japanese regulators — and even then, reporting obligations for crypto businesses, particularly those exchanges not offering securities, remains unclear.
From what we’ve seen in Japan, regulators tend to act quickly and appear to be moving in close unison with new developments in the crypto market. Earlier this year, new amendments to the regulatory landscape were introduced, with the new rules implemented to effectively govern crypto custody service providers, as well as businesses dealing in crypto derivatives. In 2019, the FCA proposed a ban on the sale of crypto derivatives to retail investors, explaining that such products could be capable of being classified as financial instruments pursuant to MiFID and, therefore, within its regulatory scope. Now, nearing the end of 2020, there have been no announcements confirming whether there will indeed be a ban on the sale of crypto derivatives to retail consumers, with top exchanges like Binance still having the ability to provide such products to retail investors.
The FCA’s latest crypto consumer research found that most crypto exchange consumers in the U.K. tend to use non-U.K. based exchanges. And while the report does not directly attribute this to the ambiguous regulatory position in the U.K., having a clearer understanding of their obligations can only help U.K.-based crypto exchanges moving forward.