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Counsel Kate Gee discusses what could be next for crypto regulation, following recent amendments to the Financial Services and Markets Act 2023.

Kate’s article was published in the FTAdviser, 20 September 2023, and can be found here.

With the recent amendments to the Financial Services and Markets Act 2023, the UK government is taking some initial formal steps to regulate the crypto sector.

The amendments, some of which will come in to force in October this year, are widely considered as an entry in the statute book which starts to give some clarity about the regulatory framework for digital assets and crypto companies, in respect of registration requirements and financial promotions.

Globally, market participation in crypto has continued to grow at both retail and investor level. However, regulators worldwide have been slow to introduce comprehensive – and coordinated – measures to protect investors. Similarly, crypto companies have had to navigate uncertainty surrounding the regulations that do – or do not – apply to their business and services, and the challenges that come with operating a business across multiple jurisdictions with inconsistent (or non-existent) regulations.

In the aftermath of the high-profile collapse of FTX, and noting the SEC complaints recently filed against Binance and Coinbase in the US, it is a timely – and welcome – step towards manging the risks and providing some clarity to companies operating in this rapidly developing sector.

Commentators have voiced concern about whether the FSMA amendments go far enough. Last year, Rishi Sunak set out plans to make the UK a global hub for crypto technology and investment. The consultation in February 2023 confirmed that the government’s “firm ambition is for the UK to be home to the most open, well-regulated, and technologically advanced capital markets in the world. Delivering on this ambition means taking proactive steps to harness the opportunities of new financial technologies.”  Against this background, ministers may have had to tread a fine line between safeguarding investments, while simultaneously retaining sufficient market confidence and international competitiveness to be in a position to fulfil this ambition.

The amendments to FSMA aim to provide clarity, certainty and protection for consumers, businesses and investors in the rapidly growing and evolving digital asset sector.  The FCA hopes that the developments will help to strengthen protection, and enable customers to be better informed about risks associated with their investments.

So, which digital assets are within scope?

Section 69(4) of the Act defines a crypto asset as ‘any cryptographically secured digital representation of value or contractual rights that (a) can be transferred, stored, or traded electronically, and (b) uses technology supporting the recording or storage of data (which may include distributed ledger technology)’.

This definition is broad and covers both regulated crypto assets, such as security tokens and e-money tokens, and unregulated crypto assets, such as utility tokens and exchange tokens, which were previously outside the regulatory perimeter.

However, questions have been raised about wither or not this definition is sufficiently “future proof” to capture technological advancements and new types of digital assets that emerge in the coming months and years.

What are the most notable developments?

One of the most significant implications of the new regulations is that crypto firms that wish to market regulated activities to UK consumers are required to have an establishment in the UK and be authorised here.  Firms that do not meet these criteria must apply to the FCA for new (or varied) authorisation. This will have a direct impact on crypto platforms and exchanges, as well as firms that provide related services or activities.  Inevitably, the requirement for registration will give the FCA greater oversight of firms operating in the crypto sector and their specific operations, including in relation to financial promotions where the FCA – recently – has increased its focus.

Another notable development is the explicit recognition of crypto assets as a type of investment that falls within the scope of existing financial services regulation and supervision.  This means that cryptocurrencies, cryptoassets and related activities will fall to be regulated by the FCA in much the same way as it oversees the issue and trading of stocks and bonds, and related services.

How is the sector likely to react?

The FCA’s Director of Consumer Investments, Lucy Castledine, has insisted the authority will take action against any firms illegally marketing to UK consumers.  At the same time, there is a concern over the reluctance or refusal of some ‘overseas and unregulated crypto firms’ to commit to the new regime.

Perhaps foreshadowing this, the FCA has indicated that firms may be able to apply for more time to comply with the tougher rules – for example, some firms may be permitted time until January 2024 to introduce features that require greater technical development.

As these changes are brought into force, it remains to be seen how robustly the FCA will crack down on firms. There are questions over whether it has sufficient staff levels with the relevant capability to properly and comprehensive monitor and police the sector, in particular considering the overseas firms that market investment opportunities to people in the UK. Certainly, the FCA’s registration process to date has been considered cumbersome and slow, and the amendments will only increase the pressure on its resources.

To have the impact required, we will need to see robust and decisive action from the FCA.

In the meantime, while the new legislation beds in, consumers should carefully scrutinise the opportunities presented to them and specifically consider the extent to which the relevant crypto company has engaged – or at least taken steps to engage – with the developing regulatory framework.

At the same time, change is often a catalyst for disputes.  With any regulatory developments, there is an inevitable learning exercise as the market responds to and implements the necessary changes to their businesses.  It seems reasonable, therefore, to expect to see litigation arising out of the changes to the regulatory framework and the corresponding pressures on businesses as they are forced to adapt.