On Tuesday 20 November, City & Financial hosted an event on the regulation of cryptocurrencies in London. In this blog, I will share the key messages imparted from the UK regulators at this event.
Christopher Woolard, Executive Director, Strategy and Competition, Financial Conduct Authority
Martin Etheridge, Head of Division, Note Operations, Bank of England
Gillian Dorner, Deputy Director, Financial Services Domestic Strategy, Her Majesty's Treasury.
Setting the scene
Crypto assets are still in a regulatory transition period. The UK regulation of crypto assets is now largely guided by a tri-party task force made up of:
1. Financial Conduct Authority (FCA)
2. Bank of England (the Prudential Regulation Authority)
3. Her Majesty’s Treasury.
Future regulations in crypto assets will largely be driven by this task force. They suggested referring to two papers for regulatory clarity: Crypto Asset Task Force, Final Report, October 2018 and Treasury Select Committee, Digital Currencies Inquiry, September 2018.
The Task Force meets every six months and is due to publish their next update in early 2019. The UK government meanwhile, is still highly supportive of technology innovation but regulators continue to emphasize the importance of customer protection and maintaining market integrity. The FCA are not currently concerned with any potential threats from crypto assets to financial stability. However, they will continue to monitor the crypto market size and any 'linkage' to systemically important banks (GSIBs). Market size and linkage are the two main determinants for regulatory heightened engagement.
UK regulatory clarity
The FCA now clearly classifies tokens into three main asset classes:
- Exchange tokens (e.g. BTC, ETH, LTC). These tokens do not provide any rights or access to a product or service.
- Utility tokens (e.g. access tokens). These tokens are used to access a specific product or service on a distributed ledger platform (DLT). They are also used to raise capital.
- Security tokens (e.g. regulated investment products). These tokens are a 'specified investment' under the Financial Services and Markets Act 2000 (regulated activities) and may also be financial instruments under MiFID II. They infer a right of ownership or share of future profits. They are also used to raise capital.
The FCA has confirmed that it does not consider cryptocurrencies to be commodities or currencies under MiFID II. They are clear that although cryptocurrencies are not themselves regulated in the UK, it regards the derivatives of cryptocurrencies to be captured under MiFID II and therefore likely regulated as financial instruments. Crypto derivative products include crypto futures, crypto contracts for difference (CFDs), crypto options and transferable securities.
The Task Force was also explicit in its recent paper that they were looking at a potential prohibition of the sale of these crypto derivatives to retail consumers. They seem particularly concerned with crypto CFDs.
With respect to the classification of tokens, the taskforce refers to a regulatory perimeter to determine whether a crypto asset behaves like a regulated financial instrument.
The UK 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.
- The FCA are seeing genuine DLT use cases and benefits from both their Sandbox and Project innovate programmes set-up to support fintechs. The majority of these projects are DLT-related. They caveat this progress with the fact that solutions have not yet scaled and been properly tested.
- The main risks the taskforce see with crypto assets at the moment are: 1) consumer investment risk and 2) financial crime and fraud risk.
- The FCA and the FSB don’t currently see any systemic risk in relation to crypto assets. They will both continue to monitor market size and links to GSIBS.
- The taskforce will continue to monitor the actions of global regulators.
Regulators are going to face a number of challenges. It is very difficult, if not impossible to regulate within a blockchain ecosystem. For example, if people start getting paid their salaries in crypto assets, as is happening in Japan right now, and as more retailers accept crypto as payment (adoption is growing) then eventually financial transactions will bypass the regulated financial system altogether.
For the first time in history we are seeing a product/instrument such as a token, that could be construed as behaving like part-security, part-currency and part-commodity. Any regulatory classification will need to be an agreed global taxonomy or regulatory arbitrage will emerge – people will move to more their crypto assets to more favourable regulatory jurisdictions.
The biggest issues facing institutions from adopting crypto are:
- Price volatility
- No regulated exchanges
- Reputational risk
- Lack of regulatory clarity.
What institutions want is:
- Clarity from regulators
- Regulated digital custody
- SEC approved ETFs.
(source: TABB research Group).
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