Key messages from the UK regulator on CrypoAssets

On Wednesday 23rd January 2019, the Financial Conduct Authority published a consultation paper (CP 19/3) called 'Guidance on Cryptoassets'.

Read this if you want to understand if your crypto activity is deemed to be regulated by the FCA or if you want to better understand what the FCA will be focusing on. The FCA consultation period is now open until 5th of April and is an opportunity to provide feedback. Expect a full policy on CryproAssets in the summer of 2019, which means regulation.

This consultation is relevant to:

• Firms issuing or creating cryptoassets
• Firms marketing cryptoasset products and services
• Firms buying or selling cryptoassets
• Firms holding or storing cryptoassets
• Financial advisers
• Professional advisers
• Investment managers
• Recognised investment exchanges
• Consumers and consumer organisations.

Brief summary of the FCA’s key messages:

• Business as usual – we are still dealing with the ongoing paradox of the underlying token (e.g. BTC, ETH, XRP) being regulated yet the derivative (BTC Futures) being unregulated.
• Increasing consumer risk of harm, noted by the FCA - The FCA is beginning to take notice of mainstream financial service entering the market a small derivatives market (BTC Futures, NDFs) emerging. They note, that there is “growing evidence at a global level of increasing harm”. What this means is that The FCA and UK Taskforce will become more active in monitoring for systemic risk and consumer harm, and if escalated further provides a stronger incentive to regulate.
• The FCA is a “technology neutral” regulator.
• The FCA is looking to see whether cryptoassets fall under four regulatory definitions:
  1. Is it a ‘Specified Investment’ under the Regulated Activities Order (RAO)?
  2. Is it a ‘Financial Instrument’ under MiFID II?
  3. Is it captured under Payment Services Regulation (PSRs)?
  4. Is it captured under E-Money Regulations (EMRs)?

See further clarification below to determine if your cryptoassets activity falls under FCA regulation...

• The FCA recognises that fraud and volatility as the main reasons the UK hasn’t seen mainstream adoption of Crypto Assets [reference: sections 2.15, 2.20, 2.26, 2.27 and 2.45]
• The FCA see limited benefits emerging from cryptoassets but substantial harm relating to fraud, price volatility, money laundering and terrorist financing – further good news for those institutions who want to see regulation. [reference: sections 2.21, 2.22, 2.23, 2.42, 2.30, 2.31, 2.26 and 2.27]
• Consumers who buy Crypto Assets still have limited recourse (investor protection) under the Financial Services Compensation Scheme (FSCS) or Financial Ombudsman Service (FOS).
• The FCA and UK Taskforce are interested in working with international partners to mitigate risks in cryptoassets.

Do your cryptoasset activities fall under FCA regulation?

• The FCA recognises that fraud and volatility as the main reasons the UK hasn’t seen mainstream adoption of cryptoassets [ref: sections 2.15, 2.20, 2.26, 2.27 and 2.45]
• The FCA see limited benefits emerging from cryptoassets but substantial harm relating to fraud, price volatility, money laundering and terrorist financing – further good news for those institutions who want to see regulation. [ref: Sections 2.21, 2.22, 2.23, 2.42, 2.30, 2.31, 2.26 and 2.27]
• Consumers who buy cryptoassets still have limited recourse (investor protection) under the Financial Services Compensation Scheme (FSCS) or Financial Ombudsman Service (FOS).
• The FCA and UK Taskforce are interested in working with international partners to mitigate risks in cryptoassets.

In summary:

• The FCA uses a ‘regulatory perimeter’ which describes the boundary that separates regulated and unregulated financial services activities.
• Firms carrying on regulated cryptoasset activities in the UK must obtain the appropriate authorisation from the FCA.  Consumers can check if a firm is regulated by checking the FCA website to determine if a firm is regulated.
• Cryptoassets have many of the features of a financial instrument (including being purchased for speculative reasons) but this does not make it a Specified Investment under RAO or a Financial Instrument under MiFID II.
• Firms must consider the territory they are operating in, the nature of the financial instrument and the services they offer to determine if they are inside or outside the regulatory perimeter. 

The FCA classification views cryptoassets as a:

Store of value:  Bitcoin for example would fail to be a stable store of value as it is subject to wild valuation swings.  Arguably a number of national currencies would also fail this test but central banks have chosen to ignore this point.

Medium of exchange:  You can swap a UK pound for goods and services pretty much anywhere in the UK.  The FCA notes that only circa 600 outlets take Bitcoin in the UK and so it is not a widely accepted medium of exchange.

Unit of account:  Can you easily use a cryptocurrency to measure costs between different items and services?  No, because of the wild price swings and limited acceptance. The FCA notes, that it is not easy to produce easy comparisons.

My view

The key take home message from this FCA update is that the FCA (and UK taskforce) recognises an increasing risk to consumers with an emerging cryptoasset derivatives market (eg BTC futures, NDFs)  and mainstream institutional players entering the market. This is good news for institutions who want cryptoassets regulated is it provides a further incentive for the FCA to regulate. But don’t expect a formal policy statement until Summer 2019!