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The UK’s Financial Services and Markets Act represents the first steps to a far-reaching crypto regulation regime – but does it go far enough?

  1. The UK has taken a significant step towards establishing a comprehensive regulatory framework for digital assets by enacting new provisions under the Financial Services and Markets Act 2023 (FSMA 2023), which came into force last Tuesday (29 August).
  2. According to the UK government, the primary aim of these new provisions is to
    1. Provide clarity, certainty and protection for consumers, businesses, and investors in the rapidly growing and evolving digital asset sector and
    2. To “[facilitate] the international competitiveness of the economy of the United Kingdom and its growth in the medium to long term”.
  3. One of the key changes introduced by FSMA 2023 is the explicit recognition of crypto assets as a type of investment that falls within the scope of existing financial services regulation and supervision. Under Section 69(4) of the Act,
      1. “Any cryptographically secured digital representation of value or contractual rights that:-
        1. Can be transferred, stored, or traded electronically and
        2. Uses technology supporting the recording or storage of data (which may include distributed ledger technology).
  1. This definition covers both.
    1. Regulated crypto-assets, such as security tokens and e-money tokens, and
    2. Unregulated crypto assets, such as utility and exchange tokens, were previously outside the regulatory perimeter.”
  1. The Act’s provisions also create a new DESIGNATED ACTIVITIES REGIME (DAR) that allows the government to regulate certain activities related to crypto assets without requiring prior authorisation from the Financial Conduct Authority (FCA).
  2. The DAR will initially cover activities already regulated under EU laws, such as safeguarding and the administration of crypto assets.
  3. However, it may include other activities, such as validation and governance of crypto assets.
  4. Firms engaged in designated activities must comply with the rules set out by the FCA or the government in secondary legislation, and more serious breaches may be punished by either a fine or, in circumstances where serious criminal activity is involved, a prison sentence.

FSMA 2023 also deals with regulating stablecoins used as a means of payment (Payment Stablecoins).

  1. These are digital assets that aim to maintain a stable value by pinning their value to other assets, usually fiat currencies.
  2. Payment Stablecoins pose potential risks to financial stability and consumer protection owing to their potential scale and interconnectedness with the financial system.
  3. Therefore, FSMA 2023 gives the government the power to regulate Payment Stablecoins in terms of issuance, redemption, governance, risk management and consumer protection.
  4. Moreover, Payment Stablecoins that are deemed systemically important may be subject to dual regulation by the FCA and the Bank of England (BoE) and may be covered by the Special Administration Regime in case of failure.
  5. Finally, FSMA 2023 also enables the creation of a digital securities sandbox (DSS) that will allow firms to test new technologies, such as distributed ledger technology, in relation to security tokens.
  6. The DSS will focus on two areas:
    1. First, functions performed by central securities depositories, such as settlement, notary, and maintenance of securities; and
    2. Second, operation of trading venues for security tokens. The DSS will operate under a modified legislative framework that will facilitate innovation and experimentation while ensuring adequate safeguards for participants.
  7. The government is currently consulting on the design and operation of the DSS and plans to launch it later this year.
  8. The legal profession has broadly welcomed the crypto-related provisions of FSMA 2023.
  9. Signature Litigation’s Kate Gee tells CDR:
    1. “The vulnerabilities – and corresponding risks – of the crypto sector have been highlighted by the recent high-profile failure of several crypto platforms and exchanges (for example, ). However, market participation has continued to grow at both retail and institutional level. Globally, regulators have been slow to introduce measures to protect investors.”
    2. “One significant implication of this 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.
    3. Firms that do not meet these criteria must apply to the FCA for new (or varied) authorisation.
    4. This will have a direct impact on crypto platforms and exchanges, as well as firms that provide related services. The requirement will also 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.”
  10. Nicola McKinney, a partner at the London-headquartered disputes boutique Quillon Law, could be more enthusiastic, pointing to the limited scope of the provisions and the need for greater cross-border cooperation. She tells CDR:
    1. “Upcoming amendments to the Financial Services and Markets Act 2023 concerning crypto assets reflect the landscape of increasing regulatory action in the crypto sector, with high levels of public interest, together with recent high-profile reports of fraud, financial crime and investor losses in the digital assets industry, causing increased policy scrutiny over how the sector should be both promoted and regulated in the UK.”
    2. “However,” she cautions, “the new FSMA provisions are in reality very limited in scope, given the diversity of crypto-asset products that are now available, the frequency of innovation, and how consumers interact with them. Regulators, policymakers, and parliamentary bodies have thus far been inconsistent in their tone and recommendations on how these crypto challenges should be met, with divergent attitudes and conflicting strategies emerging as to how digital assets should be treated if the UK is to realise its goal of becoming a global crypto hub”.
  11. McKinney concludes:
    1. “Notwithstanding the policy-level tensions, the recently announced provisions continue the likely direction of travel, looking to further bring services around crypto-assets within the regulatory remit of the FCA and other bodies, and expanding the existing framework, while other elements of the Act, such as the creation of a digital securities sandbox, have an eye on making provision for new technologies. Collaboration, particularly across national borders, will prove key in the UK’s race to establish itself as a world leader in digital assets.
    2. Regulators, policymakers, and the crypto industry itself must coordinate to establish effective regulation while also being agile enough to respond to crypto’s constantly evolving nature.”
  12. AND IN THE EU…
    1. While many of the provisions in FSMA 2023 are like the EU’s Markets in Crypto Assets Regulation (MiCA), the UK is adopting a more phased strategy.
    2. The initial phase of regulatory updates gives priority to regulations for Payment Stablecoins, while the second phase addresses proposals to incorporate additional crypto assets into a regulatory framework. In the meantime, existing regulations, including the financial promotion regime and Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) regulations, remain applicable to other digital assets.
    3. Other notable distinctions exist between the UK's strategy and MiCA. For instance,
      1. There is no suggestion of a reserve requirement on asset-referenced tokens in the UK's approach.
      2. Non-Fungible Tokens (NFTs), which are mostly not included in MiCA, are planned to be part of future regulatory updates in the UK.
      3. Authorised entities such as banks will not automatically be granted permission to engage in crypto-asset activities.
      4. Furthermore, lending activities related to crypto are subject to regulation.
    1. Last month, France’s financial regulator, Autorité des Marchés Financiers for crypto platforms in advance of MiCA coming into effect on 1 January 2024.


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