Manoj’s article was originally published in Financial Regulation International, 29 October 2022, and can be found here.
Crypto regulation is necessary to encourage innovation in the crypto asset investment market and protect investors
Manoj Mistry, Managing Director, IBOS Association
Divergence from the EU in financial services regulation has always been at the heart of the Brexit project. MiCA, the long-awaited crypto regulations being implemented by the EU, will soon be followed by the UK’s own version. But the lack of equivalent protection between them makes their divergent paths all too obvious.
Whereas MiCA’s impact is wide-ranging, the UK’s regulatory ambition appears to be much more limited, affecting only digital settlement assets and increasing conditions for crypto supervision.
Thanks to a broad definition that maximises its regulatory reach across multiple asset types, MiCA will regulate crypto assets including investments. Excluding purely mined coins, new issues of crypto assets will be required to publish a white paper. These may be similar to previous white papers that were regularly published for initial coin offerings (ICOs), detailing information on the planned business purpose, the people involved and technical design.
In regulating just a few crypto assets, the UK’s “digital settlement asset” definition is narrower, including stablecoins as a means of payments. But it does not yet include crypto assets as an investment class.
The UK’s lighter regulatory touch can be seen in the financial services and markets bill currently making its way through the legislative parliamentary process and the policy and handbook rules for high-risk investments, recently published by the Financial Conduct Authority (FCA).
Regulatory differences between the EU and the UK also extend to service providers. MiCA’s definition includes trading, advice, orders, as well as custody and crypto-to-crypto and crypto-to-fiat exchange, whereas the UK is likely to concentrate on fewer services, such as exchange and custody.
In the absence of additional regulation, protection afforded to UK retail investors in crypto assets is less apparent than what has been implemented for their EU counterparts. This makes it hard to appreciate what investment security benefits Brexit is delivering for UK-based investors in the context of crypto assets, which are universally regarded as a high-risk asset class.
All this is happening as a protracted crypto winter continues to weigh heavily on the market: although the bubble has not entirely burst, investor enthusiasm has certainly diminished. After reaching spectacular highs a year ago, all the leading cryptocurrencies continue to trade at levels far below their 2021 peak. The aggregate value of the crypto market remains stuck below the $1 trillion level, having been well over double that figure just 12 months ago.
The global economy has also dramatically shifted in 2022, as crypto enthusiasm has been swept aside by harsh economic realities: the energy crisis, resurgent inflation, rising interest rates, a sterling currency crisis and the much-heralded potential of a recession just around the corner for much of the eurozone.
Against this backdrop, investor sentiment has shifted. As safety and stability become the watchwords in uncertain times, riskier asset classes have lost their lustre. Evidence of crypto assets’ inherent volatility can be seen in the precipitous falls of cryptocurrencies, followed by sustained lower valuations. This further helps to explain the need for tighter UK regulation that better protects investors.
There are loopholes too. Under the UK’s anti-money laundering regime, crypto asset firms have to register with the FCA when they set up in the UK, but are not required to if they do not have a UK base. This anomaly serves as a primary example of how UK investors are potentially vulnerable when not adequately protected.
To ensure that protection of UK investors is at the very least adequate, the FCA should be aiming to regulate crypto investment in a similar manner to the EU’s MiCA regulations.
The UK is at least keen to issue warnings about crypto investment risk and making it mandatory to provide investors with such warnings so that have a clear understanding of what protection they do and not have.
The wording of the FCA’s new rules is unambiguous: “This is a high-risk investment and you are unlikely to be protected if something goes wrong”. While this may serve to deter some from taking unnecessary, unaffordable levels of risk, it does nothing to protect those investors that choose to do so.
According to several observers, facilitating innovation in the UK crypto space is the reason why the FCA decided not to extend regulation to crypto investments. However, it is hard to fathom the logic applied in this decision.
Instead, further UK regulation would help to encourage innovation in the crypto asset investment market. Critically, this would also reassure investors as well as protecting them.