Manoj’s article was originally published in Global Risk Regulator, 1 October 2022, and can be found here.
Regulating crypto assets in the UK and what are the protection rights for investors?
Manoj Mistry, Managing Director, IBOS Association
It may be tempting to dismiss the new Brexit Freedoms Bill, designed to make significant changes to the legal status of retained EU law and the post-Brexit regulatory landscape, as more about style than substance. But that would be unwise. For Britain to pursue its own path in regulation has long been a key government objective. Nowhere is this more apparent than in financial services, most notably in crypto assets.
Brexit has certainly enabled divergence from EU regulation. Just how divergent the UK’s approach is can be seen in the differences between crypto regulation now being implemented across the EU and its UK equivalent.
The EU has reached agreement on the markets in crypto-assets (MiCA) which covers issuers of unbacked crypto-assets and stablecoins, as well as the trading venues and the wallets where crypto-assets are held. This brings crypto-assets, crypto-assets issuers and crypto-asset service providers under a single EU regulatory framework for the first time.
But plans for the UK’s regulatory scope are distinctly more modest, aimed only at regulating digital settlement assets and increasing conditions for crypto supervision. This lighter regulatory touch is evident in the financial services and markets bill that is now progressing through the UK parliament and from the Financial Conduct Authority (FCA), which has recently published a policy and handbook rules for high-risk investments.
Thanks to a broad definition that aims to maximise its regulatory reach, MiCA will regulate investments across multiple crypto asset types, providing a specific regulatory framework at an EU level. With the exception of purely mined coins, issuers of new crypto assets will have to publish a white paper setting out their detailed plans, akin to the transparency required in a prospectus.
According to the European Council, MiCA will protect consumers against “some of the risks associated with the investment in crypto-assets, and help them avoid fraudulent schemes. With the new rules, crypto-asset service providers will have to respect strong requirements to protect consumers wallets and become liable in case they lose investors’ crypto-assets.”
By regulating just a few crypto assets, the UK is taking much smaller steps. Its narrower “digital settlement asset” definition includes stablecoins that are used as a means of payment, but does not yet include crypto assets as an investment class.
The regulatory differences 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 currently focusing on fewer services, like exchange and custody.
The rationale for MiCA is that consumers have very limited rights to protection or redress, especially if the transactions take place outside the EU. Manifestly, protection for UK retail investors in crypto assets is less obvious compared to their EU counterparts. Indeed, they appear to be facing greater potential risk in a high-risk asset class.
Regulation has arrived in the middle of a long crypto winter. After reaching record highs, Bitcoin and other leading cryptocurrencies now trade more than 70 per cent down on their 2021 peak. This has driven the crypto market’s total value below the $1 trillion level, well below half what it was 12 months ago.
As the world economy continues to shift dramatically this year, exuberance has given way to the harsh realities of a global energy crisis, resurgent inflation, increasing interest rates and currency turmoil, leading to much talk of a looming recession across the eurozone.
The mood among investors has shifted too: seeking a safe harbour in uncertain times, they have largely abandoned riskier asset classes. If the recent pattern of sharp falls followed by sustained lower market valuations characterises the crypto asset market’s inherent volatility, it also underscores the need for tighter regulation to protect UK investors.
Even in the existing rules, there are loopholes. For example, the UK’s anti-money laundering regime requires crypto asset firms that establish in the UK to register with the FCA; but this regulation does not apply if they have no UK base. It shows that retail investors are not adequately protected and potentially vulnerable.
As a matter of prudence, the FCA should be aiming to regulate crypto assets in line with regulations now being implemented across the EU which are designed to protect consumers.
UK regulators are keen for brokers and exchanges to highlight the risk of crypto investments, making it mandatory for them to provide investors with warnings, so that they have a clear understanding of what protections they have, or more notably, they do not.
A very clear warning appears in the FCA’s new rules: “This is a high-risk investment and you are unlikely to be protected if something goes wrong”. But although this might deter some from taking high levels of risk, it does very little to protect those that do.
Some suggest that the FCA’s decision not to extend regulation to investments was designed to facilitate innovation in the UK crypto space. But the logic behind this argument appears flawed. In reality, more regulation would encourage innovation in the crypto asset investment market rather than limit it, helping to reassure and protect investors.