This article was originally published in Thomson Reuters Regulatory Intelligence, 3 October 2022, and can be found here.
What are the protection rights for crypto consumer investors?
Manoj Mistry, Managing Director, IBOS Association
Brexit has always been championed by its supporters as the critical means by which divergence from the EU in the regulation of financial services can be achieved. Evidence of this ambition being realised is now apparent in long-awaited crypto regulation being put in place across the EU, which is soon to be followed by the UK equivalent. But the lack of equivalent protection makes their divergent paths more obvious.
As Europe finally reaches agreement on crypto assets (MiCA) regulation across markets and EU member states, plans for the UK’s regulatory scope appear to be notably more limited, regulating only digital settlement assets and increasing conditions for crypto supervision.
Both the financial services and markets bill that is currently making its way through the UK parliamentary process and the policy and handbook rules for high-risk investments, recently published by the Financial Conduct Authority (FCA), demonstrate a much lighter regulatory touch.
In practice, MiCA will regulate crypto assets including investments. This is made possible thanks to a broad definition which maximises the EU’s regulatory reach across multiple asset types that now fall under its crypto umbrella. Except for purely mined coins, issuers of new crypto assets will have to publish a white paper setting out their plans in detail, requiring the sort of transparency that typically applies in a prospectus.
By contrast, the UK is taking smaller, tentative steps by regulating just a few crypto assets. Its “digital settlement asset” definition is narrower, including stablecoins that are used as a means of payments. But critically, it does not include crypto assets as an investment class. At least not yet.
The regulatory differences between the EU and the UK extend to service providers. MiCA’s far-reaching definition includes trading, advice, orders, as well as custody and crypto-to-crypto and crypto-to-fiat exchange, whereas the UK seems set to focus on fewer services, like exchange and custody.
Without further announcements concerning additional regulatory requirements, the protection for UK retail investors in crypto assets is currently less obvious when compared to their EU counterparts, particularly with respect to their legal rights. It is therefore hard to see in the context of crypto assets what investment security benefits Brexit is delivering for UK-based investors in what is universally regarded as a high-risk asset class.
Regulation has finally arrived in the midst of a protracted crypto winter: the bubble may not have burst, but investor enthusiasm has certainly waned. After the highs of a year ago, Bitcoin, Ethereum and other leading cryptocurrencies continue to trade at levels that are more than 70 per cent below their 2021 peak. Meanwhile the aggregate value of the crypto asset market remains below the $1 trillion level, having been comfortably more than double that figure less than 12 months ago.
In an environment that has shifted dramatically this year, crypto exuberance has given way to the harsh economic realities of an energy crisis, rising inflation, increasing interest rates and the potential of a looming recession in much of the eurozone.
The mood among investors has certainly changed too. As they now seek a safe haven and stability in uncertain times, riskier asset classes have largely been abandoned. The precipitous falls of cryptocurrencies, followed by sustained lower market valuations, characterises the inherent volatility of the crypto asset market. It also helps to underpin the continued need for tighter regulation that protects investors.
The UK’s anti-money laundering regime requires crypto asset firms to register with the FCA when they set up in the UK. But if they do not have a UK base, this regulation does not apply. This loophole serves as a primary example of how retail investors are potentially vulnerable and not adequately protected.
On any objective view, the FCA should aim to regulate crypto investment in line with the regulations implemented by the EU. This can only serve to protect consumers.
True, the UK is set to legislate on crypto investment risk warnings, making it mandatory to provide investors with warnings about risk, so that have a clear understanding of what protection they do have, or more particularly, have not.
The FCA’s new rules provide a distinctly blunt warning: “This is a high-risk investment and you are unlikely to be protected if something goes wrong”. Although this may deter some from taking unnecessary (or unaffordable) levels of risk, it does nothing to protect those that do.
Some commentators have argued that the FCA reached the decision not to extend regulation to investments in order to facilitate innovation in the UK crypto space. But it is hard to see the logic that applies in this argument. Ultimately, further regulation would encourage innovation in the crypto asset investment market rather than limit or curtail it. This would also reassure investors as well as protecting them.