The UK is moving in the right direction on crypto regulation – but the country must move faster, the author of this article argues.
The writer of this article is Brett Hillis, partner at law
firm Reed Smith
and a member of On-Chain, the firm’s dedicated crypto and digital
assets group. The team has more than 100 lawyers working across
the US, the UK, Europe, Asia and the Middle East.
The way that the crypto and digital assets space evolves
continues to be important for the wealth management sector, and
we are pleased to carry these insights. The usual editorial
disclaimers apply. Please email the editor at [email protected]
if you wish to get involved in the conversation. We welcome
feedback from those in the frontlines of this technology.
The UK government has made no secret of its ambition to turn the
UK into a cryptocurrency hub. That is a laudable ambition, but
the UK faces a crowded and competitive market internationally.
There is plenty to attract cryptocurrency and other digital asset
businesses to Britain, but the UK must recognise that, in the
face of competition from other jurisdictions, it cannot afford to
stand still.
Troublingly, however, the UK regulators at least do not appear to
have come to this realisation when it comes to retail investing.
Tellingly, it has been five years since the Financial Conduct
Authority last consulted on selling investment products that
reference crypto assets to retail clients, with the corresponding
ban on this having been in force since January 2021. Since then,
however, the global picture has changed dramatically. Recent
developments of particular significance include the US and Hong
Kong granting regulatory approval for bitcoin exchange-traded
funds (ETFs). In the European Economic Area, meanwhile, investors
have been free to invest in physically backed bitcoin
exchange-traded products (ETPs) since 2019.
But the only movement from the FCA has been to allow
institutional investors to invest in bitcoin and ethereum ETPs.
As a result, it is hard to escape the conclusion that the UK’s
stance is much more conservative when it comes to the retail
market for products referencing crypto assets.
An outdated position?
The FCA’s position is intended to protect retail investors and
that of course remains of paramount importance. But the FCA’s
position assumes that unlike institutional investors, in general,
retail investors will not have the ability to accurately assess
the risks and values of the underlying crypto assets no matter
what other regulatory protections are put in place to protect
them.
The FCA’s argument in banning retail investors from investing in
ETPs rests on a number of assumptions which may well have been
correct in 2019. But crypto markets have matured considerably
since then. Despite this, the FCA has not re-evaluated its stance
as to whether the same challenges apply or that a retail ban is
the best way to deal with them.
For instance, the arguments made five years ago that crypto
assets have no inherent value, that they are vulnerable to market
manipulation and financial crime, and that their pricing is
extremely volatile may not have the same strength now as they did
then. And even if those points were as true now as then, it
does not follow that a retail ban is the best response. As
a result, were the FCA to undertake another consultation now, it
is hard to imagine that it would arrive at the same conclusion.
The FCA’s approach leaves UK regulation in a curious place.
Cryptoassets are not wholly within the FCA’s regulatory
perimeter. Particularly significant is that they fall outside the
scope of the FCA’s product intervention powers, which means that
no crypto assets themselves have been banned by the FCA. In other
words, it is not within the FCA’s powers to ban bitcoin or
ethereum.
Anti-money laundering regulations have been extended to encompass
crypto exchanges, brokers and custodians, which do fall
within the scope of the FCA’s regulatory powers, but the FCA’s
role in this regard is to warn investors of the risks associated
with crypto assets as an investment product rather than to
prevent access to them.
Consequently, because the FCA’s position has not altered, the ban
on ETPs for retail investors has left the UK regulating crypto
assets and crypto asset ETPs differently – notwithstanding
the fact that the products share a similar risk profile. In fact,
the banned product is arguably the less risky of the two due to
the custody and safekeeping arrangements.
Where next?
Since 2021, the FCA has been given further powers to regulate
crypto assets, with the financial promotion regime extended to
cover crypto assets. The FCA has set detailed requirements
relating to the promotion or sale of these products to retail
consumers – which have perhaps unsurprisingly not encouraged
retail investors – and it is apparent that the FCA intends to
take an active approach to its enforcement responsibilities.
For instance, on the first day following the introduction of a
new cryptocurrency marketing regime, the FCA issued 146 alerts to
firms, reminding them of their obligations to protect UK
consumers from illegal promotions. In of itself, this assertive
approach to regulation should not necessarily be seen as a cause
for concern. Rather, the strict approach to marketing can play an
important role in helping educate consumers about risk. But
educating consumers about risk is one thing, denying them the
opportunity to invest is quite another.
It is also out of step with the UK’s wider approach to regulating
crypto assets as it has developed. This has not foreclosed the
market but provided strong protections to retail investors. The
FCA’s financial promotion regime for crypto assets shows that
retail investors can be enabled to buy crypto assets subject to a
heavily regulated customer journey. It seems incongruous
that a similar approach is not taken with fully-regulated
products referencing such crypto assets.
Indeed, overall, the FCA’s regulation of cryptocurrencies and
digital assets deserves credit both for the rules it has drawn up
and its practical approach to enforcing them. The ultimate result
of this should be the confidence of the industry.
But that confidence may well be dented by the ongoing ban on
retail investors, particularly in light of other jurisdictions
reassessing their position. It is, of course, vital that retail
customers are protected from exposure to undue risks, but this
should be done in a way that does not create unnecessary
obstacles to investment. For all of the positive aspects of the
UK’s regulatory regime, the FCA has also created such an
unnecessary obstacle to retail investment and the sooner that is
addressed the better.
