In February 2018, the UK Treasury Committee launched an inquiry into digital currencies. In the course of its inquiry the Committee received oral and written evidence from a number of key players in the crypto space, including representatives from Ripple, CryptoUK and Blockchain, together with evidence from the FCA (the UK financial services regulator), the Bank of England and HM Treasury.
Earlier than expected, the Treasury Committee published its crypto-assets report and conclusions and recommendations on 19 September 2018.
As the law currently stands in the UK, crypto-assets fall outside of the FCA’s regulatory remit.
In terms of Initial Coin Offerings (ICOs), whether or not an ICO is regulated in the UK will depend on how it is structured and what the token subsequently represents. If an ICO falls within the FCA’s regulatory perimeter, the FCA would also be required to ensure an appropriate degree of protection for ICO investors. However, when tokens represent a claim on prospective services or products, they do not amount to transferable securities or other regulated products and therefore fall outside the FCA’s regulatory perimeter.
In terms of anti-money laundering requirements, the European Parliament adopted the Fifth Anti-Money Laundering (AML) Directive on 19 April 2018. The Fifth AML Directive will extend AML and Counter-Terrorist Financing rules to crypto-currency exchanges.
In its report the Treasury Committee identifies the following key risks of crypto-assets:
- High price volatility – caused by their lack of inherent value, the fluctuation of price based on market sentiment makes crypto-assets particularly unsuitable for retail investors, in the Committee’s view.
- Hacking – investors have lost significant amounts of money due to successful hacks of crypto-asset exchanges. There is no collective deposit insurance scheme to compensate investors in the event of a hack, nor do individual exchanges generally have arrangements in place to do so. This constitutes further evidence that crypto-assets are particularly ill-suited to retail investors.
- ICOs – these generally fall outside of regulation and the FCA has issued stark consumer warnings on associated risks. Investors can lose out due to inadequate business proposals, hacks, or fraud. The Committee believes that the development of ICOs has exposed a regulatory loophole that is being exploited to the detriment of ordinary investors. It recommends that the Regulated Activities Order is updated to bring ICOs within the FCA’s perimeter as a matter of urgency.
- Money laundering and terrorist financing – The Committee urges the Government to treat the transposition of the Fifth AML Directive as a priority, and to expedite the consultation process, which is currently not planned to finish until the end of 2019.
- Market manipulation – low trading volume and capitalisation creates a greater opportunity for price manipulation such as ‘pump and dump’ schemes.
- Advertising and investor protections – the Committee states that the FCA’s consumer warnings are a “feeble corrective” to misleading crypto-asset advertisements. As crypto-asset activities fall outside the FCA’s regulatory perimeter, the FCA is restricted in the actions it can take. The Committee believes that the FCA needs more power to control how crypto-exchanges and ICO issuers market their services, by bringing the activities they perform into the regulatory perimeter
Conclusions and Recommendations
The Committee believes that crypto-assets are likely to be here to stay. The Committee concludes that it is for the UK Government and financial services regulators to decide whether they will allow the current “wild west” situation to continue, or whether they are going to introduce regulation. It believes that the current ambiguity surrounding the UK Government’s and the regulators’ positions is “clearly not sustainable”. Given the scale and variety of consumer detriment, the potential role of crypto-assets in money laundering and the inadequacy of self-regulation, the Committee strongly believes that regulation should be introduced. At a minimum, regulation should address consumer protection and anti-money laundering.
The Committee believes that if the UK develops an appropriate and proportionate regulatory environment for crypto-assets and if future innovations in crypto-assets proved themselves as beneficial to society and industry, the UK could be well placed to become a global centre for this activity.
The Committee considers that introducing the regulation of crypto-assets and associated activities by extending the Financial Services and Markets Act 2000 (Regulated Activities Order 2001) would be the quickest method of providing the FCA with the necessary legal powers to execute its duties of protecting consumers and maintaining market integrity. Designing a new framework of regulation would inevitably take much longer and given the growing risks surrounding crypto-assets and subsequent consumer detriment, the introduction of regulation should be treated as a matter of urgency.
The Committee notes that although the global regulatory response to crypto-assets is in its infancy, given the UK has yet to introduce any crypto-asset regulation, it is in a position to learn from those experience of countries that have done so. It also recognises the importance of international cooperation on the regulation of crypto-assets and associated activities. The Committee encourages UK regulators to continue engaging with international bodies to ensure best practice from other regulators is learned and applied to the UK context.
We now wait to see how the UK Government responds.