The UK government has consistently promoted the country as a global hub for cryptoassets investment and technology. Beyond rhetoric, there are multifaceted considerations for firms that provide services in or to the UK as the various supervisory and governmental bodies continue to define and apply detailed rules intended to foster innovation and consumer protection. The scale to which regulations are interpreted or applied can vary according to perception of cryptoassets as a whole, with the Financial Conduct Authority (“FCA”) taking on more authority over the rules that apply to the sector.
In this country guide we'll delve into the crypto regulatory landscape in the UK, exploring the key regulations, players, and ongoing developments that shape this dynamic ecosystem.
Approach to Regulation
1. Money Laundering, Terrorist Financing, and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs)
The MLRs regime has been in place for cryptoasset exchange providers and custodian wallet providers operating within the UK since January 2020. This necessitates registration with the FCA for the purposes of anti-money laundering and counter-terrorist financing supervision (AML/CTF).
A cryptoasset exchange provider is defined as an entity involved in the exchange of cryptoassets for fiat currency or other cryptoassets, while a custodian wallet provider safeguards and administers cryptoassets or private cryptographic keys on behalf of customers. Registration is required if services are provided by way of business and in the course of business carried on in the UK.
Is the activity carried on by way of business?
- Commercial element: the FCA will consider matters to assess whether the individual or organisation advertises, acts, or holds itself out in such a way they are providing services by way of business related to cryptoasset services.
- Commercial benefit: the FCA will also consider whether there will be a direct or indirect benefit from this service.
- Relevance to other business: it is possible that services form only part of the overall business activities. The significance will be considered in relation to other services.
- Regularity/frequency: the FCA will also consider matters to assess whether the frequency of carrying on a cryptoasset service suggests that it is being carried on as a business.
Is the activity carried on in the UK?
- Where the business has a UK office or its head office in the UK this may indicate that the service is being carried on in the UK. If the office is not a registered office or head office, the FCA will need to consider the type of service that is carried on by that office (offices).
- Where the business has no UK office or other activity in the UK, beyond simply having a client in the UK, the FCA are likely to consider that the business is not carrying on UK business. For example, an exchange provider with UK customers but no UK office will not require register under the MLRs.
Registering with the FCA under MLRs is a rigorous process that demands adherence to stringent AML standards. The FCA expects businesses to provide a risk-based assessment of potential areas of consumer harm and mitigation measures during the application process. Firms should consider the appointment of compliance staff in the UK, such as an MLRO, and the implementation of high-quality business plans and business-wide risk assessment tools. A physical office is likely to be required, but will be considered on a case-by-case basis.
Once the FCA has received all the necessary information, the regulator has a three-month period to come to a decision. Only around 14% of applications are eventually approved, with the FCA pointing to poor quality applications as the main reason for rejection. The regulator has advised that firms seek specialist expertise ahead of submitting an application.
2. The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO)
The second regime classifies cryptoassets based on their characteristics and functions, determining whether they fall under the purview of the RAO.
The FCA categorises cryptoassets into three groups:
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- Security Tokens: These are tokens that represent specified investments and are subject to regulation.
- E-money Tokens: Tokens meeting the definition of electronic money under the Electronic Money Regulations 2011 (e-money regime).
- Unregulated Tokens: Including utility tokens and major cryptocurrencies like Bitcoin and Litecoin.
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Regulation can come via the Financial Services and Markets Act (FSMA) and the e-money regime. Under FSMA, any person intending to conduct regulated activities must make an application for permission to the regulated. These activities are defined specifically and exhaustively in the RAO. The list of specified investments broadly consists of:
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- Deposits
- Electronic money
- Contracts of insurance
- Shares
- Instruments creating or acknowledging indebtedness
- Alternative finance investment bonds
- Government and public securities
- Instruments giving entitlements to investments
- Certificates representing certain securities
- Units in a collective investment scheme
- Rights under a pension scheme
- Greenhouse gas emissions allowances
- Emission allowances
- Options
- Futures
- Contracts for differences
- Lloyd’s syndicate capacity and syndicate membership
- Funeral plan contracts
- Regulated mortgage contracts
- Regulated home reversion plans
- Regulated home purchase plans
- Regulated sale and rent back agreements
- Credit agreement
- Consumer hire agreement
- Rights to or interests in certain specified investments
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The application of the regulatory framework means that if a cryptoasset has the same characteristics of a specified investment, then it will be subject to the legislative framework. In general, and with exception to security tokens, cryptoassets do not currently fall within the definition of a specified investment. There is a degree of ambiguity in whether ‘staking’ services will amount to a unit in a collective investment scheme (fund), given such arrangements may be considered as fitting within the definition.
The UK government issued a consultation in February 2023 titled the ‘Future Financial Services Regulatory Regime for cryptoassets’, and a response in October 2023. The government noted that it intends to use existing regimes where possible, including through bringing stablecoins where used as a means of payment within the regulatory perimeter through changes to the Electronic Money Regulations 2011 and Payment Services Regulations 2017.
The FCA issued a discussion paper in November 2023 which outlines their proposed approach to regulating fiat-backed stablecoins issuance and custody. The responses to this paper will be examined before any next steps, although it is unlikely that the FCA deviate significantly from their current prudential, custody, operational and backing assets requirements. There are certain areas that are likely to cause tension within the industry, including a requirement for issuers to enable redemptions directly with them within 24 hours of the request.
The second phase, which will follow in 2024, will involve capturing a broader range of activities involving cryptoassets, including:
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- Admitting a cryptoasset to a cryptoasset trading venue;
- Making a public offer of a cryptoasset;
- Operating a cryptoasset trading venue which supports: (i) the exchange of cryptoassets for other cryptoassets; (ii) the exchange of cryptoassets for fiat currency; (iii) the exchange of cryptoassets for other assets (e.g. commodities);
- Dealing in cryptoassets as principal or agent;
- Arranging (bringing about) deals in cryptoassets;
- Making arrangements with a view to transactions in cryptoassets;
- Operating a cryptoasset lending platform; and
- Safeguarding and/or administering a cryptoasset.
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3. The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO)
HM Treasury recently brought “qualifying cryptoassets” in scope of the UK Financial Promotion Regime through secondary legislation. The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (FPAO), which amends the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO), was implemented on 08 June 2023. There was be a four-month period before it became effective as of 08 October 2023.
A 'qualifying cryptoasset' is any cryptographically secured digital representation of value or contractual rights that can be transferred, stored or traded electronically, and uses technology supporting the recording or storage of data (which may include distributed ledger technology), that is both fungible and transferable. Notably, it does not capture Non-Fungible Tokens or custodial services.
The financial promotion regime only applies to cryptoasset promotions – it will not affect the regulatory status of the underlying activity. The FCA has outlined that qualifying cryptoassets will be treated within the Restricted Mass Market Investments (RMMI) product category, which allows marketing to retail consumers with certain restrictions.
What is a Financial Promotion?
A financial promotion is ‘an invitation or inducement to engage in investment activity or to engage in claims management activity that is communicated in the course of business.
A financial promotion is technology agnostic which means it includes most forms of communication (e.g., digital posters, celebrity endorsements, social media, website links, website banner ads, email marketing). The FCA has outlined that it intends to capture promotional communications only, distinguished from those which seek to merely inform or educate.
Notably, the financial promotion restriction will apply to any in-scope promotion capable of having an effect in the UK, even where it is communicated by an overseas person.
Rules
The FCA’s Policy Statement PS23/6 sets out the financial promotion rules for RMMI cryptoassets. The rules set out new requirements for:
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- Risk warnings and summaries
- A 24-hour cooling off period
- Personalised risk warning pop-ups
- Client categorisation requirements
- Appropriateness assessments
- Banning incentives to invest
- Record keeping requirements
- Overarching need to ensure fair, clear and not misleading and in line with new consumer duty rules
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Overseas Element
All financial promotions that are capable of having an effect in the UK will be captured. In essence, anything that can be viewed by UK persons is within scope.
This applies even in the scenario that the UK person cannot access the product of the financial promotion. A financial promotion includes anything that is an invitation or inducement to enter into the controlled activity.
If overseas firms intend to continue marketing to UK consumers once the regime comes into force, they must consider which route they will use to lawfully communicate their promotions and how they will meet the relevant requirements of that route.
If firms decide to no longer provide services to UK consumers, the FCA expects them to have in place orderly wind-down plans to minimise any impact on UK consumers. Firms may find the FCA’s Wind-down Planning Guide useful in considering their plans.
Qualifying Cryptoasset Financial Promotion Authorisation Routes
There are four distinct routes through which cryptoasset promotions will now be authorised and regulated.
Route A: FCA-Authorised Firms
Firms authorised under the UK Financial Services and Markets Act (FSMA), such as banks and UK-licensed investment firms, can freely communicate cryptoasset financial promotions.
Route B: Approval by an Authorised Person
Unauthorised entities can still promote cryptoassets, but these promotions must be approved by an authorised person in accordance with FCA-specified rules. However, there's a significant catch – authorised firms will need explicit approval under a new Section 21 gateway from the FCA to continue this practice. This involves costs, acceptance of liability, and a demonstration of relevant knowledge and expertise in financial promotions.
Route C: Registered Cryptoasset Businesses (Temporary Measure)
Recognising the challenges posed by the Section 21 gateway, the government has introduced a temporary option. Cryptoasset businesses registered with the FCA under the MLRs can communicate financial promotions. However, this option has its limitations given the significant time and commitment it takes to register under the MLRs.
Route D: Existing Exemptions
Certain exemptions within the Financial Promotions order still apply to cryptoasset promotions. These exemptions can provide some flexibility in promoting cryptoassets.
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- Overseas Exemption: Allows promotions to have an effect in the UK but targets persons outside the UK. Clear disclosures are required, and systems must prevent non-exempt individuals from accessing them.
- Non-Real Time Communications and Solicited Real-Time Communications
- Investment Professionals
- Communications by Journalists
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Approach to Legislation
Financial Services and Markets Bill
In June 2023, the Financial Services and Markets Bill received Royal Assent, officially becoming law through what is now known as the Financial Services and Markets Act 2023. It’s a landmark piece of post-Brexit legislation for financial regulation in the UK and will provide regulators and government with the tools to regulate more widely.
The Act contains a number of provisions which will be used to create the new regulatory structures for cryptoassets and amend the existing regimes to explicitly accommodate the regulation of cryptoassets. This will be done through the Regulated Activities Regime and the newly created Designated Activities regime, as mentioned above.
Economic Crime and Corporate Transparency Bill
The ‘Bill’ amends the existing definition under the Proceeds of Crime Act 2002 (POCA) to account for cryptoassets. The former definition under POCA was more limited to ‘money’ and would not cover crypto or exchanges/custodian wallet providers.
Broadly speaking, this allows for two distinct categories of asset recovery powers: i) criminal and ii) civil:
i) Criminal regime gives law enforcement powers which are used to impose a debt against any person convicted of a crime, who is found to have benefited from their crime(s).
ii) Civil regime provides powers to order the direct possession of identifiable assets deemed to have been obtained through unlawful conduct (or intention).
Under the criminal regime, requirements for an arrest are removed. Provisions for officers to recover cryptoassets in a similar way to tangible property (e.g., officers can recreate wallets and transfer assets into them) are also enabled along with giving the courts the power to authorise the sale of cryptoassets / destruction in exceptional cases.
Under the civil regime, enforcement officers are granted more powers to search and seize relevant cryptoasset-related items - which is a new concept - to support their investigation. This could include a piece of paper of a user’s cryptoasset key (or document on their computer etc), or hardware wallet. Law enforcement can then recover assets directly from an exchange provider subject to the courts approval. The exchange would then have to realise customer cryptoassets subject to an order and pay the resulting sum over to the court.
Cryptoassets as Property
An area of focus of the Law Commission has been whether a cryptoasset can constitute property. In this respect, the Law Commission has proposed that a third category of personal property – referred to as “data objects” – should be established to accommodate cryptoassets.
A thing should be capable of falling within the proposed 'third category' if:
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- It is composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals;
- It exists independently of persons and exists independently of the legal system; and
- It is rivalrous.
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Approach to the Travel Rule
As of September 2023, the UK has introduced travel rule requirements in line with guidance from the Financial Action Task Force (FATF). This mandates specific information accompanying cryptoasset transfers.
UK-based cryptoasset businesses must comply with the Travel Rule before permitting an inter-cryptoasset business transfer and should verify the information it receives. As with the Travel Rule for wire transfers, the information required from parties to the transfer of cryptoassets varies based on the value of the transfer and whether all CBs involved in the transfer are carrying on business in the UK. UK-based CBs must collect, where relevant, inter-cryptoasset business transfers takes place:
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- below the €1,000 de minimis threshold, only "basic information" relating to the name and account number of the originator (i.e. the sender) and beneficiary (i.e. the receiver);
- above the de minimis threshold, the 'basic information' of the originator and beneficiary, and also:
- if the originator is a firm, the customer identification number or address of the originator's registered office; or
- if the originator is an individual, the customer identification number, or address, or birth certificate number / passport number / national identity card number, or date and place of birth; and
- above the de minimis threshold, but involving only UK-based CBs, the basic information, subject to a requirement to provide (within three business days) further information to the beneficiary CB on request. Multiple linked transactions from one originator which collectively exceed the de minimis threshold will be considered as exceeding the threshold.
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Approach to Taxation
The UK’s crypto tax rules are subject to frequent adaptations by HMRC. HMRC has a data-sharing program in place with all UK exchanges, and has the KYC information consumers provided when signing up for any UK-based exchange or wallet. Tax-free events include:
- buying crypto with GBP
- Holding crypto
- Transferring crypto between your own wallets
- Donating crypto to charity
- Gifting crypto to your spouse
In general, consumers cryptoassets will be subject to Capital Gains Tax or Income Tax. This depends on the specific transactions and utility to which a consumer uses their digital assets – if it’s seen to be making an income you will logically pay income tax. As HMRC sees crypto as a capital asset, when you dispose of it consumers will generally pay capital gains tax on the gains. This will cover selling, trading, spending, or gifting (unless to a spouse). DeFi transactions may also be subject to tax, depending on the nature of the transaction and whether it has the nature of capital or income.
Next Steps
The UK's regulatory and legislative approach to cryptoassets is continually evolving to accommodate the ever-changing dynamics of the crypto market. As technology and financial products continue to advance, the UK is committed to striking a balance between promoting innovation and safeguarding consumers.
Navigating the intricacies of crypto regulation in the UK is essential for individuals and businesses involved in the crypto space. Understanding the tripartite regulatory framework, key regulations, and ongoing developments is crucial for compliance and success in this rapidly evolving ecosystem. Stay tuned for further updates as the regulatory landscape continues to adapt to the challenges and opportunities presented by cryptoassets.
Note: This text is the sole work of the author and does not bind BlockReg Advisors Ltd. nor does it constitute legal advice. All rights reserved.
If you would be interested in learning more about the UK, and how you can play a bigger role in defining the upcoming rules and regulations, please reach out to [email protected]
