Recent Crypto Announcements: The Impact for Asset Managers and Investors

Over the past few weeks, the FCA, PRA, and HMT have all released announcements about crypto-asset regulation. These announcements focus on the extension of regulation to stablecoin providers and the risks for financial services firms with proprietary crypto exposures, and represent another step towards a more comprehensive crypto regulatory regime.

Although the announcements do not seem to have a significant impact on asset managers and investors, they are interesting for understanding the crypto environment and crypto service providers. After all, crypto is certainly on the move: a report published by PwC last year highlighted a global increase in crypto fund AUMs from $2 billion in 2020 to $3.8 billion in 2021.

Summary of announcements

There are also points managers should note about their regulatory obligations, particularly in the FCA statement. The FCA’s and PRA’s expectations of crypto businesses and those with exposure to crypto-assets should also give regulated managers some insight into what the FCA is likely to expect of them when the management of crypto-assets and risks for their investor clients. The HMT publication also highlights the government’s interest in the role of Distributed Ledger Technology (DLT) in securities trading and similar wholesale market activities, highlighting benefits such as greater efficiency and transparency/traceability of transactions while noting drawbacks such as the disruption of current practices. and greater fragmentation. The application of DLT to the activities of market users, including managers and investors, with no interest in crypto as an asset class, is important and HMT recognizes this.

The HMT posts are part of a campaign to make the UK a global hub for crypto-assets and also include announcements about a financial market infrastructure sandbox, ongoing work on decentralized finance – DeFi, the work of the Center for Finance, Innovation and Technology, the Royal Mint’s release of a non-fungible token (NFT) and proposals for crypto-asset engagement groups. In addition to the regulatory announcements, an important tax and crypto announcement for fund managers is worth mentioning: John Glen said in a speech that the UK will change the investment manager exemption to remove disincentives for UK fund managers to include crypto-assets in their portfolios. Our briefing on this can be viewed on our website.

A further step towards more universal regulation

As noted above, the publications continue the regulatory push in the crypto-asset sector, with the expansion of the financial promotion regime, which will see “eligible crypto-assets” fall into the category of “restricted investments”. in the mass market” being a recent example (see our recent blog post for more details). They also reinforce concern about combining or including unregulated crypto-assets with or in regulated products offered to retail investors: FCA rules prohibit the sale of derivatives and related structured products to retail investors and managers authorized retail funds may not hold crypto-assets in those funds. .

Although extensions to the Money Laundering Regulations 2017 which came into effect in 2020 require various crypto-asset providers to register with the FCA, there is still no requirement for companies carrying out activities, such as management or advice on Bitcoin and similar crypto-assets, to become FCA. authorized. Additionally, securities laws such as the Prospectus Regulation and the Market Abuse Regulation do not apply to crypto-assets other than “security tokens”. However, general anti-fraud laws apply, as do general regulatory standards, such as those set by the Advertising Standards Authority (ASA) which recently issued a notice requiring these advertising crypto-assets to clearly indicate that the crypto-assets are neither regulated nor protected. .

Whether the general law applied by the courts is sufficient to protect crypto-asset investors and users of crypto-asset infrastructure will remain with decisions, such as that of Tulip Trading Ltd c. Bitcoin Association for BSV and others, leading some to argue that additional regulatory protection is needed. In Trade in tulips the court refused to accept that blockchain software developers and/or controllers owed a duty of care to blockchain users that required them, for example, to restore access to stolen crypto-assets and reverse known frauds , while leaving the door open to the imposition of other, more restricted rights in the future.

FCA Regulated Companies and Cryptoassets

The FCA’s statement on crypto-asset exposure follows a more comprehensive letter from the PRA.

The statement and letter stand as reminders to all relevant regulated companies of their existing obligations when interacting with or being exposed to crypto-assets and related services and notices, among others, the following:

  • be clear with customers – when assessing the risks posed by crypto-assets, take a similar approach to regulated activities and ensure consumers understand what is regulated and unregulated;
  • appropriate systems and controls – having appropriate systems and controls in place to counter the risk of a business being misused for financial crime purposes and where businesses doing business with crypto-asset service providers verify the FCA listed and have sufficient due diligence and money laundering controls in place;
  • assess risks – assess the risks posed by a client whose wealth or funds are derived from the sale of crypto-assets or other crypto-asset-related activities, using the same criteria that would be applied to other sources of wealth or funds noting that the trail of evidence behind crypto transactions may be weaker; and
  • custodial considerations – apply Principle 10, which requires a firm to put in place adequate protection for client assets, and check whether the Client Assets Sourcebook (CASS) applies to crypto-assets held or managed.

Statements about regulatory capital, which focus on financial stability, are unlikely to resonate with investment managers. Managers will, however, need to consider the points above, which are relevant to any regulated company tasked with managing the assets of others, including their crypto-assets.

The regulation of stablecoins

The HMT’s response to its 2021 consultation on the UK regulatory approach to crypto-assets and stablecoins focuses on stablecoins, although it examines the current state of UK crypto-asset regulation in general and the use of distributed ledger technology.

The response affirms the regulatory taxonomy of crypto-assets in the UK: “exchange tokens”, such as Bitcoin, and “utility tokens”, remain “unregulated” (although financial promotion changes and enforcement AML requirements to suppliers qualify this term); security tokens, with the characteristics of otherwise regulated investments, are regulated. Single-fiat currency-linked stablecoins need to be regulated as crypto service providers, such as exchanges and third-party custodians, will need to become FCA authorized on HMT’s current proposals. This does not extend to those managing stablecoins although, given that they represent value tied to cash and assets such as gold, it is not clear if a manager would need to manage tokens while it can manage the underlying assets. HMT has decided that algorithmic stablecoins, or those that can be tied to assets other than fiat currency, will not be regulated because they share similar characteristics to unsecured crypto-assets and do not offer sufficient price stability.

By focusing on stablecoins, HMT seeks to:

  • Amend the Electronic Money Regulations 2011 and Payment Services Regulations 2017 bringing stablecoins more firmly within the scope of electronic money and payments regulation and imposing authorisation, governance and organization of the FCA, as well as conduct requirements for issuers of stablecoins and entities providing related services;
  • the introduction of a new Regulated Custody business to capture the provision and organization of custody with related FCA authorisation, governance and organization and safeguard requirements;
  • extend the applicability of Part 5 of the Banking Act 2009 to include stablecoin activities to apply where the risks posed may be systemic and thus meet the Bank of England’s supervisory threshold; and
  • extend the scope of the Financial Services (Banking Reform) Act 2013 to ensure that relevant stable payment systems are subject to appropriate competition regulation by the payment systems regulator.

These changes have little direct impact on investment managers. They do, however, point to increased regulatory obligations, in particular the requirement to protect against the loss of crypto-assets through appropriate technology. Liaison with the above points on appropriate systems and controls and custodial considerations, technological integrity, and senior management’s understanding of technology, both its own and that of third-party service providers, are themes that can only grow in importance for anyone managing crypto-assets.

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