As we have reported previously, the House of Commons Treasury Committee (the Committee) launched an inquiry earlier this year in order to investigate the role of cryptocurrencies in the U.K., including the opportunities and risks that they may bring to consumers, businesses, and the government and associated bodies. It specifically aimed to evaluate the appropriate regulatory response to cryptocurrencies, and how regulation could be balanced to provide adequate protection for consumers and businesses without stifling innovation.
The Committee held a number of evidence sessions and received numerous written submissions from interested parties. It published its findings on September 19, 2018 (the full report is available here).
Summary of Committee’s conclusions
The current U.K. regulations do not presently apply to cryptocurrencies or most tokens, ICOs, and crypto- exchanges. This is because in the Committee’s view most ICOs do not promise financial returns, but instead offer future access to a service or utility. As a result, investors are extremely unlikely to have access to regulatory protections and risk being defrauded or losing their money. (Note that the Committee’s view differs sharply from the view of U.S. regulators, which view the vast majority of ICOs as at least implicitly promising financial returns based on an increase in value of the tokens.)
The development of ICOs has exposed a regulatory loophole that is being exploited to the detriment of ordinary investors (including loss of deposits through fraud and hacking, or losing access to funds due to the loss of passwords). Crypto-assets are especially risky since their volatility is much greater than other asset classes, and because they can be used to launder the proceeds of serious crime and terrorism. Crypto-asset markets are also particularly vulnerable to manipulation, and they fall outside the scope of market abuse rules. Self-regulation within the crypto-asset industry (e.g. the Crypto U.K. initiatives) is insufficient to give investors the appropriate level of protection.
In terms of the underlying technology, although small-scale uses for blockchain may exist, the Committee has not been presented with any evidence to suggest that universal applications of the technology are currently reliably operational.
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 crypto-asset regulation should be introduced in the U.K.
The Committee has considered two alternative methods for introducing such regulations:
- Setting up a new framework of regulation for crypto-assets that is separate to existing financial services regulation.
- Extending the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) to include a new category of crypto-asset activities (at the minimum, to control how crypto-exchanges and ICO issuers market their services).
While the first option may afford more flexibility and potentially offer a more nuanced approach, it would undoubtedly take much longer than the alternative route of amending the RAO. The introduction of regulation should be treated as a matter of urgency and the Committee strongly prefers the second option.
The U.K. government used this route in the past when bringing peer-to-peer lending within the existing regulatory perimeter. This enabled the Financial Conduct Authority (FCA) to consult on its regulatory approach for peer-to-peer lending and subsequently introduce targeted rules and regulations, including:
- Minimum prudential requirements.
- Rules designed to minimize the risk of loss due to fraud, misuse, and to provide for the return of client money in the event of a firm failure.
- Rules on the resolution of disputes.
The U.K. Treasury has not yet decided on how to incorporate crypto-assets into the current regulatory framework, but is considering expanding the RAO as a method. Whichever method is chosen, the Committee urges that the regulatory framework should include at a minimum the issuance of ICOs and the provision of crypto-exchange services.
Additionally, the Committee urged the U.K. government to consider replicating the relevant provisions of the Fifth Anti-Money Laundering (AML) Directive in U.K. law with respect to cryptocurrency as quickly as possible. The AML Directive will extend AML and counter-terrorist financing rules to digital currencies, expanding the rules to cover entities holding, storing and transferring digital currencies. The AML Directive came into effect on July 9, 2018 and EU member states will have until January 10, 2020 to implement it. If the U.K. leaves the EU before then without an agreed transition period, the Committee counsels the U.K. government to consider replicating the relevant provisions of the AML Directive under U.K. law in any event.
Aside from investor protection, the implementation of crypto-asset regulation in the U.K. may enable the crypto-asset industry to move to a more mature business model. It will also attract institutional investors, which may lead to increased liquidity and could reduce some of the inherent risks outlined in the report.
The Committee’s report and its conclusions clearly indicate that the U.K. is moving towards regulation of businesses involved in issuing, dealing in or advising on digital currencies, tokens, and ICOs. What form such regulation eventually takes remains to be seen, but the Committee urges the U.K. government and the FCA to take active measures to protect investors and intervene in the crypto-asset marketplace as soon as possible.