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Crypto-matters Volume 2 - Legal developments on crypto-assets and Blockchain technology

Crypto-matters Volume 2 - Legal developments on crypto-assets and Blockchain technology
  • United Kingdom
  • Crypto assets
  • Financial services and markets regulation
  • Financial services and markets regulation - Hedge funds
  • Financial services


Bringing our clients the latest important legal developments related to crypto-assets and the use of Blockchain technology in financial services and markets

Legislative and regulatory developments

FCA Final Guidance on cryptoassets

The published Guidance is as we expected, having been one of a few law firms listed as having responded to it, and clarifies the scope of the FCA’s remit over different types of token. The short point is that the FCA’s powers are set by statute and legislation, and as such, whilst the Guidance provides some welcome clarification regarding how this works, it is not within the FCA’s power to expand its own remit.

We are glad to see that the FCA has taken on board and agrees with our suggestion to separate e-money tokens from the utility tokens and security tokens category, by creating a specific unregulated token category for exchange tokens and utility tokens other than e-money. This will help avoid confusion between e-money tokens and utility tokens generally, as the unregulated tokens class will clearly be unregulated.

The most interesting point in the Guidance is as regards the FCA’s suggestion that, even if a cryptoasset is unregulated, if the relevant business is an FCA regulated business, then the FCA may seek to exert authority over business involving those unregulated cryptoassets under its principles for business. These principles, for example, require that firms conduct their business with integrity, exercise due skill and care, treat their customers fairly, and observe proper standards of market conduct. Whilst the content of these principles are unlikely to be controversial, what is controversial is whether the FCA can, or even should, in fact, exercise supervision over the conduct of unregulated business undertakes by a regulated firm, when it cannot do so for the same business conducted by an unregulated firm.

FCA – Prohibiting the sale to retail clients of investment products that reference cryptoassets

The FCA has published the findings of its recent consultation on a potential prohibition of the sale of derivatives that reference certain types of cryptoassets to retail consumers. The FCA finds that retail consumers ‘cannot reliably asses the value and risks of derivatives and exchange traded products that reference certain cryptoassets’, in particular because the underlying assets have no inherent value and the prices are notoriously volatile. Additionally, market abuse and financial crime is widespread in the secondary cryptoasset market, including cyberthefts which prove difficult to remedy.

In light of this, the FCA has proposed a ban on the sale, marketing and distribution of derivatives and exchange traded notes referencing unregulated and transferable cryptoassets, or ‘crypto-derivatives’ as it has named the products collectively. The aim is to protect consumers and ensure high regulatory standards in financial markets. Furthermore, the FCA proposes that these measures will ensure the UK’s international reputation as a safe and transparent place for financial services dealings will be maintained.

As of yet, the FCA does not propose to extend the ban to cover non-retail investors or collective funds since they are better placed to understand the inherent risks and their exposure to crypto-derivatives is somewhat limited: the main objective of the proposed ban is to reduce the harm to retail consumers. However, those involved with cryptoassets should note the steps towards regulating the sector.

The FCA has been established as the supervisor of the future cryptoassets AML/CTF regime

In its 2019-2022 Economic Crime Plan, the Economic Crime Strategic Board has proposed seven ‘strategic priorities’ to support its vision of preventing economic crime and harm to society and protecting the UK economy whilst supporting growth and prosperity. It aims to fulfil these through a set of proposed actions, one of which is to establish the FCA as the supervisor of the future cryptoassets anti-money laundering (AML)/counter-terrorist financing (CTF) regime.

As identified in the Cryptoasset Taskforce’s report, their largely unregulated nature means that cryptoassets have become a facilitator of criminal activity. To combat this threat, and move towards bringing the cryptoasset sector into line with the financial sector as a whole, the government plans to increase the scope of AML/CTF regulation to include all relevant cryptoasset businesses by January 2020. Its aim is to provide ‘one of the most comprehensive responses globally’ to combat the problem of cryproasset use enabling illicit activity. The FCA will supervise cryptoasset firms and may be granted increased regulatory tools in recognition of the new challenges that regulating the cryptoasset sector will bring.

IOSCO “Issues, Risks and Regulatory Considerations Relating to Crypto-Asset Trading Platforms”

IOSCO is considering the potential risks and considerations in relation to crypto-asset trading platforms. We have submitted our views on this, which will be public shortly.

Germany – another approach

Germany is taking a different approach than the FCA when it comes to the scope of cryptoassets regulation. By end of July, the German Federal Government adopted the draft of a new legislation (the “Draft Act”) that qualifies cryptoassets as financial instruments. According to the Draft Act, Cryptoassets are ‘digital representation of value that is not issued or guaranteed by a central bank or a public authority, and does not possess a legal status of currency or money, but is (i) accepted by natural or legal persons as a means of exchange on the basis of an agreement or of customary exercise or (ii) serves investment purposes and which can be transferred, stored and traded electronically’. The proposed definition of cryptoassets goes beyond what is required under AMLD5: By including investment tokens (“…serves investment purposes…”) the Draft Act extends the regulatory perimeter to a wider range of tokenized assets. Financial services like operating trading facilities, investment broking or providing investment advice regarding crypto currencies and other cryptoassets will therefore require a license by the German regulator (‘BaFin’).

Furthermore, the Draft Act implements a new regulated financial service: ‘crypto custody’. Wallet providers and custodians for institutional crypto investors handling the private keys necessary to hold and transfer cryptoassets will, therefore, have to apply for a licence. It is important to note that this licence cannot be combined with any other financial services licence and that it does not cover crypto assets that qualify as securities. Crypto custodians will therefore not be subject to MiFID and Financial service providers and custodian banks have to set up independent entities if they want to provide crypto custody. However, the Government has already announced new legislation which will facilitate the issuance of digital securities. When this legislation becomes more specific, it might turn out that the currently proposed limitations and requirements will be redesigned. Unless there is a license requirement in their home state and they are adequately supervised, Crypto custodians from other EU-jurisdictions cannot passport their services into Germany and hence have to establish local branches if they intend to actively offer their services in Germany.

The Draft Act is to enter into force by 1 January 2020 but has yet to be adopted by parliament (Bundestag). Currently active crypto custodians are deemed to be licensed retroactively and preliminary if they notify BaFin by 1 February 2020 of the intention to apply for a license and file their licence application by 30 June 2020.

Other news

Eversheds-Sutherlands have contributed to thinkBLOCKtank EU Token Regulation Paper, which analyses the EU legal and regulatory framework applicable to token sales in Europe. The paper provides an overview of the relevant national legal and regulatory framework in a number of individual EU jurisdictions, and includes recommendations and suggested courses of action. The paper can be downloaded here.

Eversheds-Sutherlands have also co-authored the RegTech Book: The Financial Technology Handbook for Investors, Entrepreneurs and Visionaries in Regulation. The book is made up of contributions from noted experts in the field, and brings together an understanding of the RegTech eco-system and its use cases in the financial services industry. The book explores the economic impact of digitization and datafication of regulation and reveals the opportunities and challenges brought by the application of innovative technologies such as blockchain and artificial intelligence. More information is available here.

Also, check out our Cryptocast!

We are proud to present our cryptocast, where we round up the latest changes, and will be interviewing legal experts regarding developments relevant to the crypto community. Cryptocasts are available on:

How Eversheds Sutherland can help

We have an award winning crypto assets practice, with our work being “Highly Commended” at the Financial Times Innovative Lawyers Europe awards 2019. We were also runners up for the Banking and finance Team of the Year with the British Legal Awards.

We pride ourselves in coming up with practical yet principled solutions for clients, drawing on our understanding of the cryptoassets industry, through the work that we have done for leading cryptoassets businesses. For further information please contact us.