HMT sets out UK's approach to regulating stablecoins; other cryptoassets to follow?

What has HMT published and which cryptoassets are in scope?

HM Treasury has published a consultation on the future regulatory landscape as it will apply to cryptoasset issuers and firms providing cryptoasset services. The consultation does not have any legal effect, but it does set out in broad strokes the direction of future cryptoasset regulation in the UK.

In particular, the proposals do not set out detail on the precise requirements that issuers and service providers will be expected to meet. Instead, they are concerned with the expansion of the scope of the regulatory perimeter to include first stablecoins and, in the future, other unregulated cryptoassets.

The primary concern of HMT is to "ensure that tokens which could be reliably used for retail or wholesale transactions are subject to minimum requirements and protections as part of a UK authorisation regime". As a result, the proposals are primarily focused on stablecoins which reference an underlying asset or assets, such as a single fiat currency or a group of investment assets, as HMT considers them to be the most stable types of cryptoassets. Where tokens are also considered to be e-money tokens, then they may fall within scope of both the new regulatory regime and the EMRs.

The proposals also consider the systematic use of stablecoin payment systems in a way that functions essentially as a currency. HMT suggest that such tokens may be required to comply the same Bank of England regulatory requirements as GBP, which it is subject to as our national currency. However, these considerations are vague, since no such systematic adoption seems likely in the near future.

Unregulated exchange and utility tokens (such as Bitcoin and Ether) and algorithmic stablecoins remain out of scope of the authorisation regime (for now), although they are, and/or may be brought, within scope of AML and financial promotions regimes. However HMT is soliciting advice, in relation to future proposals, on the following issues:

• whether there is value in treating unregulated tokens, such as popular utility and exchange tokens, as speculative investments under the regulatory perimeter; and
• whether any clarifications or amendments could be made to pre-existing regulations to support the issuance and use of regulated security tokens. Our view is that such clarifications may, if successful, reduce the likelihood of future actions by regulators against issuers, such as the US SEC's action against Ripple in relation to XRP on 22 December 2020.

This is a marked contrast to the European MiCA proposal, with the UK seemingly proposing a piecemeal approach to regulating the industry as threats emerge or become more significant.

We provide cryptoasset services, what does that mean for our firm?

The proposals identify the following cryptoasset services, performed in relation to in-scope cryptoassets, as requiring authorisation (if the proposals were implemented):

• transmission of funds;
• custody and administration of stablecoins for third parties;
• executing transactions;
• exchanging stablecoins for fiat money and vice versa;
• validating payment transactions; and
• facilitating access to stablecoin networks or underlying infrastructures by participants.

There will be some exemptions available, such as for small payment service providers that do not meet a minimum volume of transactions.

HMT is also consulting on potential location requirements to protect UK residents from active marketing of unregulated in-scope tokens from overseas issuers or service providers. The proposals range from a complete prohibition on active marketing to UK residents by all firms that are not established and authorised in the UK to the imposition of no restrictions whatsoever, although a compromise between these two extremes is a more likely ultimate option.

The standards that an authorised firm must meet in relation to in-scope cryptoasset services are broadly similar to those of an authorised firm under FSMA/MiFID. Depending on the activities performed, firms may be required to have in place or meet:

• prudential requirements, including capital, liquidity and auditing requirements, in order to protect consumers and financial stability;
• orderly failure and insolvency requirements;
• appropriate safeguarding practices for all tokens on wallets and exchanges, including the protection of keys to those tokens;
• systems and controls, risk management, and governance requirements;
• conduct requirements;
• financial crime requirements, including anti-money laundering and counter-terrorist financing rules;
• outsourcing requirements;
• operational resilience, service reliability and continuity requirements;
• security requirements, in particular in relation to safeguards against cyber security risks and cloud security;
• reporting and notification requirements in relation to both regulators and customers; and
• record keeping requirements.

What about issuers of crypto assets?

In addition to cryptoasset service providers, cryptoasset issuers are also caught where they issue, create or destroy in-scope stablecoins, where they manage reserve assets that are backing the value of a stablecoin and/or where they are providing custody/trust services for those assets to ensure stabilisation of the stablecoin. Issuers performing these activities in relation to in-scope cryptoassets will be subject to broadly the same requirements as service providers (as listed above).

Is this the UK's response to MiCA?

As we have previously discussed, in September 2020 the European Commission published its proposed Regulation on markets in crypto assets (MiCA), which will bring all cryptoassets not currently in scope of EU regulation within the EU's regulatory perimeter. These cryptoassets will be subject to a bespoke regulatory regime made up of a patchwork of existing EU regulations and applied on a proportional basis.

We also previously predicted that the UK's regime would look similar to the MiCA proposals, on the basis that a regulatory regime that did not provide the same regulatory protections as those enjoyed by investors in EU cryptoassets would make UK cryptoasset investments less desirable. However, the proposals are, in fact, substantially different in scope and focus from those in MiCA (see below).

What are the main differences between HMT's proposals and MiCA?

In summary, quite a lot of things in the HMT proposals are different to those in MiCA. We think the most relevant is in the fundamental approach to cryptoassets.

Specifically, MiCA aims to regulate all cryptoassets, with stablecoins being subject to a more rigorous regime. In doing so, it treats cryptoassets essentially as a new class of regulated asset. On the other hand, HMT's proposals are primarily focused on the use of cryptoassets in payment services and, more broadly, as they perform as currencies or quasi-currencies

As a result, although many of the obligations on in-scope market participants under HMT's proposals are similar to those under MICA, HMT's proposed treatment of cryptoassets is very different because the scope of cryptoassets in scope is considerably smaller. While MiCA is concerned with all unregulated cryptoassets, the HMT proposals will initially only catch those cryptoassets that do, or have potential to, function similarly to currencies. As a result, it is primarily concerned with stablecoins as they are used in payment services.

HMT stresses, however, that this is the first of many consultations and that they specifically intend to capture certain stablecoins. We can expect more to come from HMT in the future…

Author: Anna Burn