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Rachel Waggott, Head of Regulatory Affairs at Innovate Finance 
12 April 2022
HM Treasury (“HMT”) announced its ambition for the UK to become a global hub for the cryptoasset industry, during Innovate Finance’s Global Summit 2022 last week. John Glen, Economic Sectretary to the Treasury, in his landmark speech addressed elements of the long-awaited response to the 2021 HMT consultation on stablecoins and also set out a broader vision for the crypto-asset sector in the UK.
Headlines at a glance:
<ul>
<li>HMT proposes to bring stablecoins used as payments within the UK’s regulatory perimeter and introduce a new regulated custodial activity with respect to stablecoins;</li>
<li>The Financial Conduct Authority (“FCA”) will hold a two-day ‘CryptoSprint’ in May, which will afford industry participants the opportunity to shape the regulator’s thinking on the development of future crypto-asset regulatory policy;</li>
<li>The Royal Mint will issue a Non Fungible Token (“NFT”) by the summer;</li>
<li>A Financial Market Infrastructure (“FMI”) sandbox will be launched by 2023 to allow participants to test use cases for distributed ledger technology (“DLT”);</li>
<li>Taxation rules for crypto-assets will be reviewed;</li>
<li>The Law Commission of England and Wales will undertake a new project to consider the legal status of Decentralised Autonomous Organisations (“DAOs”); and</li>
<li>The Government intends to establish a Crypto-asset Engagement Group made up of regulators and industry, which will provide constructive challenge and advice to Government.</li>
</ul>
The substantive details relating to many of these announcements are yet to be shared publicly by HMT and other stakeholders. This blog picks out key areas of interest and provides further detail, where available.
<h3>Stablecoins and custodial activity to be brought within the regulatory perimeter</h3>
HMT set out in its <a href="https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1066166/O-S_Stablecoins_consultation_response.pdf" target="_blank" rel="noopener">response to the 2021 consultation</a> the required amendments to the current regulatory regime to bring stablecoins used as payments within the regulatory framework. The changes capture all stablecoins that reference fiat currencies, including single currency stablecoins as well as stablecoins that reference a range of currencies, given the potential for these stablecoins to become utilised as a widespread method of payment.
There are three main changes:
<ul>
<li>The Electronic Money Regulations 2011 and the Payment Service Regulations 2017 will be amended. The Government considers that an amended e-money framework will provide a consistent framework for the regulation of stablecoin issuance and the provision of wallets and custody services.</li>
<li>Part 5 of the Banking Act 2009 will be extended to include stablecoin activities, where the risks posed have the potential to be systemic and so the threshold for supervision by the Bank of England (“BoE”) is met. For firms authorised by the FCA under the Banking Act, the BoE will be the lead prudential authority.1</li>
<li>The scope of the Financial Service (Banking Reform) Act 2013 will be extended to make stablecoin-based payment systems subject to appropriate competition regulation by the Payment Systems Regulator (“PSR”).</li>
</ul>
In addition to these three changes, HMT indicated that it will introduce a new regulated custodial activity. HMT’s rationale is that the role of a wallet provider is a key feature of crypto-assets, in comparison to ‘traditional’ e-money.
Presently, the details are very scarce – the Government intends to set out in legislation how the new activity will be brought within the regulatory perimeter in addition to the scope of the FCA’s powers in this space.
The FCA will establish the detailed suite of regulatory rules applicable to stablecoin custodians, including for example:
<ul>
<li>Prudential and organisationa requirements;</li>
<li>Reporting requirements;</li>
<li>Conduct of business requirements;</li>
<li>Operational resilience;</li>
<li>Custody / safeguarding arrangements; and</li>
<li>Consumer protection measures.</li>
</ul>
Innovate Finance anticipates that the Government may set out further details in the Financial Services Bill, which is to be tabled this summer.
<h3>Unregulated tokens, Decentralised Finance and other new market developments</h3>
HMT has stated that it continues to assess the appropriate regulatory response to other forms of crypto-assets used primarily as retail investment and decentralised finance (“DeFi”) more broadly. This dovetails with existing work led by HMT and the FCA to extend the UK’s financial promotions regime to qualifying cryptoassets (though the financial promotions changes will enter into force ahead of any additional HMT proposals on unregulated tokens and DeFi).
HMT intends to work collaboratively with other international partners to ensure common standards that foster innovation and harmonise guidance and concepts.
We expect HMT to consult later in 2022 on its proposed approach to other unregulated tokens and DeFi. We anticipate that the Government will also be considering these developments through the prism of its Net Zero targets, so there could be a requirement on proof of stake over proof of work mining, amongst other climate-related considerations, for example.
<h3>CryptoSprint and the FMI Sandbox</h3>
On 10 and 11 May, the FCA will hold a <a href="https://www.fca.org.uk/events/cryptosprint">CryptoSprint</a>. This will be focused on informing regulatory policy changes based on evolving technologies. The FCA intends to work collaboratively with participants on three specific problem statements to explore the challenges facing the industry and provide an opportunity to collaborate on policy developments. The FCA welcomes applications from innovators, academics, regulators, technologists and other subject matter experts.
Additionally, the FCA and BoE are to jointly launch and run a regulatory sandbox in 2023 to test new applications of DLT with a view to transforming financial markets by delivering greater efficiency, improved liquidity, enhanced transparency, and greater security. This would seem to mirror the EU’s plans for a pilot regime for market infrastructure based on DLT.
<h3>Creating a crypto-friendly tax environment</h3>
The Government intends to explore ways to increase the international competitiveness of the UK’s tax system to encourage further development of the crypto-asset market in the UK – this will include consideration of how DeFi loans will be treated for tax purposes.
The UK is also involved in the negotiations on the “OECD Cryptoassets Tax Reporting Framework”, which will ensure enhanced transparency and consumer confidence in the market, and foster a level playing field in tax reporting at a global level.
<h3>Law Commission work on DeFi and digital assets</h3>
The Economic Secretary to the Treasury trailed that the Law Commission of England and Wales is to undertake a project to explore the legal status of DAOs. Further details are yet to be announced.
Additionally, the Law Commission looks set to <a href="https://www.lawcom.gov.uk/project/digital-assets/">consult on digital assets</a> in mid-2022. The Law Commission recognises that reforming the law to provide legal certainty provides a strong foundation for the adoption of innovative products and services connected to digital assets.
<h3>Further information</h3>
You may also be interested in Innovate Finance’s response to the FCA’s consultation on strengthening financial promotions rules for high-risk investments, including crypto-assets – you can read our response <a href="https://www.innovatefinance.com/blogs/fca-consultation-paper-strengthening-our-financial-promotion-rules-for-high-risk-investments-including-crypto-assets-cp-22-2-innovate-finance-response/">here</a>.
If you have any questions or comments, please do not hesitate to get in touch at policy@innovatefinance.com.
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1 This has ties to the BoE’s earlier <a href="https://www.bankofengland.co.uk/paper/2022/responses-to-the-bank-of-englands-discussion-paper-on-new-forms-of-digital-money">Discussion Paper on new forms of digital money</a>, which included systemic stablecoins. The BoE’s <a href="https://www.bankofengland.co.uk/financial-stability-in-focus/2022/march-2022">Financial Policy Committee</a>  (“FPC”) has commented that the growth of stablecoins used for payments could increase the role of non-banks in the financial system, which carries financial stability risks to be managed and mitigated. The FPC has previously <a href="https://www.bankofengland.co.uk/paper/2021/new-forms-of-digital-money">set out expectations</a> that systemic stablecoins would need to meet before they could be acceptable for widespread adoption as a means of payment.
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