The UK’s Financial Conduct Authority (FCA) is ramping up its regulatory scrutiny of the cryptoasset sector. Through a new key industries act, they are publishing a stream of consultation papers and draft legislation to increase transparency, enhance consumer protection and improve operational resilience. The FCA's recent activity signals a significant shift in the UK's approach to cryptoassets, which has been relatively slow until now. Their stated purpose is to bring cryptoassets under existing regulatory structures. As a result, they would put the UK on the same footing as jurisdictions such as the United States. The FCA is actively seeking industry feedback to refine its understanding of the crypto market's operations, benefits, risks, and potential risk mitigation strategies.

The FCA’s holistic approach reflects these desires through proposals requiring any crypto firms that serve UK customers to comply with strict standards. These firms will need to follow new rules to limit the issuance of stablecoins and the custody of cryptoassets. The FCA has invited industry stakeholders to provide comments on these consultation papers by July 31, 2024, as it aims to strike a balance between fostering innovation and protecting consumers.

Stablecoin Issuance and Cryptoasset Custody

On May 28, the FCA published consultation paper CP25/14 on the conduct of business rules in relation to stablecoin issuance and cryptoasset custody. This discussion paper provides background on proposed requirements for issuers, with a focus on the offer and redemption of qualifying stablecoins. It further addresses the custody and maintenance of assets backing these stablecoins. The FCA intends to mandate that issuers disclose key information about their qualifying stablecoins, ensuring transparency and informed decision-making for consumers.

The proposals made in CP25/14 aim to ensure a robust framework for stablecoins. This makes these coins increasingly important in the broader cryptoasset ecosystem. By establishing uniform benchmarks for issuers, the FCA is taking important steps to mitigate harm. This action intends to address risks posed by stablecoins, such as possible financial instability and insufficient transparency. These requirements help ensure that stablecoins operate within a safe and sound regulated space. This arrangement instills a greater level of confidence to users of the technology and to investors.

That’s because overseas firms can issue stablecoins without any authorization in the vast majority of circumstances. If they release these coins in the UK, then they need to be authorized. The FCA takes seriously its responsibility to regulate activities within its jurisdiction. It acknowledges the worldwide scope of the cryptoasset market. This kind of approach stops regulatory arbitrage. It provides a level playing field for all firms doing business in the UK, regardless of their home jurisdiction.

Prudential Regime for Cryptoasset Firms

On May 28, the FCA released consultation paper CP25/15. This Discussion Paper, published to accompany CP25/14, is about shaping the prudential regime for cryptoasset firms. This paper proposes a framework for ensuring that crypto firms have adequate financial resources to manage risks and protect consumers. The prudential regime enhances the safety and soundness of crypto firms. Specifically, it prevents or mitigates failures before they occur that could harm customers.

Among the proposed prudential requirements are capital adequacy, liquidity risk, and risk management standards. Crypto firms should be required to maintain adequate capital to absorb expected risks. Alternatively, they must ensure they have good liquidity on hand to meet all of their obligations. At a minimum, the FCA should conduct a review of every firm’s risk management. They’re concerned that the companies are managing all risks, not just market risk, credit risk, operational risk, etc.

The FCA is in the process of establishing a more robust and sustainable regulatory framework for cryptoasset-related activities in the UK. They intend to do this by creating a customized prudential regime. This in turn will go a long way toward creating the trust and confidence the market needs, encouraging more participants and more innovation. The FCA's approach is consistent with international efforts to regulate cryptoassets and ensure that firms operating in this space are subject to appropriate oversight.

Expanding Regulatory Perimeter

Separately, the UK is in the process of revising the Financial Services and Markets Act 2000. This new base will undoubtedly include strong, bright-line regulations addressing the growing world of cryptoassets. Widthening the FCA’s jurisdiction This expansion touches a wider scope of cryptoasset activities than you might think. In doing so, the FCA will be more empowered to both supervise and enforce adherence to regulatory standards. Because of this, the draft legislation requires that crypto firms servicing UK customers need to ensure very high standards. In short, these standards prioritize transparency, consumer protection, and operational resilience.

Regulators are incredulously widening the regulatory perimeter. This recent shift indicates their growing recognition of cryptoassets’ importance to the financial system. As cryptoassets attract more consumers and business, we should regulate them to protect investors and the financial system. This would help protect consumers and maintain financial stability. The FCA’s enforcement-oriented approach to regulating cryptoassets stands in stark contrast to its promotion of innovation in the market. Concurrently, it seeks to reduce risks by establishing a regulatory framework that fosters responsible development.

The FCA’s draft legislation says all firms providing UK retail consumers would need to be authorized. This requirement ensures that companies trading in the UK market are subject to the FCA’s oversight. Yet they are still subject to the regulatory requirements outlined by the FCA. Special implications for overseas firms Overseas firms that serve only UK institutional customers typically wouldn’t need authorization. If those UK institutions are acting as conduits to UK consumers, then some form of authorization should be necessary. This provision demonstrates the FCA’s focus and priority on protecting retail customers. These customers would typically be more susceptible to the risks associated with cryptoassets.

"appears more aligned with the US, bringing crypto assets into the existing regulatory perimeter rather than developing bespoke legislation for them" - Nick Price, a Partner in the Commercial Disputes team at Osborne Clarke

Discussion Paper and Industry Feedback

Prior to the consultation papers, the FCA published a discussion paper on May 2, outlining its approach to regulating cryptoasset activities. This white paper raised 54 topical questions for the industry and stakeholders. It wanted their input on the most effective way to regulate cryptoassets. The 2021 discussion paper did touch on a wide range of significant and emerging topics. It focused on what should be regulated, how various classes of cryptoassets should be treated, and how existing regulatory principles should apply to cryptoasset activities.

The FCA's proactive engagement with the industry underscores its commitment to developing a regulatory framework that is both effective and proportionate. The FCA continually encourages and facilitates input from stakeholders. This strategy further assists the agency in making its regulations knowledgeable and cognizant of the distinct market attributes of the cryptoasset space. FCA’s consumer duty consultation process allows the FCA to identify possible unintended consequences of its proposals. It allows them to know what to adjust.

The FCA was looking for responses to both consultation papers by 31 July. This provides stakeholders ample opportunity to study the proposals and provide their feedback. That feedback will be important in determining what the final form of the FCA’s regulations will look like. The FCA will carefully consider all comments received. It will update its proposals accordingly, as needed, informed by that feedback.