The UK is moving in the right direction on crypto regulation – but the country must move faster, the author of this article argues. 

The writer of this article is Brett Hillis, partner at law firm Reed Smith and a member of On-Chain, the firm’s dedicated crypto and digital assets group. The team has more than 100 lawyers working across the US, the UK, Europe, Asia and the Middle East.

The way that the crypto and digital assets space evolves continues to be important for the wealth management sector, and we are pleased to carry these insights. The usual editorial disclaimers apply. Please email the editor at tom.burroughes@wealthbriefing.com if you wish to get involved in the conversation. We welcome feedback from those in the frontlines of this technology.

The UK government has made no secret of its ambition to turn the UK into a cryptocurrency hub. That is a laudable ambition, but the UK faces a crowded and competitive market internationally. There is plenty to attract cryptocurrency and other digital asset businesses to Britain, but the UK must recognise that, in the face of competition from other jurisdictions, it cannot afford to stand still.

Troublingly, however, the UK regulators at least do not appear to have come to this realisation when it comes to retail investing.

Tellingly, it has been five years since the Financial Conduct Authority last consulted on selling investment products that reference crypto assets to retail clients, with the corresponding ban on this having been in force since January 2021. Since then, however, the global picture has changed dramatically. Recent developments of particular significance include the US and Hong Kong granting regulatory approval for bitcoin exchange-traded funds (ETFs). In the European Economic Area, meanwhile, investors have been free to invest in physically backed bitcoin exchange-traded products (ETPs) since 2019.

But the only movement from the FCA has been to allow institutional investors to invest in bitcoin and ethereum ETPs. As a result, it is hard to escape the conclusion that the UK’s stance is much more conservative when it comes to the retail market for products referencing crypto assets.

An outdated position?
The FCA’s position is intended to protect retail investors and that of course remains of paramount importance. But the FCA’s position assumes that unlike institutional investors, in general, retail investors will not have the ability to accurately assess the risks and values of the underlying crypto assets no matter what other regulatory protections are put in place to protect them.

The FCA’s argument in banning retail investors from investing in ETPs rests on a number of assumptions which may well have been correct in 2019. But crypto markets have matured considerably since then. Despite this, the FCA has not re-evaluated its stance as to whether the same challenges apply or that a retail ban is the best way to deal with them.

For instance, the arguments made five years ago that crypto assets have no inherent value, that they are vulnerable to market manipulation and financial crime, and that their pricing is extremely volatile may not have the same strength now as they did then.  And even if those points were as true now as then, it does not follow that a retail ban is the best response.  As a result, were the FCA to undertake another consultation now, it is hard to imagine that it would arrive at the same conclusion.

The FCA’s approach leaves UK regulation in a curious place. Cryptoassets are not wholly within the FCA’s regulatory perimeter. Particularly significant is that they fall outside the scope of the FCA’s product intervention powers, which means that no crypto assets themselves have been banned by the FCA. In other words, it is not within the FCA’s powers to ban bitcoin or ethereum.

Anti-money laundering regulations have been extended to encompass crypto exchanges, brokers and custodians, which do fall within the scope of the FCA’s regulatory powers, but the FCA’s role in this regard is to warn investors of the risks associated with crypto assets as an investment product rather than to prevent access to them.

Consequently, because the FCA’s position has not altered, the ban on ETPs for retail investors has left the UK regulating crypto assets and crypto asset ETPs differently – notwithstanding the fact that the products share a similar risk profile. In fact, the banned product is arguably the less risky of the two due to the custody and safekeeping arrangements.

Where next?
Since 2021, the FCA has been given further powers to regulate crypto assets, with the financial promotion regime extended to cover crypto assets. The FCA has set detailed requirements relating to the promotion or sale of these products to retail consumers – which have perhaps unsurprisingly not encouraged retail investors – and it is apparent that the FCA intends to take an active approach to its enforcement responsibilities.

For instance, on the first day following the introduction of a new cryptocurrency marketing regime, the FCA issued 146 alerts to firms, reminding them of their obligations to protect UK consumers from illegal promotions. In of itself, this assertive approach to regulation should not necessarily be seen as a cause for concern. Rather, the strict approach to marketing can play an important role in helping educate consumers about risk. But educating consumers about risk is one thing, denying them the opportunity to invest is quite another.

It is also out of step with the UK’s wider approach to regulating crypto assets as it has developed. This has not foreclosed the market but provided strong protections to retail investors. The FCA’s financial promotion regime for crypto assets shows that retail investors can be enabled to buy crypto assets subject to a heavily regulated customer journey. It seems incongruous that a similar approach is not taken with fully-regulated products referencing such crypto assets.

Indeed, overall, the FCA’s regulation of cryptocurrencies and digital assets deserves credit both for the rules it has drawn up and its practical approach to enforcing them. The ultimate result of this should be the confidence of the industry.

But that confidence may well be dented by the ongoing ban on retail investors, particularly in light of other jurisdictions reassessing their position. It is, of course, vital that retail customers are protected from exposure to undue risks, but this should be done in a way that does not create unnecessary obstacles to investment. For all of the positive aspects of the UK’s regulatory regime, the FCA has also created such an unnecessary obstacle to retail investment and the sooner that is addressed the better.