In its policy statement PS19/22, “Guidance on crypto-assets”, the Financial Conduct Authority (FCA) divided crypto-assets into “three broad categories”: exchange tokens, utility tokens and security tokens.

Originally published by ThomsonReuters © ThomsonReuters.

The FCA further explained that while security tokens are investments for the purposes of the Financial Services and Markets Act Regulated Activities Order 2001, as amended, (RAO), this would not always be the case for utility tokens and would not be the case for exchange tokens such as Bitcoin, Litecoin and Ether.

This means that the transfer, purchase and sale of cryptocurrencies (but not crypto derivatives), including the operation of a cryptocurrency exchange, all fall outside the regulatory remit of the Financial Conduct Authority (FCA). The FCA has clarified that it regards derivatives (i.e., futures, options and contracts for differences in respect of exchange tokens (i.e., BTC) as regulated investments.

There is little appetite to require that traders and exchanges only dealing in exchange tokens become authorised persons under the RAO. There has, however, been growing recognition in government circles that crypto-assets are increasingly being used by unscrupulous organisations and individuals as a means to move and launder money and assets which, if they had been processed through the regular banking sector, would have been subject to detailed scrutiny.

Crypto-asset activities

On January 10, 2020, the FCA became the anti-money laundering and counter-terrorist financing (AML/CTF) supervisor of UK crypto-asset businesses under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). This was actioned through the Money Laundering Regulations 2019, which inserted a new reg 14(A) into the MLRs,
covering the operations of certain crypto-asset activities.

The amended MLRs provide that a business is considered to be in the “regulated sector” for the purposes of the Terrorism Act 2000 (as amended by reg 14A) to the extent that its activities consist of:

A crypto-asset exchange provider:

• exchanging, or arranging or making arrangements with a view to the exchange of, crypto-assets for money or money for cryptoassets;
• exchanging, or arranging or making arrangements with a view to the exchange of, one crypto-asset for another; or
• operating a machine which utilises automated processes to exchange crypto-assets for money or money for crypto-assets.

Or a custodian wallet provider:

• a firm or sole practitioner who by way of business provides services to safeguard, or to safeguard and administer crypto-assets on behalf of its customers, or private cryptographic keys on behalf of its customers to hold, store and transfer crypto-assets, when providing such services.

Registration with the FCA

The amended MLRs provide that businesses intending to carry on crypto-asset activities within the scope of reg 14A of the MLRs by way of business in the UK are, according to reg 56(1) of the MLRs, required to be registered (from January 10, 2021) with the FCA for AML/CTF purposes.

Businesses which carry on crypto-asset activities within the scope of the MLRs and are not on the FCA’s register or on the list of firms with Temporary Registration, are required to cease such activities immediately and to return any money or crypto-assets that fall within the scope of the MLRs to customers. They must also take into account all relevant and appropriate regulations and laws, including but not limited to the Proceeds of Crime Act 2002 (PoCA).

Under reg 86 of the MLRs, it is a criminal offence to provide or continue to provide services involving crypto-assets without registration. Firms carrying on such activities without being on the FCA’s register are at risk of being subject to the FCA’s criminal and civil enforcement powers (as set out in the MLRs).

This is where the problems begin. The FCA did not expect a very large number of applications. It asked firms to make their applications by June 30, 2020 with a view to having processed all applications ready for the January 10, 2021 deadline.

Temporary Registration Regime

The FCA was, however, surprised by the sheer number of applicants wanting to register. By mid-December 2020 the regulator had only registered four firms and had a waiting list of hundreds. This resulted in the FCA’s announcement on December 16, 2020 that it was launching a Temporary Registration Regime (TRR) for existing crypto-asset businesses which had applied for registration before December 16, 2020, and whose applications were still being assessed. These firms were given an extension until July 9, 2021, by which time the FCA expected to have been able to have processed all applications for registration. That was good news for firms which had applied, whose regulatory status was in effect grandfathered while the FCA worked through the backlog.

The not so good news was that the FCA brought forward the deadline for applications from January 10, 2021 back to midnight on December 15, 2020, leaving firms which had not yet applied and new businesses completely high and dry.

The original July 9, 2021 extension, however, did not leave the FCA anywhere near enough time to consider applications for registration. As a result, on June 3, 2021 the FCA announced a further extension of the TRR from July 9, 2021 to March 31, 2022. Crucially, however, this was only for firms which had applied for registration before December 16, 2020, and whose applications were still being assessed, thereby allowing those firms only to continue trading.

The latest announcement therefore does nothing for new firms, or for firms which had failed to apply before mid-December 2020. The government may make positive noises about digital assets and supporting financial services post-Brexit, but the reality is that this approach is a deterrent to firms wishing to bring digital asset business to the UK.

The FCA has also been actively encouraging certain firms which did apply in time and which are under the TRR to withdraw their applications, where it considers the application was unnecessary and wishes to reduce the numbers of applicants. The FCA has nonetheless explained to those firms that, if they withdraw, they do so entirely at their own risk, leaving them open to prosecution should they turn out to be in breach. Not an attractive prospect.

The author has worked with several clients in this position. In certain cases, the FCA has been correct. The author has, however, had to explain to the FCA that the client is in fact subject to the MLRs and needs to remain subject to the TRR — a rather counter-instinctive position for a financial services lawyer.

Registration, not authorisation

Questions also need to be asked about why the FCA is taking so long to review applications for what is, after all, “registration”, not authorisation.

“A significantly high number of businesses are not meeting the required standards under the Money Laundering Regulations. This has resulted in an unprecedented number of businesses withdrawing their applications,” the FCA comments on its website.

The author’s experience of working with firms going through the application for registration is that, despite this being a registration rather than authorisation, the FCA is carrying out extreme levels of due diligence on firms. In many cases, it would be quicker for the firms to extend their activities to cover trades in crypto derivatives and to apply for a full-scale authorisation as an arranger, organised trading facility or multilateral trading facility (MTF), which cannot be what the legislators had in mind when they created this regime.

Originally published in Regulatory Intelligence