On September 19th, the Treasury Committee published a report on crypto-assets for its Digital Currencies inquiry.
Crypto-assets and most Initial Coin Offerings (ICO) are currently not within the scope of Financial Conduct Authority (FCA) regulation. Crypto-asset investors are currently afforded very little protection from the litany of risks, namely there are no formal mechanisms for consumer redress, nor compensation.
The regulation for digital tokens is a developing area as the current United Kingdom (“U.K.”) financial services law was not developed with the use of digital tokens in mind. Therefore, it is important to bear in mind that subtle differences in the legal structure and function of digital tokens can have significant regulatory consequences. There are several general approaches to the regulation of digital tokens in the U.K. whether:
1) to treat them as a commodity or other form of physical property. Where this is the case, the marketing, purchase, and sale of the digital token will largely be unregulated from a U.K. financial services law perspective, except if it falls with the U.K. law definitions of a derivative.
2) to treat them as a financial instrument or a security or a unit in a fund including a collective investment scheme involving digital tokens or an alternative investment fund.
3) to treat them as money or a currency.
The regulatory categorization of the digital token is important as it will determine the extent to which if any U.K. authorization, prospectus, marketing restrictions, systems, controls, procedures, the conduct of business, anti-money laundering and anti-terrorist financing requirements apply.
U.K. Collective Investment Scheme
The term “Collective Investment Scheme” (“CIS”) is deliberately broad and vague and so it is capable of capturing a wide range of arrangements even if the parties to the arrangements do not intend to create or establish a ‘fund’ or a collective investment.
In the context of digital tokens, arrangements are capable of being a treated as a CIS in circumstances where participants pay cash to an ‘issuer’ in exchange for a certificate or token which gives the participants/investors an entitlement to underlying property (e.g., gold, silver, wine, art, etc.), if the underlying property is managed by a third party (the term managed could entail administrative functions such as arranging for the property to be stored and/or insured) or if the contributions or profits of the participants/investors are pooled.
Therefore, arrangements relating to digital tokens need to be carefully scrutinized to determine whether they are within the U.K. CIS regime even if the intention is not to create a fund or collective investment.
U.K. Alternative Investment fund analysis
An Alternative Investment Fund (“AIF”) is defined in Article 4(1)(a) of the Alternative Investment Fund Managers Directive (“AIFMD”) as any “collective undertaking including investment compartments thereof, which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy and which is not required to be authorised under Article 5 of Directive 2009/65/EU” (the EU Directive dealing with authorisation of open-ended retail funds).
All elements of the AIF definition must be present in order for the digital token arrangements to be treated as an AIF.
E-money is defined in the Directive 2009/110/EC as electronically stored monetary value represented by a claim on the electronic money issuer which:
(i) is issued on receipt of funds for the purposes of making payment transactions;
(ii) is accepted by a person other than the electronic money issuer; and
(iii) is not otherwise excluded.
The E-money directive is implemented in the U.K. through the Electronic Money Regulations 2011. In many instances, the digital token will not be treated as e-money because:
- there is no claim against the issuer of the digital token for the value of the digital token acquired
- it does not have ‘monetary value’ (as it is not a currency); and
- the digital token is not issued on receipt of funds.
The UK authorities have taken a generally cautious but positive approach towards virtual currencies and the blockchain industry as a whole. The wait-and-see regulatory strategy has been recently substituted with a much-needed sandboxing program that allows for some form of cryptocurrency regulation in the UK, without actually having it.
When it comes to cryptocurrency exchanges and custodians, even though they’re not under the FCA’s oversight, the UK authorities intend to apply AML regulations in order to comply with the EU’s 5th AML Directive. Along the same lines, the Treasury has revealed their intentions to regulate cryptocurrency traders, requiring them to abide by KYC regulations and disclose their identities as well as report suspicious activities.
Other countries such as the USA, are also introducing new ways of regulating cryptocurrencies. If the regulatory task force is approved, they will have to provide answers to certain questions regarding the current status of digital currencies.
The global regulatory response to crypto-assets is still in its infancy. Nonetheless, given the UK has yet to introduce any crypto-asset regulation, it is in a position to learn from those experience of countries that have done so. If the Government decides that crypto-asset growth should be encouraged, appropriate and proportionate regulation could see the UK become a global center for this activity.
Crowd for Angels raises funds for companies by issuing shares, crowd bonds, and tokens. The FCA-regulated crowdfunding platform aims to monitor these developments closely as they come along.