Clifford Chance

Global regulators have taken a range of approaches to responding to virtual currencies.

Law Business Research Ltd have published the second edition of The Virtual Currency Regulation Review. The Review is a country-by-country analysis of developing regulatory initiatives aimed at fostering innovation, while at the same time protecting the public and mitigating systemic risk concerning trading and transacting in virtual currencies

The UK chapter of The Virtual Currency Regulation Review, written by Peter Chapman and Laura Douglas,  provides an overview of how crypto assets fit into the current UK regulatory framework. It covers the following issues: -

• Introduction to the legal and regulatory framework
• Securities and investment services laws
• Banking and money transmission
• Anti-money laundering
• Regulation of exchanges
• Regulation of miners
• Regulation of issuers and sponsors
• Criminal and civil fraud and enforcement
• Tax
• Other Issues
• Looking ahead

Introduction to the legal and regulatory framework

At present, some but not all types of virtual currencies are regulated in the United Kingdom (UK). In general, the structure and substantive characteristics of a virtual currency will determine whether or not it falls within the UK regulatory perimeter, and if so, which regulatory framework or frameworks will apply. In its Guidance on Cryptoassets, the UK Financial Conduct Authority (FCA) identifies three broad categories of virtual currencies (or cryptoassets), with the following features:

• Security tokens: virtual currencies with characteristics that mean they provide rights and obligations akin to traditional instruments such as shares, debentures or units in a collective investment scheme, meaning that they do fall within the UK regulatory perimeter.
• E-money tokens: virtual currencies that meet the definition of electronic money (or e-money) under the Electronic Money Regulations 2011 (EMRs). Again, they fall within the UK regulatory perimeter.
• Unregulated tokens: virtual currencies that are neither security tokens nor e-money tokens and therefore fall outside the UK regulatory perimeter. They include virtual currencies that are not issued or backed by any central authority and are intended and designed to be used directly as a means of exchange, which the FCA refers to as exchange tokens but are often called cryptocurrencies. Unregulated tokens also include ‘utility tokens’, which grant holders access to a current or prospective service or product but exhibit features that would make them akin to securities. Utility tokens may be the same as or similar to reward-based crowdfunding.

In its Guidance, the FCA states that although it recognises these three broad categories of cryptoassets ‘they may move between categories during their lifecycle’ and assessing whether a particular virtual currency falls within the UK regulatory perimeter ‘can only be done on a case-by-case basis, with reference to a number of different factors’. More generally, the Guidance sets out the FCA’s views on when virtual currencies fall within the current UK regulatory perimeter. This Guidance is not binding on the courts but may be persuasive in any determination by the courts, for example when enforcing contracts.

Questions to consider when identifying potentially applicable regulatory regimes

There are various ways in which market participants’ activities relating to virtual currencies might be regulated in the UK. When analysing whether, and if so how, activities relating to a particular virtual currency may be regulated, it is helpful to consider the following questions:

• Might virtual currencies be transferable securities or other types of regulated financial instruments or investments?
• Might arrangements relating to the issuance of virtual currencies involve the creation of a collective investment scheme?
•  Might virtual currencies give rise to deposit-taking, the issuance of electronic money or the provision of payment services?
• Might the issuance of virtual currencies or the operation of an exchange for virtual currencies be regulated as crowdfunding?
• Might the relevant activities concerning virtual currencies fall within the scope of the UK anti-money laundering legal and regulatory regime?

Interaction with EU financial services regulation and the impact of Brexit

The UK is currently a Member State of the European Union (EU). Therefore, EU-wide rules regulating the provision of financial services apply to the regulation of virtual currencies in the UK, whether through the direct application of EU regulations or under UK legislation implementing the requirements of EU directives.

For instance, the UK has implemented into national law requirements of:

• the recast Markets in Financial Instruments Directive (MiFID II), which regulates investment services and activities relating to financial instruments;
• the Capital Requirements Directive and Regulation, which regulate the activities of credit institutions, including deposit-taking;
• the revised Electronic Money Directive and the revised Payment Services Directive, which regulate activities relating to the issuance of electronic money and the provision of payment services, respectively; and
•  the Fourth EU Anti-Money Laundering Directive, which regulates entities conducting activities giving rise to money laundering risks.

These EU regulatory requirements may be integrated into or sit alongside domestic UK regulatory requirements, such as those under the Financial Services and Markets Act 2000 (FSMA), the EMRs and the Payment Services Regulations 2017 (PSRs). At the time of writing, the UK is due to leave the EU on 31 October 2019. This follows the outcome of the Brexit referendum vote in June 2016, the service of notice of the UK’s intention to leave the EU under Article 50 of the Treaty on European Union on 29 March 2017 and subsequent extensions to the Article 50 notice. However, the government has committed to preserve and onshore most existing EU and EU-derived legislation as it stands immediately before the UK’s departure through the European Union (Withdrawal) Act 2018. Therefore, the analysis of whether virtual currencies are regulated in the UK (including under applicable EU-wide regulatory frameworks) should not be affected by Brexit, at least in the short term.

Read the full UK Chapter

PDF Chapter reproduced with permission from Law Business Research Ltd.