Crypto industry is bracing for major regulatory transformation in the EU and the UK

Crypto regulations have been a major focus of discussion over the past two years, with different jurisdictions moving quickly to formulate legislative structures. The high-profile collapse of FTX, the world’s second-largest cryptocurrency exchange, in November raised further questions about how crypto companies operate and how they’re regulated.

FTX wasn’t the year’s only high-profile collapse. Crypto hedge fund Three Arrows Capital filed for bankruptcy in July following the collapse of TerraUSD, a stablecoin and crypto lenders, Voyager and Celsius Network, also filed for bankruptcy. As 2022 drew to a close, many were left wondering just how the sector has been allowed to conduct business without the same rules or scrutiny faced by traditional financial services companies. Financial regulators worldwide have hinted that their regulatory stance is set to toughen, but to the full extent and how effective regulation will be largely remains uncertain.

The European Union (EU) is determined to be the trailblazer on its mission to lead the international crypto regulatory field with the introduction of Markets in Crypto-Assets (MiCA) Regulation. The UK is not far behind either. The HM Treasury published a surprise consultation paper, "Future financial services regulatory regime for cryptoassets", on 31 January 2023, showing its determination to bring some order to the chaos.

What is EU's MiCA?

MiCA Regulation is a proposed regulatory framework planning to harmonize crypto assets and related activities across the EU. MiCA Regulation's key aim is to provide clarity and legal certainty for market participants operating in the crypto-asset sector and also providing solid consumer protection and financial stability. The regulation tackles several key issues, including the lack of transparency and accountability in the sector, the potential risks associated with crypto-assets, and the requirement to prevent money laundering and terrorist financing.

What are the key MiCA Regulation provisions?

• Definition of crypto-assets: The regulation defines crypto-assets as "a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology."
• Authorization requirements: MiCA introduces legislation for the authorization and supervision of crypto-asset service providers (CASPs) in the EU. CASPs include entities such as crypto exchanges, custodian wallet providers, and crypto-asset trading platforms. CASPs will need to meet certain criteria in order to obtain authorization, such as having adequate governance arrangements and robust risk management processes.
• Conduct of business rules: The MiCA Regulation provides a framework for the conduct of business rules for CASPs, including the need for disclosure, transparency, and market integrity.
• Investor protection: The regulation brings important measures to enhance investor protection, such as for CASPs to provide clear and accurate information to customers, and rules around the marketing and distribution of crypto assets.
• Market abuse: MiCA includes provisions to address market abuse in the crypto-asset sector, such as insider dealing and market manipulation.

How will MiCA impact the international market?

The greater regulatory clarity and legal certainty for crypto-asset service providers (CASPs) operating in the EU will likely attract more investment and innovation to the EU's crypto-asset sector. This will make it a more competitive player in the global market.

The focus on investor protection and market integrity is likely to have a positive impact on the wider international market. Robust regulatory standards has enabled the EU to set an example for other jurisdictions to follow, potentially leading to a more level playing field for international CASPs and greater investor confidence in the sector. This has no doubt encouraged the UK to set its focus to having a clear legislative crypto agenda. 

However, the MiCA Regulation may result in some challenges for international CASPs, most likely for those based outside of the EU. CASPs that provide or are looking to provide services to EU client will likely be required to comply with the MiCA Regulation's authorization requirements and other regulatory standards. As such, this could increase their compliance costs and create barriers to market entry. Further, the MiCA Regulation could potentially create conflicts with other jurisdictions' regulatory frameworks, leading to regulatory fragmentation and complexity.

The impact of the MiCA Regulation on the international market will probably be complex and multifaceted and much will depend on a range of factors. These include having clarity to the numerous questions raised on the legislations as well as the level of international cooperation on crypto-asset regulation that will be harnessed.

What is the UK doing? 

As anticipated, the EU has set the motions running for jurisdictions keen to lead in the crypto world. HM Treasury published a consultation paper, "Future financial services regulatory regime for cryptoassets" without warning on 31 January. The paper was not mentioned as part of the Edinburgh Reforms announced in December 2022, but nevertheless marks the start of the journey for UK cryptoassets regulation.

It's a bold move by the UK signifying its governments commitment to enticing crypto businesses to its jurisdiction and a clear strategic move to lead the international regulatory stage alongside the EU. 

What are the key proposals?

Wider remit of UK's regulatory scope: the definition of activities that require authorizations under the Financial Conduct Authority (FCA) to be widened and to include: payment activities; exchange activities; investment and risk management activities; lending, borrowing and leverage activities; safeguarding activities; and validation and governance activities.

Increased responsibility to cryptoasset traders: Cryptoasset trading venues will be responsible for defining content requirements for admission and disclosure documents to ensure that cryptoasset exchanges meet fair and solid standards.

• Market abuse: A tailored crypto-specific market abuse regime to tackle the differences in market abuse regime to discourage problematic types of activities.
• Issuance and disclosure regime to be introduced: Bespoke issuance and disclosure requirements to be implemented that understand the crypto market better and encourage better standards. 
• Expanding regulations to crypto-asset intermediation activities: A shift to understand the clear risk that arise from engaging with financial intermediaries and custodians of cryptoassets. Procedures to be introduced to improve conflicts of interest, governance and division of client assets and other similar issues. 
• Push for better ESG: Recommendation for evidence around sustainability of cryptoassets has also been included to align with the global efforts for better ESG.

How will the UK's proposed legislations impact the international market?

There is a clear effort by the UK to stamp its mark as a crypto-friendly jurisdiction and encourage more crypto and blockchain technology-based companies to choose the UK as it's favored jurisdiction.

The policy makers are aiming to bring clarity with better regulations whilst also stimulating growth, innovation and competition in the UK. It will also give better protection to consumers to make the appropriate risks. Whilst they wish to introduce robust regulations, they have highlighted the importance of the rules being proportionate, focused as well as flexible.

If the legislations are truly able to balance flexibility with robust governance, the UK may be the leading regulator in this area. Although the practical implications are hotly anticipated.

Why are these regulatory transformations important for US businesses?

Given that crypto businesses often have a global reach, US businesses should be aware and be ready to follow and implement these changes. As it stands, the US continues to lag behind the EU and the UK in its approach to formulating a regulatory framework for crypto. These regulatory powerheads will likely set the tone of the crypto regulations for the international platform.

This might encourage the US legislators to bring more clarity and harmonization to currently fragmented and complex regulatory framework. There are increasing noises being made by US lawmakers urging for "more effective oversight of crypto markets" to avoid a situation where broader financial markets would be affected by such events.

Osborne Clarke comment

The next few years will be an exciting period for the evolvement of legislation in the crypto world and it will be interesting to see how the global players harmonize or differ in their approaches. More importantly, it will be intriguing to see the behavior of market participants in response to the new regulatory environment.