Crypto View - October 2023

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It seems that every time I sit down to write Crypto View someone publishes something else that needs to be included. So here we are; a week late. And today the FCA published a discussion paper on regulating stablecoins. I can't win. We'll cover that in November's issue, as I couldn't leave this any longer. So this issue we will look at the implementation of the financial promotion regime with respect to cryptoassets - the first time crypto has been subject to regulation in the UK. We also have a look at two other HMT papers on stablecoins that came out on the same day as HMT's response to the consultation on the future financial services regulatory regime for cryptoassets (which we covered in a special Crypto View last week). We also look at economic crime reform in the UK, some new digital asset laws in Germany, (another) bit of litigation involving Craig Wright, and as usual we look at MiCA developments.

Financial Promotions

October saw cryptoassets come within scope of the financial promotion regime in the UK. As of 08 October, there are only four routes to legally promote cryptoassets to customers in the UK:

• The promotion is communicated by an authorised person.
• The promotion is made by an unauthorised person but approved by an authorised person (note that authorised firms need to submit a P11 notification to the FCA before carrying out such approvals - if not, it could cause problems).
• The promotion is communicated by (or on behalf of) a cryptoasset business registered with the FCA under the MLRs.
• The promotion is otherwise communicated in compliance with the conditions of an exemption in the Financial Promotion Order.

Promotions that are not made using one of these 4 routes will be in breach of section 21 of the Financial Services and Markets Act 2000 (FSMA), which is a criminal offence punishable by up to 2 years imprisonment, the imposition of a fine, or both. To be clear, this applies extraterritorially, and so any marketing that is capable of having effect in the UK, regardless of where the marketing firm is based, is caught by this new regime.

Since coming into force, the FCA has warned firms about common issues it has seen from firms carrying out financial promotions, including:

• promotions making claims about the 'safety', 'security' or ease of using cryptoasset services without highlighting the risk involved
• risk warnings not being visible enough due to small fonts, hard-to-read colouring or non-prominent positioning
• firms are failing to provide customers with adequate information on the risks associated to specific products being promoted

It has also published its long-awaited finalised Non-Handbook Guidance on Cryptoasset Financial Promotions. This has largely maintained its proposed guidance from GC23/1, despite concerns raised from the industry about a number of points in that guidance consultation. While it has tried to clarify that the Consumer Duty only applies to the authorised firms approving financial promotions, there remains some lack of clarity with regards to so-called "complex yield models". In the final guidance, the FCA has "amended the Guidance to recognise that there are differences between the underlying activities of complex yield models such as between staking, borrowing and lending, and specifically that staking can comprise different activities". However, it is not clear exactly which controlled activity staking (or indeed borrowing or lending) falls within. It has removed the text from the consultation that describes what it means by staking, which could potentially be read as conflating staking with borrowing and lending, while maintaining that they are subject to the financial promotion regime. More clarity on this would be much appreciated.

If you have any questions on this, please do reach out, we would be happy to discuss further.

The other two HMT Publications

Alongside the response to the future financial services regulatory regime for cryptoassets, HMT also published two papers on stablecoins. The first was a response to the consultation that ran last year (and received 26 responses) which sought views on the proposed application, with amendments, of the Financial Market Infrastructure Special Administration Regime (FMI SAR) to systemic payment systems, and service providers of systemic importance to those systems which use digital settlement assets (DSAs). The next steps following the response include:

• The government intends to lay regulations to Parliament which implement the policy, broadly as described in the initial consultation regarding the overarching framework.

• Further secondary legislation (building on PESAR and IBSAR) on the procedural elements is then planned.

• The proposals in the consultation do not extend to DSA firms that are not considered to be systemic, however, the Government will consider whether bespoke insolvency arrangements should be developed in time for non-systemic stablecoin firms (e.g., a new special administration regime).

• BoE will also consider whether further guidance on the operation of the FMI SAR is necessary going forwards.

• The government also intends to engage with industry practitioners in due course on what they would require to address a failure of such a firm.

The core of the proposals is to appoint the FMI SAR as the primary regime for systemic DSA firms which are not banks, meaning that the Bank of England (BoE) will be the "lead authority" for systemic DSA firms. In a scenario where a stablecoin firm were to be recognised by HMT as 'systemic', the government expects that BoE would act as the lead prudential supervisor, and the FCA for its conduct regulation. The PSR would also have jurisdiction under their regime for systemically important service providers under Part 5 of the Financial Services (Banking Reform) Act 2013.

Broadly the regime is concerned with financial failure, but the consultation notes that it "may be necessary to add an additional statutory justification to the court to make an FMI administration order to cover possible sources of non-financial failure" suggesting the established ground of 'fairness', a term utilised within the IBSAR and the PESAR. If this is taken forwards, the government will, as far as possible, follow precedent from existing SARs in establishing this additional statutory justification. The FMI SAR will, however, have a new objective (similar to PESAR) of the "return or transfer of customer funds and custody assets" - which will allow for the return of funds or assets to be in the most appropriate form, and which may include fiat currency, DSA, or another cryptoasset (or a combination of both). This will be balanced by BoE on a case by case basis with the existing objective of continuity of service.

In terms of the practicalities, the proposals note that BoE will have powers to direct administrators or introduce further implementing rules, but they will be required to consult with the FCA ahead of any order (noting that BoE will remain 'autonomous'). In terms of liability, administrators will have immunity from liability in damages in respect of action or inaction in accordance with a direction given by BoE, and that HMT may agree to indemnify persons on similar grounds. Administrators will be paid out of the assets of the firm under administration.

Generally it is noted that the powers are only meant to address systemic DSA firms that operate within the UK, but the response notes that BoE has powers to require, if it deems appropriate, a systemic DSA firm operating in the UK market to establish a UK presence. For firms entirely outside the UK, the response notes that steps "requiring a globally operating systemic DSA firm to have a local presence within the UK [are] being considered". More locally, it is intended that the modifications to the FMI SAR will also apply in Scotland and Northern Ireland, although modifications for local insolvency law are required.

The other paper confirmed the government's intention to facilitate and regulate the use of fiat-backed stablecoins in UK payment chains. This will include bringing the use of fiat-backed stablecoins in payment chains into the Payment Services Regulations 2017 (PSR 2017) and bringing the activities of issuance and custody of fiat-backed stablecoins where the coin is issued in / from the UK within the regulatory perimeter of FSMA and the RAO. This policy update aims to clarify the distinction between the government's plan to regulate certain activities relating to fiat-backed stablecoins in phase 1 (the FCA published its discussion paper relating to this) and the regulation of activities relating to wider types of cryptoassets (for example, so-called algorithmic stablecoins, and commodity-backed tokens) which (a) will not be caught in phase 1 but (b) the government propose will be in scope of phase 2.

Economic crime reform in the UK

On 26 October 2023, the UK's Economic Crime and Corporate Transparency Act came into law. This is a significant piece of legislation, which introduces the most significant economic crime reforms in the UK for over a decade.

In particular, the Act will give UK law enforcement new powers to seize and recover cryptoassets associated with suspected illicit activity. Existing asset recovery powers will be extended to cover cryptoassets, meaning that law enforcement will be able to seize, freeze and confiscate cryptoassets that are suspected to represent the benefit of money laundering, fraud, cyber attacks or other criminal conduct. These powers will extend to cryptoassets held by an exchange with a presence in the UK. The date on which the new powers will come into effect is yet to be confirmed.

Other key changes contained in the Act include:

• A new corporate offence of 'Failure to Prevent Fraud', which could make any organisation with exposure to the UK criminally liable if its employees or agents commit a fraud offence intending to benefit the organisation, unless 'reasonable' fraud prevention procedures were in place. This new offence could apply, for example, in cases involving misselling or the manipulation of financial data.
• New transparency requirements for UK entities and new investigative and prosecutorial powers for the company registry, Companies House.
• In relation to anti-money laundering, new information sharing powers for the private sector and new intelligence gathering powers for law enforcement.
• A new, lower, test for attributing liability for economic crimes to a corporate, based on the involvement of a 'senior manager'.

For more information, please contact my colleague Jon Malik.

New Digital Asset Laws in Germany

On October 23, 2023, the Ministry of Finance presented a draft bill for a Financial Market Modernization Act (the FinmadiG). The FinmadiG comprises different chapters covering the implementation of DORA into German law as well as the MiCA.

The first chapter includes the new Crypto Markets Supervision Act (KMAG). The KMAG will include an amended version of the currently existing national regulation regarding cryptoassets. The creation of a new Act should reflect the approach to separate financial instruments regulation from cryptoasset regulation as is the case on EU level. Institutions that currently conduct banking business and provide financial services in relation to cryptoassets under national law will be dealt with in this new piece of legislation.  

BaFin will be granted wide-ranging supervisory powers. This also includes amendments to existing legislation, namely the Securities Trading Act (WpHG), the Securities Institution Firm Act (WpIG) and the Banking Act (KWG). Furthermore, the German Money Laundering Act (GwG) will also be amended, which means that issuers of asset-referenced tokens will also be obligated parties under the German AML rules.

The KMAG is scheduled to take effect on 01 July 2024, while the rest of the law is scheduled to take effect on 30 December 2024.  To discuss this further, please contact Jochen Kindermann or Lena Schäfer.

Tulip Trading (Craig Wright) litigation continues to result in judgments

Readers may be familiar with the Tulip Trading case which is working its way through the courts in England. The case raises an issue of fundamental importance to DLT networks: do the developers of networks owe duties to the holders of assets native to the blockchain in question? The case is brought by Tulip Trading Ltd, which is ultimately owned by Dr Craig Wright. Tulip claims that it was hacked, losing c.£4.5bn in assets (made up of BTC, BCH and BCHA) and that, on the basis that the developers of those networks owe duties to holders, the developers can be ordered by the Court to write a software patch which will return the assets to Tulip.  

The developers argue that, before the Court determines the question of whether they owe duties to holders, it first needs to determine whether or not Tulip ever owned the assets in the wallets that were (allegedly) hacked. The developers therefore asked the Court to determine whether Tulip ever owned the assets as a preliminary issue, with a view to knocking the claim out before the main trial.

In support of their case that the Courts should deal with this as a preliminary issue, the developers wanted to rely on judgments from separate cases which, they say, show Dr Wright to be dishonest. The long standing principle (established by Hollington v Hewthorn) is that a Court will not rely on findings in other judgments when making its own findings, and Tulip argued that this principle prevented the developers using the past Wright judgments in evidence. The Court disagreed, concluding that while the Hollington principle does apply to evidence used at trial, it does not apply where the Court is considering whether to order a preliminary issue. The Court can therefore take the past judgments into account when deciding whether to order a preliminary issue. The case continues...

Dutch Court: Too high costs charged by DNB for assessment of crypto registration requests

DNB charges registered crypto service providers costs for so-called 'supervisory acts'. DNB budgets the annual amount it expects to incur from one-off supervisory actions (e.g. the registration of crypto service providers) and the costs of ongoing supervision of crypto service providers. The costs exceeding the budget of one-off supervisory acts may be offset against the costs of ongoing supervision. The total costs to be charged are borne by all registered crypto service providers.

On 4 October 2023, the Court of Rotterdam ruled in a case initiated by 11 registered Dutch crypto service providers (CASPs) against the Dutch Central Bank (De Nederlandsche Bank "DNB"). These CASPs appealed to the costs charged by DNB for the assessment of their registration requests. In this context, they stated that DNB acted outside the scope of the registration regime when assessing these registration requests. To substantiate this statement, the crypto service providers pointed out that it follows from article 47 of the European AMLD that the crypto registration regime should only consist of the following two requirements:

• mandatory registration; and
• the assessment of the trustworthiness (betrouwbaarheid) and suitability (suitability) of senior management and beneficial owners.

According to the crypto service providers, any costs incurred by DNB for requesting and reviewing information that is unrelated to those two requirements may not be charged to them. The Court ruled in favour of the crypto service providers by determining that DNB is indeed not permitted to charge any costs for tasks performed that go beyond the scope of article 47 AMLD. Moreover, according to the Court, the provisions in Dutch law implementing the AMLD (and DNB's application thereof) that go beyond the scope of article 47 AMLD are in fact 'non-binding'.  We suggest that the ruling of the Court confirms the distinction that should be made between a registration regime on the one hand and a more far-reaching licensing regime on the other hand. Please also see our comments on this in the Dutch financial newspaper Het Financieele Dagblad (available here).

It is yet to be seen what the impact of this ruling (to which DNB can still appeal) will be on the way DNB assesses submitted crypto registration requests in practice, but we would expect that such assessment should be limited to the relevant trustworthiness and suitability assessments.  For more information, please contact Koen van Leeuwen and Sophie Wesselink

This month in MiCA

On 17 October 2023, ESMA published a statement and a letter to encourage preparations for a smooth transition to MiCA. In its statement, ESMA calls on entities currently providing crypto-asset services to already take action on six specific items. One of these is that such entities should apply for a MiCA licence as soon as possible. In this context, ESMA notes the following in respect of the grand-fathering clause and cross-border activities:

"Cross-border activities by an entity benefiting from grand-fathering may occur only if the entity complies with relevant legislation applicable in both the home and host Member States. The provision of crypto-asset services during the transitional period should in any case always comply with the applicable national laws in the Member State where the services are provided. Entities benefiting from grand-fathering will be forbidden from conducting cross-border activities in Member States where the grand-fathering clause is not (or no longer) applicable."

As MiCA allows for some flexibility for EU Member States as regards the length of the transitional period (with a maximum of 18 months), the above implies that an entity applying for a MiCA licence in its home state should keep an eye on the applicable transitional periods of all the other EU Member States it is active in. In other words, the scenario in which an entity would need to cease to provide crypto-asset services in a host state in which a shorter transitional period applies than in its home member state is not unthinkable.

In its letter, ESMA calls on member states to consider limiting the optional grand-fathering period to 12 months instead of 18 months. ESMA is concerned that extensive use of the grand-fathering clause for entities already providing crypto-asset services would weaken the effectiveness of the MiCA rulebook.

In news from the Netherlands, the AFM recently stated in a publication that participants who have intentions to apply for a MiCA license can already (optionally) notify the AFM of this intention.

There have also been a number of consultations published, both by ESMA and the EBA. We are now seeing more movement on secondary legislation and guidelines for implementing the legislation, and expect this to continue. We saw:

• ESMA's second consultation on crypto market rules
• EBA consulting on draft Regulatory Technical Standards (RTS) on the minimum content of the governance arrangements on the remuneration policy
• EBA consulting on draft RTS on the procedure for the approval of white papers of asset-reference tokens (ARTs) issued by credit institutions.
• EBA consulting on draft RTS on internal governance arrangement for issuers of asset-referenced tokens