A Global Approach Towards Private Crypto-Asset Reg?
Will the new FSB Directory prompt a forward-looking discussion.
17 May 2019
The Financial Stability Board (FSB) recently published a Crypto-assets regulators directory ahead of April's meetings of finance ministers and central bank governors from across the G20. The Directory provides a list of the regulatory and standard-setting bodies in each FSB jurisdiction that are responsible for dealing with crypto-assets issues, and regulating the aspects covered by them.
It comes as an extension of the FSB's reports from July ('Crypto-assets: Report to the G20 on the work of the FSB and standard-setting bodies') and October last year ('Crypto-asset markets: Potential channels for future financial stability implications') calling for an international approach to regulating crypto-asset markets.
In the directory, the FSB adopts a broad definition of crypto-assets as "a type of private asset that depends primarily on cryptography and distributed ledger or similar technology [(DLT)] as part of their perceived or inherent value". While its definition covers many subsets of crypto-asset, the FSB's reporting focuses on crypto-assets as a form of virtual/digital currency (e.g. Bitcoin, Bitcoin Cash, Ethereum/Ether, Litecoin, Dash, Monero, Decred etc) and as a utility token (that may be exchanged for either fiat currency or another form of virtual/digital currency) or security token (that may be used to acquire products/services but also may be held and traded for investment purposes), and analyses the crypto-asset markets, including initial coin offerings, to identify areas of regulatory weakness. The FSB does not consider central bank digital currencies or crypto-assets issued by other public sector entities in its reports.
The FSB monitors for vulnerabilities affecting the global financial system and helps to direct financial regulation across the G20. While the historic position of the G20 has been that there is "limited" interconnectedness of crypto-assets on the wider financial system (at the time of the October 2018 report the crypto-market is estimated to have represented just 1% of global GDP) to warrant an international response, global markets are changing rapidly, new crypto-currencies are being created every day and an increasing number of banks have become involved in the trading and storage of crypto-assets.
Despite the evolving market, the Directory highlights just how regulation has diverged at national level:
- The treatment and characterisation of 'crypto-assets' varies enormously across jurisdictions or, in some cases, may not yet have been clarified.
- The financial governance frameworks within FSB member jurisdictions also drives different policy priorities for regulating crypto-assets (e.g. for AML/CFT enforcement purposes; registration or licensing regimes; "virtual" taxation rules; cybersecurity; data protection; and/or customer protection).
By their very nature 'crypto-assets' do not align with the objectives of most domestic financial stability frameworks – crypto-assets are often decentralised, operate with little or no governance structure, and allow for anonymous transactions to take place. As a result, there has long been debate on how crypto-assets will become more integrated in the financial services sector. As Mark Carney, ex-chair of the FSB and Governor of the Bank of England, noted last year “[w]ider use and greater interconnectedness could, if it occurred without material improvements in conduct, market integrity and cyber resilience, pose financial stability risks…”. Back in March, the Basel Committee on Banking Supervision (BCBS) (an international standard-setting body part of the FSB) warned banks of the financial stability risks of cryptocurrencies like Bitcoin.
It appears the Directory has come at the right time – cryptocurrency is reported to have gained almost $50bn in total market capitalization since January this year, making it one of the best performing asset-classes of 2019. In early April, the price of Bitcoin shot up 50% within 24 hours and is reaching new heights regularly. The trigger for this latest Bitcoin surge remains uncertain – affirming the FSB's position that the volatile trading market should be more closely scrutinized and actively discussed.
Regulators have already demonstrated their willingness to apply existing legislation to new digital markets and technologies. The U.S. Securities and Exchange Commission (SEC) recently published new framework guidance on how to apply its three-stage "Investment Contract" analysis (for determining whether something is a security or not) to digital assets – indicating how its existing rules can be better applied to decentralized and hybrid investment models. Such guidance shows that the SEC is looking at the reality of a crypto investment (where tokens may have been bought for use on the network, and not for an "expectation of profit") and how individual investors instead rely on a decentralized community of users on the network.
Recent trends also show that the "regulatory gap" where crypto-assets do not fit neatly into existing regimes is closing, particularly in jurisdictions that take a more "tech-neutral" stance towards regulation. Just last week the UK Jurisdiction Taskforce (UKJT) of the LawTech Delivery Panel (established by the government, judiciary and the Law Society to promote the use of legal sector technology) launched a consultation on, amongst other things, the legal status of crypto-assets and DLT. The results of the consultation will help to conclude whether English private law is fit for purpose and target key issues of legal uncertainty regarding crypto-assets – comments are due by 21 June.
The growth of crypto-asset trading exchanges has also attracted more vigilant monitoring by regulators, the courts and law enforcement agencies. The Singapore International Commercial Court (SICC) recently gave judgment in its first cryptocurrency litigation on 14 March 2019. The decision gives important guidance on the relationship between a cryptocurrency exchange and its users, and how the common law doctrines may be applied to new technologies. We've also seen regulators, such as in Hong Kong and the UK, become more proactive in their response to crypto-insolvency situations.
Conclusions & Takeaways
The global regulatory landscape for crypto-assets remains unclear. But as crypto-asset trading once again surges, activity in the markets is increasingly "private", and cryptocurrencies (like Bitcoin) are establishing themselves as a recognised asset class, the Directory signifies a small but necessary step towards international regulatory standards. But what will this look like?
- Digital assets. Will regulating crypto-assets mean (a) re-examining how "traditional" assets are regulated (e.g. as with relevant securities laws in the US), or (b) widening the perimeter? If it were to be scenario (a), "non-security type" crypto tokens would still need to fit within a recognised class of asset (currently the position in most jurisdictions has been to leverage existing consumer protection laws). If the Directory is intended to prompt a forward-looking discussion, the creation of new legal asset classes could be inevitable…
- Enforcement action. As a marker of regulatory cooperation, will we see a step up in enforcement action and will market participants be forced to do things "by the book" (and become aware of their territorial perimeter)? Will market participants take these steps pre-emptively?
- Liability. Who will regulators focus on – issuers, investors, intermediaries or exchanges? If it were to be the latter, this could tighten the distribution and liquidity (and availability and value) of crypto-assets. Unless regulators ban cryptocurrency exchanges entirely, the crypto-trading market may soon become the preserve of large “compliant” exchanges (and a number of banned exchanges and individuals in jail).
- Warnings and statements. Staying on top of this evolving, digital market will mean prioritisation by regulators on distribution channels and on those instruments which are either fraudulent, false or misleading or which domestic investors are most exposed to. Expect there to be increased investor and consumer warnings by regulators and national authorities.
- Core principles to align policies: Will we see core principles establish, like we have seen for AI regulation? In its October 2018 report the FSB sets out its metrics used for monitoring financial stability in crypto-markets. AML/CTF standards are likely to remain the policy priority across FSB jurisdictions, but the metrics may help to align the varying policy decisions elsewhere. A "live" framework of broad principles from which to road test more innovation regulation seems the obvious next step for the regulators.
This article was written by Jenni Polson, Trainee Solicitor.
For more information or regulatory advice speak to our team of international regulatory experts below.