Crypto View - March 2023

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Well, it is time to dig out a jumper, find my waterproof, and return to London - my time in Dubai has come to an end. What has struck me most about Dubai, and the region more generally, is an optimism about the cryptoasset industry that it is possiblto forget when looking at the news coming out of other jurisdictions - the US and UK in particular (more on that below). It has been a difficult month for financial services and banking, which has spilled over into the FinTech and crypto sectors, and this issue looks at the fallout from the SVB, Signature and Silvergate collapses. We also look at how this has impacted banks' relationships with the cryptoasset industry, and a ratcheting up of regulatory intervention towards the cryptoasset industry in the US. The much heralded amendment to the UK's financial promotion regime has been laid before parliament, the first step on the path to bringing cryptoassets more firmly under the powers of the FCA. On the subject of financial promotions, Belgium has also introduced new legislation governing the marketing of cryptoassets. Finally we take a look at the developments in tokenisation, and the DLT Pilot Regime.

Banking and Crypto

The news of the failure of Silicon Valley Bank (SVB) in both the US and the UK, as well as Silvergate and Signature Bank in the US, and the subsequent fallout has dominated the headlines over the last month. Both Signature and Silvergate were two of the most crypto-friendly banks in the US, while SVB was the bank of choice for start-ups, with many in the FinTech space (including VC funds that invested in crypto businesses and some cryptoasset firms). Perhaps the most visible example of this was USDC losing its peg for a period as it become apparent that it held USD3.3 billion with SVB. Thankfully Circle were able to restore the peg, helped by the US Treasury Department, Federal Reserve and Federal Deposit Insurance Corporation (FDIC) confirming that all deposits would be protected. We looked into the SVB developments in more detail here, and have a dedicated team looking at this who you can contact here.  

The collapses have left US crypto firms with fewer places to bank. It was notable that Signature Bank, which first had its deposits and most assets transferred to a bridge bank operated by the FDIC, was ultimately sold by the FDIC to Flagstar Bank, but depositors related to the digital banking business were not transferred. These depositors are encouraged to move their deposits before the 05 April, though there will certainly be fewer banks willing to take these. The same was the case for First Citizens Bank that agreed to purchase SVB, with the purchase agreement ensuring that cryptocurrencies and loans backed by crypto were excluded from the deal.

A similar reluctance to bank the crypto sector - both crypto firms, as well as retail customers who want to invest in cryptoassets - is apparent in the UK.  According to CryptoUK's members (full disclosure: Simmons is an executive member), blanket bans and restrictions of transfers have been put in place by UK banks in relation to cryptoasset platforms. There is little from a legal perspective that can stop banks from choosing who its customers are, and indeed where they can transfer their money. It is ultimately a commercial decision. However, it does seem rather paternalistic for a bank to determine what a customer can and cannot spend their money on, where not prohibited by law. It may be the case that banks are feeling pressure from regulators, to be restricting customers this way, though this should arguably be made more transparent if this is the case.  Any such UK regulatory pressure would in our view be going against the messaging from HMT and the government's aims of making the UK a place to do business in relation to cryptoassets.

Developments in the US

Perhaps linked to the banking failures, and regulatory concern with the industry, we saw US regulators (both the SEC and CFTC) continue their approach of regulating through enforcement. Coinbase confirmed that the SEC had issued it a Wells' Notice in relation to its staking service, certain listed cryptoassets, and other products and services. This is not a formal enforcement, but could well be the precursor to one. A Coinbase blog post says it intends to defend itself.  It will be interesting to see if this does indeed end up in court - we may then get some actual clarity on the US securities regime as it relates to cryptoassets. A few days later, we had the CFTC file a civil enforcement action, charging Changpeng Zhao (CZ) and three entities that operate the Binance platform with violations of the Commodity Exchange Act (CEA) and CFTC regulations. The relief sought here is penal, and includes personal prohibitions on trading commodities in the US, disgorgement of all profits, revenues, and salaries related to the activities, and a rescinding of all contracts and agreements between Binance and its customers in the US. Binance have responded to these allegations with a blog post from CZ. We shall see what the impact will be on the markets more broadly, but it does seem that there is a concerted effort by US regulators to bear down on the crypto industry.

FCA Registration woes

Regulators being unfavourable to the industry is definitely an emerging theme. The FCA has said on numerous occasions that it seeks to work with firms to help them become registered, and it has this month (3 years after introducing the registration requirement) launched a pair of webpages with some guidance as to the process of registering as well as feedback on what makes good and bad applications. However, the FCA does seem to take great pride in the number of applications that it refuses or encourages to withdraw (74%), or are rejected (11%), and we are still seeing a pretty reluctant approach to firms going through the process - with the FCA encouraging withdrawal of applications before asking any questions which may resolve an issue on a number of occasions. We do hope that the FCA, with its announced increase to its resourcing will begin working more with firms to confirm what it needs for a successful application as it has said that it does.

UK Financial Promotion Regime

The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (the Amendment Order) was laid before parliament on 27 March. The Amendment Order implements the proposals laid out by HMT in its consultation response from January 2022, bringing "qualifying cryptoassets" within scope of the Financial Promotion Order (FPO), and so being subject to s.21 FSMA requiring a firm to be authorised in order to issue or approve a financial promotion (the Financial Promotion Restriction). The Amendment Order also amends parts of the Financial Services and Markets Act 2000 (FSMA).

The key points to note are:

• Qualifying cryptoassets have been added to the list of controlled investments
• Qualifying cryptoassets are defined as: "any cryptographically secured digital representation of value or contractual rights that (a) can be transferred, stored or traded electronically, and (b) uses technology supporting the recording or storage of data (which may include distributed ledger technology)". They must also be transferrable and fungible.
• Certain controlled activities have been amended to incorporate qualifying cryptoassets, namely dealing in securities and contractually based investments, arranging deals in investments, managing investments and advising on investments. Notably cryptoasset custody is not included.
• HMT and the FCA had previously confirmed that the high net worth and self-certified sophisticated investor exemptions wouldn't apply to cryptoassets - the Amendment Order also removes the exemption for "associations of high- net worth or sophisticated investors.
• The Amendment Order does introduce a temporary and limited exemption to the Financial Promotion Restriction - allowing cryptoasset businesses that are not authorised but are registered with the FCA under the MLRs to issue their own promotions (they will not be allowed to approve other firm's promotions).

Helpfully, HMT also published a Keeling Schedule to highlight the changes made to FSMA - these largely amend provisions to include registered firms where necessary.

The Amendment Order includes a four month implementation period from when the SI comes into force. Based on the current timeline, it doesn't look as though the Amendment Order will be voted on before 25 May 2023, suggesting the Financial Promotion Restriction will apply to cryptoassets from September. We would note that the Financial Promotion Restriction applies to any financial promotion that is capable of having an effect in the United Kingdom. This is very broad and includes financial promotions from overseas. We would strongly recommend that firms that will be impacted by this get in touch to discuss changes that may need to be made to your approach to marketing in the UK.

Marketing Cryptoassets in Belgium

The Financial Services and Markets Authority (FSMA) of Belgium published a new regulation (in Dutch and French, and the press release, in English, here) this month in relation to the marketing of cryptoassets. The Regulation applies to any person (legal or natural) marketing cryptoassets in Belgium to consumers as part of a regular business activity, or on an occasional basis for remuneration. The Regulation does not apply to the marketing of cryptoassets which are considered investment instruments under Belgian law.

The new Regulation prescribes certain statements which must be included in advertisements for cryptoassets, including warnings, which must be presented in a clear and comprehensible manner. Advertisements for cryptoassets must also adhere to a number of requirements, aimed at ensuring that the information presented to consumers is not misleading or inaccurate, and that the potential risks and benefits can be properly understood. Those advertisements intended to be broadcast as part of a mass campaign (to at least 25,000 consumers) must be notified to the FSMA at least ten days before broadcast.

The regulation will apply to all advertisements from 17 May 2023 and any advertisement that was disseminated prior to this date will have until 17 June 2023 to comply with the above requirements. For more information, please do contact my colleague Martin Carlier.

DLT Pilot Regime

The EU's DLT Pilot Regime launched on 23 March. The DLT Pilot Regime allows operators of market infrastructure to test distributed ledger technology (DLT) in the issuance, trading and settlement of tokenised financial instruments. Firms must apply to the scheme and, if successful, will receive a time-limited authorisation to operate a specific type of DLT market infrastructure. As part of their authorisation, firms may be granted exemptions from certain requirements under MiFID II, MiFIR, and/or CSDR. Those exemptions are critical, and allow firms to experiment with DLT in a manner that is otherwise prohibited or the subject of regulatory ambiguity. We have prepared a client briefing on this which is very helpful.

Related to this, my colleagues Oli Ward and Rosali Pretorius have prepared a publication on Due Diligence and Design considerations when looking at tokenisation. I would encourage you to contact Oli or Rosali if you have any questions on this area.

This month in MiCA

Not much to report on MiCA this month - we still expect publication in April. One thing that we have been hearing is that there seem to be differing views from regulators on the length of the grandfathering periods that will be offered. You may remember that MiCA gives the EEA jurisdictions discretion as to whether to shorten the grandfathering period from the 18 months stated in the regulation. We are interested to see how this will play out in practice when firms who are benefiting from the grandfathering in one jurisdiction are trying to deal with customers in another jurisdiction where MiCA is now in force.