Recommendation 5

HM Government Accepted in Part

HM Treasury recognises that there are significant risks and consumer harms associated with today’s cryptoasset markets. As noted in response to earlier recommendations, that is why decisive action has been taken through the introduction of AML-CTF regime for cryptoassets, new legislation to regulate cryptoasset promotions and legislating as part of the Financial Services and Markets Bill to enable the regulation of stablecoins and cryptoassets within the financial service framework. On 1 February 2023 HMT also published a comprehensive consultation with wide-ranging proposals to further mitigate cryptoasset risks, including a draft framework for issuance disclosures, market abuse and core cryptoasset activities such as operating a cryptoasset trading platform and custodying cryptoassets. This also includes robust measures to ensure consumers understand the, often high, risks involved when making investment decisions to mitigate the ‘halo effect’ risk described in the Committee’s report. Taken together, this would create an extensive and powerful set of tools and measures for the FCA to mitigate consumer risks and ensure that individual investors are much better informed when it comes to trading decisions in all types of cryptoassets. With this in mind, the Government firmly disagrees with the Committee’s recommendation that “the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service”. The recent failure of FTX has informed the UK’s proposed approach towards protecting UK consumers. Initial findings and statements regarding the causes of this event point towards (i) the commingling of customer and firm assets, (ii) a lack of transaction documentation, (iii) inadequate information controls and cybersecurity, (iv) unmanaged conflicts of interest between the main trading platform and the proprietary trading arm (v) lack of financial and risk management capabilities (vi) deficiencies in corporate governance and (vii) excessive leverage. A system of gambling regulation, in isolation, would be unlikely to address these risk factors. It would also not be equipped to deal with insider dealing, market manipulation, predatory short selling and many other behaviours which can manifest themselves in both cryptoasset markets as well as traditional financial services markets. The Gambling Commission has a strong track record of safeguarding consumers and the wider public by ensuring gambling is safe and fair. However, overseeing financial risks, which are akin to those which exist within financial markets, is not within the mandate or field of expertise of the Gambling Commission. The cryptoasset industry is highly globalised and often borderless in nature. UK consumers currently can access products and services provided by overseas firms or applications and protocols without a clear geographic nexus. If the UK were to unilaterally adopt a system which is out of step with approaches taken globally, this could push cryptoasset activity offshore, reducing the UK’s opportunity to make it safer and capitalise on the potential benefits, while leaving consumers exposed to residual risks. The Committee’s recommendation would also not be consistent with the recommendations of the FSB and international standard-setting bodies, including the BCBS4, CPMI5 and IOSCO. The UK adopting a regulatory framework that is consistent with international standards and guidance will help provide clarity for consumers and firms, and guard against fragmentation and regulatory arbitrage. As such, HM Treasury agrees with the Committee on the pressing need for robust and timely regulation. However, the recommendation to rely on gambling regulation would represent a fundamental departure from the Government’s intended approach which reflects recommendations from global standard-setting bodies and has been carefully designed and calibrated with input from domestic regulators and international peers.