What has happened?

The UK financial regulator has published feedback on its consultation on distributed ledger technology (DLT), revealing it is taking a technology-neutral approach to regulation and that it plans further scrutiny of initial coin offerings (ICOs).

What does this mean?

The Financial Conduct Authority (FCA) has said it will gather more evidence on ICOs and conduct a "deeper examination" into the rapid developments in this sector.

The findings should help determine whether further regulatory action is necessary beyond the consumer warning the FCA issued in September.

The feedback paper does not, however, mention how long this evidence-finding exercise will take or how it will be conducted.

Earlier this year, the FCA issued a discussion paper, seeking stakeholder views on the regulatory implications of current and potential for developments of DLT in the financial markets.

The regulator received 47 responses from a range of market participants, including regulated firms, national and international trade associations, technology providers, law firms and consultancies.

John Salmon, partner in Hogan Lovells' FinTech team, said:

"In general, the FCA has made a welcome intervention into the debate on regulation of DLT. It has made it clear that it is perfectly sensible for regulated firms to use DLT but also that the rules will still apply. It has also acknowledged that due to the global nature of DLT international co-operation will be required."

The FCA said respondents expressed "particular support" for it maintaining its 'technology-neutral' approach to regulation and welcomed the FCA’s approach to new technology, including its sandbox and RegTech initiatives.

John Salmon said:

"Firms looking to implement DLT solutions should be encouraged by the FCA's statement. It is clear that it is maintaining its technology-neutral approach and is alive to the benefits of DLT networks as a whole. This position can be contrasted with the position put forward by Gibraltar's Ministry for Commerce, which proposes to regulate all DLT businesses. Awareness of the risks involved in use cases like ICOs and digital currency contracts for difference are still at the forefront of the FCA's regulatory lens and firms aiming to leverage these use cases should be particularly aware of this."

The feedback also suggested that current FCA rules are flexible enough to accommodate the use of DLT by regulated firms, and no changes were proposed to specific rules.

Many respondents suggested the DLT could deliver regulatory requirements more efficiently than current systems, substantially reducing costs for firms and regulators.

The FCA therefore plans to continue to monitor DLT-related developments, and keep its rules and guidance under review in light of these developments.

Some respondents doubted the compatibility of permissionless networks (which allow general public visibility of transactions online and are open for broad participation, compared to permissioned networks which typically feature a ‘gatekeeper’ who controls access) with the FCA's regulatory regime.

However, the FCA stated that it is overall open to all forms of deployment, permissioned and permissionless, as long as the operation risks are properly identified and mitigated.

John Salmon added:

"The aspect which might surprise readers of the statement is the comment on the use of permissionless DLT. The FCA makes it clear that it does not consider the use of permissionless or public blockchain to be incompatible with its regulatory regime or its outsourcing rules. However, it does make it clear that the normal rules of assessing the risk and carrying out due diligence should apply. It goes on to say that due to the senior managers regime, regulated firms should consider the roles and responsibilities in the DLT, which may prove to be a challenge in practice."

The regulator also plans to collaborate with industry and other regulatory authorities to ensure a co-ordinated approach towards DLT in the UK, as well as with national and international regulators to shape regulatory developments and standards.

In September, the FCA issued a consumer warning about the "very high-risk" and "speculative" nature of ICOs.

It cautioned investors about the potential for fraud, lack of investor protection, price volatility and the risk of losing all the invested capital, among other risks.

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