Last week two important reports were published in the crypto-assets space, the New York State Office of the Attorney General’s report on Virtual Markets Integrity (“VMI Report”) and the UK Parliamentary Treasury Committee report on Crypto-assets (“UK Report”). There are some common themes in the reports which are useful to consider when seeking to understand the regulatory concerns on both sides of the Atlantic and the approach of leading jurisdictions to this market.
- Both reports highlight concerns with activities in the crypto-assets market from the perspective of (i) consumer protection and (ii) market/institutional risk. There are clearly similar issues floating to the surface in both jurisdictions as crypto-assets become embedded in the trading environment in these advanced financial markets. The reports each note the expansion of crypto-trading activities and increasing retail and institutional interest with the VMI report stating: “no longer the exclusive province of tech-savvy hobbyists and traders, virtual currency now appeals to Wall Street firms and “mom-and-pop” retail investors”.
- Key risk topics highlighted across both reports include platform security, outages, volatility, lack of transparency in general (including around fees), market manipulation and insider trading and general potential for serious abuses such as money laundering and fraud. The UK Report notes, “on account of their volatility alone, crypto-assets are especially risky, particularly for inexperienced retail investors” and goes on to reference crypto exchange security deficiencies, market abuse and lack of effective AML controls as giving rise to major concerns. The VMI Report targets issues at a number of levels, on the one hand referencing the word “fraud” or “fraudulent” over ten times, and on a more granular level discussing particular issues with the trading systems being offered, as exchanges develop more professional products and services, which enable experienced traders to “power sophisticated automated trading strategies – strategies that can negatively affect the trading performance of everyday, non-automated customers.” Clear attention is being placed around these themes in both markets for future regulatory focus.
- As might be expected given the genesis of each report, they take a positive view towards more regulation and stringent regulatory enforcement, expressed in the UK Report with the statement that “the introduction of regulation could lead to positive outcomes for the crypto-asset market” and within the VMI Report it was noted that certain non-respondent exchanges had been reported to the Department of Financial Services for potential violations of New York’s virtual currency regulations. Neither report gives much attention to self-regulatory initiatives, with the UK Report in particular expressing the view that “the Committee is aware of the establishment of self-regulating bodies… [H]owever, as these standards are wholly voluntary, there are inevitably firms ignoring them… self-regulation is clearly insufficient.”
- There is a clear sense in both reports that the effectiveness of existing regulation is in question – the UK Report takes the view that US regulation is more “advanced” than the UK regime, calling for the UK to “bring investor protections in line with those in the United States”. It highlights gaps in the FCA’s remit around ICOs, regulation of cryptocurrency exchanges, anti-money laundering requirements and market abuse regulation. The VMI Report is also clearly highlighting on-going consumer protection and market abuse issues, despite New York virtual currency licensing regulations that are already in place. Both reports lean towards additional centralized regulatory measures, however interestingly, the UK Report does reference proportionality in this context and alludes to the UK as being well-placed to become a global centre for this activity in the right circumstances. Given London’s financial trading history and standing, there is a sense of importance that this may be a sector where the UK can distinguish itself, in particular in a post-Brexit world.
- Finally, the international nature of activity in this space is clearly posing challenges to governments and regulators on all sides. The VMI Report discusses issues that can arise where crypto exchange platforms are established in other international jurisdictions, including variances in approaches to licensing, transparency, insolvency and KYC/AML amongst others. The lack of meaning of where service providers are “located” in this context, the ease and speed with which they can move, together with an absence of proper information in a number of cases, is clearly causing a high degree of regulatory anxiety due to real limitations on the control that can be exerted. The UK Report compares the regulatory approach at a high level around the world and notes that with UK regulation being in its infancy, it can learn from experiences of others. Some steps have already been taken in this regard, including on-going international communication at a high level on the regulatory front and the adoption of the global sandbox (GFIN) as an international regulatory learning tool, but the suggestion here is that more needs to be done. Looking at the bigger picture, the overriding issue, that “given that crypto-assets can be created and traded anywhere in the world, the regulatory response to certain risks will only have limited success if other jurisdictions adopt a different approach” is very clearly stated, with the current situation leaving open a number of opportunities for regulatory opportunism which a combination of political will and market forces are likely to eventually fill.