Financial Services and Markets Bill

● Require all statutory CBA Panels to include at least three economic crime experts fully independent from the FCA and PRA.

HM Treasury impact assessments

10. The FSMB in its current form will require the Treasury to undertake impact assessments (IAs) on legislative proposals arising from ‘regulatory sandboxes’. [11] HM Treasury will be required to undertake a full IA prior to the sandbox being established, as well as publish an ex-post analysis on whether the technology and practices tested in the sandbox had been successful (prior to any legislative change). [12]

11. These types of IAs are a vital tool underpinning the policymaking process and ensure that regulatory proposals are properly scrutinised from a number of angles. This helps create a comprehensive understanding of policies’ potential impacts prior to coming into force. The scope of Treasury IAs should be expanded to ensure that all regulatory and legislative proposals include an assessment of any related economic crime risks as an integral consideration.

12. This should be done by updating the government’s Regulatory impact assessment (RIA) template to ensure that an analysis of the economic crime risks is included as part of the evidence base in each assessment. RIAs should be extended to include a standalone ‘ economic crime risks associated with this intervention ’ section based on both quantitative and qualitative indicators. It should also include an assessment of the costs/benefits, and wider impacts as well as establishing how the Treasury intends to monitor and evaluate risks after the regulations come into place. Additionally, when undertaking economic crime IAs the Treasury should be required to consult economic crime experts on a multi-stakeholder basis [13] to ensure the thoroughness and validity of such IAs and to guard against such assessments becoming box-ticking exercises. The Regulatory Policy Committee (RPC) should also seek to engage with economic crime experts to inform its analysis of future Treasury proposals.

Regulation of stablecoins, ‘crypto assets’ and ‘crypto exchanges’

13. The government proposes bringing ‘digital settlement assets’ (DSAs) within the regulatory perimeter [14] - the term DSA has been developed by the government to capture a range of existing and future technology products that can settle payment obligations electronically, can be transferred or stored, and which may use distributed ledger technology (i.e. ‘blockchain’). [15] The government’s initial focus will be on stablecoin products - a type of virtual asset that is designed to be pegged to a fiat currency. [16] HM Treasury will be given powers to establish an FCA authorisation and supervision regime, [17] based on existing regulation of electronic money and payments with the objective of guarding against conduct, prudential and market integrity risks related to DSAs.

14. The FSMB proposals are intended to reflect the recommendations published by the Financial Stability Board (FSB), [18] as well as those published in a joint report by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), [19] in effect assessing the applicability of international standards for financial market infrastructures to stablecoin arrangements. Although the FSB report does address potential frameworks for the management of risks relating to stablecoins, the CPMI and IOSCO report explicitly accepts that its assessment " does not address the consumer and investor protection, cyber security, data privacy, competition, market integrity taxation as well as AntiMoney Laundering/Combating the Financing of Terrorism (AML/CFT) issues related to global stablecoins (GSCs) ." [20]

15. In its 2020 report to G20 Finance Ministers and Central Bank Governors on stablecoins FATF outlined significant risks associated with stablecoins. [21] Such products are often based on public, ‘permissionless decentralised ledgers,’ [22] meaning that in practice, users are able to protect their anonymity causing a significant money laundering risk. Stablecoins’ global reach and potential for mass-adoption additionally poses money laundering risks as a result of services being segmented across jurisdictions resulting in unclear compliance, supervision and enforcement. Stablecoins also provide opportunities for ‘chain-hopping’ - where criminals jump between different cryptocurrencies in rapid succession to obscure their identity and trail. This poses a classic ‘layering’ money laundering risk as users can disguise the source of funds by quickly transferring assets across stablecoins. [23]

16. Efforts up until now to bring cryptoassets within the UK’s regulatory perimeter have been mixed. Under the Fifth Anti-Money Laundering Directive (5MLD), ‘crypto firms’ have been required to register with the FCA and demonstrate they have in place mechanisms to run KYC checks on customers and monitor AML risks. [24] In the last two years, however, only 35 out of 273 (13%) applications for authorisation under the FCA’s money laundering rules have been approved. [25] The FCA’s scepticism of crypto more broadly has resulted in it opening 300 investigations in the last year alone into crypto firms operating in the UK. [26]

17. A recent impact assessment produced by the Home Office on proposed new powers to seize illicit cryptoassets (as part of the Economic Crime and Transparency Bill 2022) warns that " cryptoassets are increasingly used by criminals to move and launder the profits of crimes including drugs, fraud and cybercrime ." [27] At the same time, the Home Office accepts that it " has limited data on the amount of and the impact of illicit behaviour in the crypto ecosystem " and states that " volatility and anonymity of the crypto-ecosystem " creates substantial uncertainty which is worsened by " unregulated or uncooperative cryptoasset service providers ." [28]

18. In January 2021 the government stated that there is a "strong case" for bringing stablecoins into the UK regulatory perimeter for payments. [29] In contrast, and in the wake of the failure of stablecoin Terra, [30] an influential US House of Representatives committee on crypto has announced draft legislation that places a temporary two year moratorium on issuing new coins until the full technical implications of operating a stablecoin pegged to the US dollar are better understood. [31] Under the draft legislation, the US Treasury would be mandated to undertake a technical study on stablecoins in consultation with the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., and the Securities and Exchange Commission before allowing the industry to grow any further in the meantime.

19. To address the dangers posed by stablecoins and other digital asset products, we recommend that the Bill be amended to:

● Ensure the FCA authorisation processes include a comprehensive analysis of any economic crime risks associated with firms and their products prior to granting any authorisation to operate in the UK.

● Require any Treasury decision to bring a DSA service provider within the regulatory perimeter to be accompanied by a full economic crime impact assessment.

Additional recommendations:

Secondary competitiveness objective

20. The draft bill intends to introduce a new secondary objective for the regulators to act in a way which facilitates medium to long-term economic growth and improves the competitiveness of the UK with particular regard for the financial services sector. [32] The bill’s explanatory notes state that the government’s objective is to give a legal basis to the competitiveness objective but without detracting from regulators’ existing obligations to protect UK firms, markets and consumers and ensure healthy competition between firms. [33]

21. Prior to the 2008 financial crisis it was widely believed that " competitiveness " in the financial services industry, and with it the UK’s ability to grow its economy, would be achieved by " lightening the regulatory burden ," " cutting red tape ," and giving industry greater involvement in their own regulation. [34] A 2010 Treasury report concluded, however, that " excessive concern for competitiveness " and acceptance of " light-touch " orthodoxy were key drivers in the regulatory failures that resulted in the crisis. [35] The IMF in its latest UK assessment has warned that a return to policies designed to enhance the competitiveness of the UK’s financial system may endanger its overall financial stability. [36]

22. The World Economic Forum in its 2019 Global Competitiveness ranked the UK as the world’s 9 th most competitive economy (out of 141), citing its maximum 100 score on macroeconomic stability as its main strength, with additional strong results for the UK’s financial system and business dynamism (7th and 9th respectively). [37] Where the UK performs badly on the competitiveness index is on security, and in particular with regard to "organized crime" where the UK is ranked 70th out of 141 countries. [38] Survey results based on interviews with business leaders point to the considerable costs faced by business in dealing with organised crime including economic crime resulting in lower overall competitiveness.

23. This failure to clamp down on organised crime causes considerable costs to the UK and acts as a major blockage to increasing competitiveness. The NCA in its latest national strategic assessment of serious and organised crime argues that serious crimes including fraud, money laundering, bribery, corruption, sanctions evasion and cybercrime inflict damage on the UK’s economy and its institutions. [39] The NCA has additionally stated that money laundering costs the UK £100 billion every year which " results in a loss of confidence in the UK economy. " [40]

24. We recommend that Parliament reformulate the ‘competitiveness objective’ to ensure regulators consider a comprehensive set of indicators including robust economic crime analysis when assessing how future regulatory interventions may affect the ‘competitiveness’ of the UK’s financial services sector.

Independence of the regulators

25. The Bill introduces measures which give the government more influence over regulators such as requiring them to " have regard to" matters specified by the Treasury when they are making rules, and explain how this has influenced their development. In addition, the Bill proposes that regulators respond annually to recommendations made by the Treasury, have a legislative duty to keep their rules under review and publish a statement of policy for how they conduct reviews of rules. [41]

26. The decision to give additional powers to the Treasury contrasts with international studies that have underlined the correlation between regulatory independence and higher performance over the long-term. In its consultation response to the Financial Services Future Regulatory Framework Review published earlier this year, the Treasury cited IMF studies that concluded: " when independent regulators make judgements on the design of regulatory standards, they are likely to deliver more predictable and stable regulatory approaches over time." [42]