Recently The Tokenizer published The Security Token RegRadar Report produced in collaboration with the government of Liechtenstein. As part of the report, we did a series of qualitative interviews with leading legal experts from nine selected countries. In this interview London-based Andy Peterkin, who is a Partner at the law firm Farrer & Co LLP, tells about UK’s regulatory approach towards the emerging security token industry and explains why infrastructure is a major focus area for the UK regulators.
What does the UK history of security tokens look like?
Andy Peterkin (AP): Going back, obviously, the possibilities of this were known and talked about in the first half of the last decade, I suppose, but it’s not really until 2016 or 2017, the regulators start paying attention to it. And the thing that really kicked it off here in the UK was the advent of the regulatory sandbox, which you’ve probably heard about. The FCA’s regulatory sandbox was really the first big one, I think, in a major jurisdiction. And the FCA, in terms of the sandbox, has been slightly ambivalent around tokens. They have allowed in people like Archax, who is an exchange.
They’re not anti token, but what they really want the sandbox to be used for is infrastructure improvements. So they’re interested if you’ve got some way of making it easier to administrate insurance agreements, or you’ve got something that assists investment management compliance, or something like that. They like using it for infrastructure, and I think Archax was able to get in there because they are infrastructure in the sense that they’re an exchange. We found that they are less keen to hear from people who just want to tokenize things.
AP: Well, I think to some extent they take the view, “Well look, we know we can tokenize things, and we’ll come onto this”, and they basically say, “We’ve told you what we think the regulation says about tokens, and security tokens, and other types of tokens. Over to you to make that work. We don’t think there’s anything particularly new under the sun.” But let me pick up the narrative again. So in ’16, ’17, they started the sandbox up. At the same time, Bitcoin was going through its first oscillation, and obviously, it hit the news in a big way. The FCA starts thinking it needs to do something about crypto assets in general, and it needs to decide what the regulation is.
So during 2017, 2018, they’re thinking about what the position should be, and in early 2019, the basic position that they come up with is that, in common with a lot of the other bigger European jurisdictions, they say, “Look, we will just treat security tokens as if they were the security they purport to be. So if you’ve got a token that is equity-like, we’ll treat it as a share. If you’ve got a token that is bond-like, we will treat it as a debt security,” and it follows from that. All the UK regulations around those securities, advising on them, managing them, arranging deals in them, apply.
So whilst, as of the last ten days, it’s wrong to say that that is the MiFID regime; it is the MiFID regime because it’s not diverged yet, and it’s not going to diverge in a major way anytime soon. So that’s basically where we are in terms of regulation.
One thing, of course, that has come about, and again, this will be common across Europe, is that the AML five has extended AML/KYC regulation to token infrastructure. So wallet providers and exchanges are now also regulated.
Is there a possible Brexit angle to this topic? I mean, now that you are on your own, what do you think will happen?
AP: Yes, it’s interesting. I mean, the general feeling here is that certainly around MiFID, the regulation will not diverge quickly because the FCA is after stability and continuity, but of course, it does open up the prospect over time. And no doubt the commission will get round at some point to finalizing their crypto-asset rumblings and consultation papers. It does leave open the possibility that the UK might go and do the same thing on crypto assets.
Is it the MiCA regulation you are thinking about?
AP: Yeah, exactly. So they might go with that, or they might not. And actually, as a jurisdiction, it’s got enough weight to not, if you see what I mean, and to do something interesting and clever around it, because it’s essentially completely new territory if we want to go and make specific regulations for it. So there’s a lot of scope, I think, for them to be creative.
Look, it’s probably just worth touching on a couple of legal points, completely outside the regulation. The first one is there was some doubt as to whether crypto assets are property for the purposes of UK law. There were a bunch of older cases that essentially held that mere information was not property. So the fact that you have written things on a piece of paper does not make the things written on a piece of paper your property. And there’s a slightly strange case where a university student had stolen exam question answers, and this is 1971 or something like that, and essentially it was held that the stuff that was written on the paper was not intellectual property or property.
And there was essentially a concern that that was analogous to a crypto asset held on a blockchain record, but we had a really helpful case called AA and Persons Unknown, which was a Bitcoin theft case, where the court said, “No, we’re very happy that this is property.” So that completely took away that level of uncertainty.
What we haven’t had yet is a case where someone has said, “I’ve got a token that links to a share in an English company. How does the company’s act apply to that?” So the answer is at the moment, we just don’t know.f
We’ve got a lot of clarity on the property point; there’s no problem there; we’re just waiting for the courts to decide exactly how the company’s act applies. My feeling is that they will simply say, “Look, you just treat this as an instrument that references to a share.” And again, we’re not going to try and make the company’s act apply in some weird and unpredictable way; just treat it as a warrant or something like that.
In this context, do you see Brexit primarily as a weakness or a strength for the UK? Because I think it could be both, actually…
AP: Yeah, I think that’s right. I mean, there is the potential of Brexit, as you say, for it to go both ways. Contrary to what some people have said, there is a very little appetite here for massive deregulation. That’s not how the FCA sees London. It sees London very much as a blue-chip jurisdiction with high standards of regulation and high standards of control. It also wants it to be a hub, which means it needs as much access to Europe as it can possibly get. So if we get it right, there’ll be a lot of cross cooperation on regulation. London will do 90% of what the EU does, and hopefully, the 10% that is different will be an improvement. I think that’s the model they’re shooting for, and that will flow across into the token space.
Based on what you just said and what you have answered in the questionnaire, it seems as if you consider the FCA and the government as knowledgeable but not particularly friendly or visionary when it comes to security tokens. And it’s a bit hard for me to understand because I’ve been part of the fintech industry for several years, and mostly I have comprehended that the FCA has had a rather innovative approach towards the fintech space. So to me, it seems a bit strange that they are somewhat reluctant to take the lead in this part of the space as well…
AP: Yeah, absolutely. I think you’re absolutely right there, and I think it’s because of the nature of the UK as a financial services centre. A lot of what we’ve got here is heavy infrastructure if you like. So it’s enormous insurance companies processing millions of insurance contracts every day; it’s huge, huge information flows in and out of investment management. And when it comes to fintech, I get the impression that that is what the FCA, from a strategic perspective, is looking to encourage. So it’s looking really to foster infrastructure improvements.
I wouldn’t want anyone to get the idea that they’re anti tokenization, or anti the token industry, or anything like that, I think it’s just down their list of priorities. They’re more interested in fintech infrastructure, they focus on other things, but they’re not hostile, so long as you comply with the regulation.