Blockchain under UK legislation and regulation?
By William Garner, partner in Financial Services & Funds
at Charles Russell Speechlys
It is impossible to have any discussion involving Fintech
these days, without the possibilities offered by blockchain technology popping
up somewhere in the conversation.
The race is on to turn blockchain technology from a system
allowing a small number of anonymous participants to deliver small quantities
of crypto-currencies to each other, into a viable means of delivery and
settlement for financial instruments. Alongside this, we need to think
about the legal and regulatory implications of using this new technology, which
is emerging into a legal and regulatory environment developed to deal with a
very different world – one that contemplated a centralised ledger and a
monopolistic settlement process. The central concepts of a distributed
ledger and potentially open access are at odds with established systems and it
is going to be difficult to reconcile them with the current regulatory
landscape.
The legal issues surrounding the use of a system using
blockchain technology that is governed by English law are generally
positive. It is highly likely that the English Courts would fall back on
the considerable body of legislation and case law in determining the validity
of a commitment made, confirmed or settled through a blockchain process and the
consequences of any failure in that process. It should therefore be
possible to design a system using blockchain technology governed by English law
that could be used to create or confirm legally binding obligations, pay or
transfer money, or validly transfer title to financial instruments and other
assets.
The regulatory position is very different; the application
of regulation to any settlement or delivery system using blockchain technology
turns on the financial instruments being committed or settled through the
system and its functionality. Most post-trade activities are outside the
scope of regulation and there are many suggested uses for blockchain technology
that would most likely not require any regulatory approvals. Take for
example, collateral management: here it would be possible to envisage a
blockchain system established between a closed and defined user group such as a
broker and its clients, which could be used to manage margin that (due to the
efficiencies of blockchain technology) could pay and release margin virtually
in real-time. Such an arrangement is unlikely to require any regulatory
approval.
Nevertheless, to realise the full potential of blockchain
technology in clearing and settlement, it would need to be deployed on a mass
scale and as that would inevitably make such a system systemically important. This alone would attract the attention of the regulators. The most
obvious potential uses for blockchain technology would be in connection with
the settlement of transactions in financial instruments. Settlement is not
a regulated concept, but operating as a central counterparty or clearing house
is, and would therefore require the operator of the blockchain system to seek
exemption under the Financial Services and Markets Act 2000. The point at
which the operator of the system would need to seek exemption would depend on
the nature of the financial instruments being settled through it and the
functionality of the system.
Even if the operation of a system using blockchain
technology did not require the operator to be recognised as a central
counterparty or clearing house, they may well be undertaking a range of
activities that would bring them within the scope of regulation. One of
the most basic potential uses for blockchain technology is its use as a
mechanism for making payments (as it currently does with
crypto-currencies). Any system being used to facilitate payments is
potentially within the scope of the Payment Services Directive (the Payment
Services Regulations 2009, in the UK) and anyone making payments through use of
a blockchain system to transfer cash would likely need to be authorised as some
form of payment services provider. If the operator of the blockchain
system was at any point providing liquidity into that system, they would
need to carefully consider whether they were undertaking the regulated activity
of issuing electronic money.
Any blockchain system being used to create or confirm
commitments relating to the sale and purchase of financial instruments may well
fall within the scope of a trading system, and therefore require regulation as
a Multilateral Trading Facility or Systematic Internaliser. If it also
went on to settle those commitments, the operator could well be involved in the
regulated activity of sending dematerialised instructions.
Probably the most significant regulatory challenge for any system employing blockchain technology is the clearing requirement imposed by the Markets in Financial Instruments Directive and European Market Infrastructure Regulation, which impose an obligation on participants to transactions in various financial instruments to submit those transactions to clearing. Therefore unless (and until) these regulations are modified to allow the use of systems employing blockchain technology, the opportunities offered by it will unfortunately remain limited.
Found this useful?
Take a complimentary trial of the FOW Marketing Intelligence Platform – the comprehensive source of news and analysis across the buy- and sell- side.
Gain access to:
- A single source of in-depth news, insight and analysis across Asset Management, Securities Finance, Custody, Fund Services and Derivatives
- Our interactive database, optimized to enable you to summarise data and build graphs outlining market activity
- Exclusive whitepapers, supplements and industry analysis curated and published by Futures & Options World
- Breaking news, daily and weekly alerts on the markets most relevant to you