The following article was first published by Law360 on July 11, 2023.
The International Organization of Securities Commissions, or IOSCO, released a consultation report in May titled "Policy Recommendations for Crypto Markets and Digital Assets."1
The consultation aims to establish a clear and strong international foundation for international regulation and cooperation regarding cryptocurrencies and digital assets to address market integrity and investor protection risks in crypto asset markets.
This article looks at IOSCO's proposals and considers whether more can be done.
The question
Cryptocurrencies and other digital assets have proliferated in recent years, encouraging expert and novice investors to speculate in highly volatile and uncertain markets.
Due to the speed at which these new markets have been established, regulators have struggled to establish robust frameworks to protect investors.
This regulatory lag has been exploited by criminals involved in fraud and money laundering and has led to high levels of exposure and risk for investors trading legitimate crypto assets.
Digital asset trading is, by its nature, a cross-border concern. Without effective coordination between states, even well-designed regulations are easily circumvented.
Such coordination is hampered by states that are unwilling to engage in international solutions and states that are engaged in nefarious conduct in the cryptosphere.
The recommendations
IOSCO's goal is to finalize its recommendations by the end of 2023. Thereafter, it will be up to individual jurisdictions to ensure that their regulatory frameworks meet the minimum standards set out therein.
IOSCO's general recommendation is that regulatory frameworks addressing digital assets should seek to achieve regulatory outcomes for investor protection and market integrity that are equivalent to those required in traditional financial markets, to facilitate a level playing field between crypto assets and traditional markets.
The consultation establishes 18 recommendations that are grouped into six categories, as follows.
Conflicts of interest
Recommendations within this category focus on risks arising from vertically integrated crypto-asset trading platform business models. Many crypto asset service providers provide multiple services within a single platform, including exchange trading, brokerage, and property trading.
The recommendations seek to ensure that effective structures are in place to mitigate conflicts of interest, including the possibility of requiring disclosure and separate registration.
The recommendations also seek to address conflicts of interest that arise from the listing and trading of crypto assets by requiring crypto asset service providers to provide accurate and sufficient information to the market about the asset and its issuer to facilitate informed decision making by From the market. Participants.
Market manipulation, insider trading and fraud
Financial crime risks in the cryptocurrency sector are high, driven by:
- Lack of effective market surveillance;
- Manipulative marketing practices such as Ponzi-style schemes;
- pumping and discharge schemes;
- Wash-trading and front running;
- Insider trading and unlawful disclosure of inside information; and
- Fraudulent, misleading or insufficient disclosure.
To address these risks, the consultation recommends establishing effective systems and controls to identify and monitor manipulative market practices and to prevent the leakage of inside information.
Fighting cryptocurrency-related financial crime will also require increased cross-border intelligence and cooperation between regulatory and law enforcement authorities.
Cross-border risks and regulatory cooperation
This last point feeds into recommendations on how participating states should adopt best practices in international cooperation to help ensure effective supervision and enforcement, and to reduce the risk of money laundering.
Many crypto asset service providers are immature market participants and have not developed a robust enough approach to regulatory compliance, meaning investor protection and market integrity issues will persist without coordinated international regulatory action to address them.
IOSCO's recommendations seek to improve existing approaches to market conduct regulation, as well as existing information-sharing tools for supervision and enforcement to address these risks.
Custody and Protection of Client Assets
The recommendations seek to safeguard client funds and assets and provide clients with clear, concise and non-technical disclosures of associated risks, to ensure that client money is held and transferred securely, avoiding inappropriate asset mixing and other possible abuses.
Operational and Technological Risk
Crypto asset service providers will need to meet certain minimum standards related to operational and technological risk and resilience. They will be required to disclose all material sources of risk and have appropriate risk management frameworks in place to manage and mitigate them.
Retail access, suitability and distribution
The promotion of crypto assets is under-regulated and crypto asset service providers often employ aggressive tactics to target retail investors who promise high returns without sufficient warning and guidance on the risks involved.
The recommendation seeks to ensure that regulations require crypto asset service providers to diligently screen and only bring on board sufficiently sophisticated retail investors who understand and are suited to the heightened speculative risks inherent in the crypto market.
New Rules of the Financial Conduct Authority
In the UK, steps are already being taken to improve regulation around the trading of crypto assets following the implementation of the Financial Services and Markets (Financial Promotion) (Amendment) Act 2000 Order 2023, which came into force on June 7 and that brings the promotion of qualified crypto assets within the scope of the FCA.
Following this amendment, the FCA issued a policy statement on June 8, announcing new advertising rules that will come into effect from early October.2
Under the new rules, the promotion of crypto assets will generally be limited to communication by persons authorized by or approved by the FCA.
Promotions that violate these rules may be sanctioned with an unlimited fine or up to two years in prison.
Analysis
Crypto asset regulation has inevitably struggled to keep up with the pace of market innovation. Improved regulation will not only benefit retail investors by protecting them against the risk of financial crime, but will also allow legitimate market participants to positively distinguish themselves from less scrupulous participants seeking to exploit legal loopholes.
The IOSCO recommendations are a valuable first step in the quest to close the proverbial barn door, but the onus will fall on individual states and trade groups to ensure they meet the standards the recommendations seek to set.
Whether this will be enough to check those who continue to benefit from weaknesses in the regulatory environment remains to be seen, particularly given the comparative sophistication of the crime at stake.
1https://www.iosco.org/library/pubdocs/pdf/IOSCOPD734.pdf.
2https://www.fca.org.uk/publication/policy/ps23-6.pdf.
