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Payments & FinTech Lawyer

UK FCA to continue to monitor DLT without immediate regulatory change following consultation with industry

The UK’s Financial Conduct Authority (‘FCA’) published on 15 December 2017 its feedback statement on Distributed Ledger Technology (‘Feedback Statement’), following its Discussion Paper on distributed ledger technology (‘DLT’) of April 2017, which sought to create a dialogue with industry on the development of DLT in the markets the FCA regulates and DLT’s impact on financial services (‘Discussion Paper’). The Feedback Statement comments on the responses received as a result of the Discussion Paper, and the FCA highlights that, among other things, it has received support for its ‘technology-neutral’ stance and that respondents felt that the current rules can accommodate DLT use by regulated firms, without changes being required. As a result, the FCA is to continue to monitor developments in this area without further regulation at present.

“It is tempting to be frustrated when a regulator doesn’t provide clear and firm guidance as to what can be done and what can’t, but I think the FCA is right to approach DLT in a measured way, first understanding what its potential benefits and risks are, then weighing those against its objectives and developing market trends, and then judging whether its existing framework of regulation can adequately accommodate the challenges and focussing on the areas where there are particular reasons why it might need to change,” said Hannah Meakin, Partner at Norton Rose Fulbright. “The market would undoubtedly be annoyed if the FCA came out with a new package of rules that were not sufficiently flexible to accommodate the nature of the technology and its potential. I think we all need to accept that the regulatory approach to DLT is going to be a developing one, in a way that reflects the technology itself and its increasingly apparent versatility.”

Respondents to the Discussion Paper welcomed engagement by the regulator with innovators for example through the FCA’s Innovate initiatives, while there were calls for the FCA to further increase its international cooperation, given the global nature of DLT. An area of concern for some respondents however involved whether permissionless networks, i.e. those that allow the general public visibility of transactions - as opposed to those networks featuring a gatekeeper with control of access - are compatible with the FCA’s current rules. While acknowledging respondents’ concerns, the FCA at present does not plan to prohibit any deployment of DLT, “provided the operational risks are properly identified and mitigated.” “This is perhaps one of the areas where I was a bit surprised by the FCA’s apparent tolerance,” comments Imogen Garner, also a Partner at Norton Rose Fulbright. “That said, the FCA makes a good point that use of a DLT (or any other) system doesn’t necessarily equate to outsourcing. It is not clear whether, when the FCA says that it didn’t discern any fundamental incompatibilities with the FCA rules in the two examples it cites, that is because the FCA didn’t consider those firms to be outsourcing, or whether they managed to comply with the outsourcing rules. We certainly think permissioned systems lend themselves more readily to some aspects of the outsourcing rules but that is not to say that compliance in respect of a permissionless system is not possible.”

“We share the view of the FCA that a permissionless network is not fundamentally incompatible with the UK regulatory regime,” comments Lee Bacon, Partner at Clyde & Co. “We certainly see advantages in a permissioned or private network, certainly for large commercial matters, but recognise that public or permissionless systems represent the most likely way of scaling the advantages of DLT. The development of tools to complement the use of permissionless networks, such as Zero Knowledge Proofs and other methods of ring-fencing information, are in their infancy but will offer a solution to the need to mitigate operational risks.”

With regard to Initial Coin Offerings (‘ICOs’), the FCA is looking to gather further evidence with a view to deciding if further regulatory action is needed. Its Feedback Statement includes a discussion of regulatory considerations in respect of ICOs, following the FCA’s ‘Consumer warning’ on ICOs, published on 12 September 2017.

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