Why UK Financial Firms Might Fall Behind the Crypto and AI Trends

Where is the regulation?

Revolutionary technologies such as crypto and artificial intelligence (AI) have posed new challenges for regulators in terms of bringing them into line without stifling innovation, while protecting the interests of market participants.

Some jurisdictions are further along than others in their regulatory journeys. The European Union for example, is spearheading the regulatory response to crypto and AI. The Markets in Cryptoassets Regulation (MiCA), which enters into force in December 2024, is the first set of comprehensive regulatory rules tailored specifically for cryptoassets, while the EU AI Act boasts a similar title for the regulation of AI technologies. In fact, EU Parliament voted to pass the EU AI Act yesterday and it is likely to apply from 2026 (more on this to follow). Details on the EU AI Act can be found here.

The UK, however, is further behind the EU, but is nevertheless devising its own regulatory agendas for crypto and AI. In fact, recent news stories has given some indication about how these could evolve.

This week, the Financial Conduct Authority (FCA) approved the launch of Bitcoin and Ethereum-backed exchange-traded notes (ETNs) for professional investors, including investment firms. ETNs are a type of debt security that tracks an underlying index of securities and trades on a major exchange in the way that a share does. The FCA originally banned crypto ETNs in 2021 due to the inherent risk associated with cryptoassets, so this change in stance reflects a greater level of acceptance toward crypto as an asset class. The ETNs will not be made available to retail investors.

In addition, the UK Government released a consultation paper last month that will seek to bring all cryptoasset service providers under the purview of the FCA. Currently, cryptoasset firms are only ‘partly’ registered with the FCA, for money laundering regulations (MLRs), and are not subject entirely to FCA regulations, including the Financial Services and Markets Act (2000). Therefore, they only need to comply with a narrow set of rules in order to achieve compliance. This makes regulation procedures for these types of firms relatively straight forward to manage.

However, the UK government is currently considering bringing cryptoassets fully under wider financial services regulation, making them subject to FCA oversight through the Financial Services and Markets Bill (2023). This will create a more cohesive and functional UK crypto regulatory environment. If the bill passes, which appears very likely given it has been passed in the House of Commons, this would require significant changes for cryptoasset firms in terms of how they operate to ensure compliance with FCA regulations. In many ways, the passing of this bill could enable a unified, transparent crypto regulatory framework in the UK to flourish, drawing parallels to the EU’s MiCA framework.

In terms of AI regulation, the UK’s progress is rather more laboured and light-touch compared to other jurisdictions, with UK Prime Minister Rishi Sunak favouring this approach. There is currently no legally binding, AI-specific regulations in the UK, with regulatory oversight for AI often integrated into other existing forms of legislation. For example, in the UK, data breaches or discriminatory decisions from AI models may lead to a financial firm breaching the Equality Act (2010).

Last month, the UK government adopted a non-binding framework for regulating AI, underpinned by five core principles. These are safety, security and robustness, appropriate transparency and explainability, fairness, accountability and governance, and contestability and redress.

15 UK regulators, including the FCA, will implement the frameworks in their respective sectors and publish their ‘annual AI strategic regulatory plans’ by 30 April 2024, exercising non-statutory powers to address sector-specific AI risks and challenges.

Given the UK’s tendency to make tweaks to existing frameworks to accommodate new trends, it is unlikely that the UK will implement its own specialist AI framework in the way that the EU has. This could leave financial firms in the UK with a lack of clarity, which could leave them lagging behind other jurisdictions in terms of realising their full AI potential.

Although the UK is giving regulatory consideration to revolutionary technology trends such as crypto and AI, a more practical, hands on approach is arguably needed to provide the foundations for both trends to flourish, not only in the capital markets space, but the entire economy.