UK Crypto Regulation – Cryptoasset Exchange And Custodian Wallet Providers Now Required To Report On Suspected Sanctions Breaches – Fin Tech

The UK authorities are taking further steps to bring crypto
businesses within the regulatory perimeter. As of 30 August 2022,
cryptoasset exchange and custodian wallet providers are required to
comply with the reporting obligations implemented by the Office of
Financial Sanctions Implementation
(“OFSI“). Crypto firms are now required
to inform OFSI as soon as practicable if they know or reasonably
suspect a person is subject to sanctions or has committed an
offence under financial sanctions regulations. Breach of a
financial sanction is a criminal offence in the UK, punishable by
up to seven years in prison and/or a monetary penalty.

This development is highly significant as there have been
concerns that Russia may be using cryptoassets and exchanges to
evade the financial sanctions imposed following its invasion of
Ukraine by the UK, the United States, the European Union, Canada
and Japan. UK action mirrors recent steps taken by the Biden
administration. In August, the US Office of Foreign Assets Control
imposed sanctions on a cryptoasset ‘mixing
service’ that allegedly has laundered over US$ 7 billion over
the past three years and follows an executive order signed earlier this year that
enhanced the US government’s ability to restrict the use of
cryptoassets in illicit finance.

Given the tragic human cost of the ongoing conflict in the
Ukraine and the intensity of governmental, media and regulatory
focus on financial sanctions, it seems highly likely that the
crypto sector will be targeted for further investigation and
enforcement by authorities on both sides of the Atlantic. Crypto
businesses with a connection to the UK (including branches) should
ensure that they have the appropriate systems and controls to
comply with these new requirements.

The Regulations

On 19 July 2022, the UK Government laid before Parliament both
The Sanctions (EU Exit) (Miscellaneous Amendments)
Regulations 2022 and The Sanctions (EU Exit) (Miscellaneous Amendments)
(No. 2) Regulations 2022 (together, the “Amending
Regulations
“) which amended the reporting obligations
set out in legislation enacting various sanctions regimes,
including Russia, Iran and Syria.

These Amending Regulations came fully into force on 30 August
2022. Should cryptoasset exchange or custodian wallet providers
fail to adhere to adhere to the requirements, they will likely be
committing a criminal offence. Under the rules, relevant firms must
immediately act if they suspect that one of their customers is
subject to sanctions or if they suspect a breach of sanctions.

A relevant firm is under an obligation to inform OFSI as soon as
practicable if it knows, or has reasonable cause to suspect, that a
person (i) is a designated person, or (ii) has committed an offence
under financial sanctions regulations, where that information is
received in the course of carrying out their business.

The Amending Regulations have defined a cryptoasset exchange as
a firm or sole practitioner that by way of business
provides one or more of the following services, including where the
firm or sole practitioner does so as creator or issuer of any of
the cryptoassets involved—

  • exchanging, or arranging or making arrangements with a view
    to the exchange of, cryptoassets for money or money for
    cryptoassets,

  • exchanging, or arranging or making arrangements with a view
    to the exchange of, one cryptoasset for another, or

  • operating a machine which utilises automated processes to
    exchange cryptoassets for money or money for
    cryptoassets”.

A custodian wallet provider has been defined by the Amending
Regulations as “a firm or sole practitioner that by way of
business provides services to safeguard, or to safeguard and
administer—

  • cryptoassets on behalf of its customers, or

  • private cryptographic keys on behalf of its customers in
    order to hold, store and transfer cryptoassets”.

Penalties

Breaches of financial sanctions are a serious criminal offence
in the UK. OFSI can respond to a potential breach of financial
sanctions in several ways, depending on the facts of the case. OFSI
has a range of responses at its disposal, including: (i) issuing a
warning, (ii) referring regulated professionals or bodies to their
relevant professional body or regulator in order to improve their
compliance with financial sanctions, (iii) publishing information
pertaining to a breach even where no monetary penalty is imposed,
if this is in the public interest, (iv) imposing a monetary
penalty, and (v) referring the case to law enforcement agencies for
criminal investigation and potential prosecution.

The most serious offences relating to the principal prohibitions
under UK financial sanctions carry a maximum sentence of seven
years’ imprisonment. Financial penalties may also apply ranging
from 50% of the total breach up to £1 million –
whichever is the greater value. OFSI guidance (linked below)
explicitly states voluntarily disclosure of the breach will likely
result in a reduction in the penalty given.

Since June 2022, OFSI has also been able to issue monetary
penalties for breaches of financial sanctions on a strict liability
basis. The Economic Crime (Transparency and Enforcement) Act 2022
lowered the threshold for the imposition of a civil monetary
penalty. For further detail on this development, please see our
memo titled Sanctions Watch UK Authority Outlines Powers to
Impose Strict Liability Civil Penalties.

In addition to financial penalties, is always important to
consider the significant reputational damage that may be caused by
the negative publicity resulting from sanctions breaches. Any
enforcement action will likely be published by OFSI and the
business media.

Details of recent enforcement actions taken by OFSI are
published on the UK government website.

On 6 September 2022, the Director of OFSI announced plans to double the agency’s
headcount by April 2023 with particular focus on enforcement and
intelligence. This development is likely to herald increased
enforcement activity as the agency expands its resources to better
investigate potential sanctions breaches.

Guidance

The recently updated general guidance for financial sanctions
states that both cryptoasset exchange and custodian wallet
providers fall under the remit of the Sanctions and Anti-Money
Laundering Act 2018 as “relevant firms“.
Cryptoassets are also explicitly included in the non-exhaustive
list of examples of “funds and economic
resources
“.

All individuals and legal entities who are within or undertake
activities within the UK’s territory must comply with UK
financial sanctions. Furthermore, All UK nationals and legal
entities established under UK law, including their branches, must
also comply with the UK financial sanctions, irrespective of where
their activities take place.

In order to assist with compliance, OFSI maintains two lists of
those subject to financial sanctions. The first is the consolidated list of asset freeze targets,
which sets out individuals, entities and ships subject to sanctions
known as “designated persons“. The second list
is of persons named in relation to financial and
investment restrictions. Persons contained in the second list
may also appear in the consolidated list.

Increased UK regulation of the crypto sector – a clear
trend

Since January 2020, the Financial Conduct Authority
(“FCA“) has been the anti-money
laundering and counter-terrorist financing supervisor of UK
cryptoasset businesses under the Money Laundering, Terrorist
Financing and Transfer of Funds (Information on the Payer)
Regulations 2017 (as amended, the
MLRs“). All cryptoasset businesses
carrying out cryptoasset activities within the scope of the MLRs in
the UK must be registered and compliant with the FCA. Businesses
that are already registered or authorised with the FCA for other
activities are further required to register with the FCA if they
are carrying on relevant cryptoasset activities.

In August 2022, the FCA published new rules relating to marketing of
high-risk investment to consumers. This follows a consultation
earlier in the year on how best to strengthen the UK’s
financial promotion rules for high-risk investments, including
cryptoassets. These rules do not however, currently apply to
cryptoasset promotions as crypto marketing is not currently within
the FCA’s remit. In January 2022, the Treasury confirmed its
intention to legislate to bring certain cryptoassets into the scope
of the financial promotion regime. Once this has been resolved, the
FCA expect to regulate crypto marketing and “follow the
same approach as those for other high-risk
investments
“.

These developments are consistent with the trend of increasing
regulatory oversight into the cryptoasset sector. It is highly
likely that the UK will see further restrictions and obligations
put in place to bring cryptoasset regulation more into line with
other regulated markets such as the financial services sector.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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