Crypto exchanges are about to face revised AML rules in the U.K. Are they ready?

Last month BitMEX, the Seychelles-incorporated crypto derivatives exchange, started flagging an “important notice” on its website for all U.K. visitors.

“HDR Global Trading Limited and its affiliates (the “HDR Group”) are not authorised or regulated by the U.K. Financial Conduct Authority,” the notice declares. “Nothing in this website is intended to constitute the marketing or promotion of HDR’s services.”

A spokesperson for BitMEX (whose parent company is HDR) told The Block that the notice was introduced “to enhance transparency for U.K. residents who visit the BitMEX website.” The spokesperson added: “We are not regulated by the U.K. Financial Conduct Authority. This has always been the case.”

Then what prompted the new notice?

The answer is probably related to a fast-approaching deadline for complying with U.K.’s amended anti-money laundering (AML) rules and a planned measure to bring certain crypto-assets into the scope of the country's financial promotion regulations.

The U.K. implemented the EU’s fifth AML Directive (AMLD5) last year by amending its own AML regime and including crypto businesses. All new and existing crypto businesses, such as exchanges and custodians, have to comply with these rules.

New crypto businesses (those that began operating after January 10, 2020) must be registered with the U.K.’s Financial Conduct Authority (FCA) before engaging in crypto-asset activities. For existing businesses, the final deadline to get registered is January 10, 2021. What's more, these firms have been advised and reminded by the FCA to apply for a “priority review” check by June 30 of this year so they can meet the January deadline.

But are they prepared?

Who is regulated, anyway?

Technically, only exchanges with an office or head office in the U.K. are required to be licensed, according to the FCA’s rules, and that doesn’t include BitMEX. 

But the U.K.’s Budget 2020, the government’s financial roadmap for the year, stated that regulators will look to bring certain crypto-assets within the remit of so-called financial promotions regulation, John Salmon, partner and blockchain leader at London-based law firm Hogan Lovells, told The Block. The government intends to consult on this matter later this year.

Any exchange that lets users engage in “regulated activity” — for example, derivatives trading — and promotes this activity to U.K. customers would need to get licensed too, said Salmon. 

Section 19 of the Financial Services and Markets Act, which took effect in 2000, states that a person must not carry on regulated activities in the U.K. unless they are authorized or exempt, said Salmon. Derivatives are classified as a regulated activity (according to the Regulated Activities Order). 

However, for U.K. regulation to apply, the activity needs to be carried out in the U.K. Generally speaking, the activity is said to be occurring wherever the ‘arranger’ is located. Therefore if the exchange is arranging the deals outside of the U.K., it would not need to be licensed. But should the exchange promote this activity to U.K. customers, it would “fall within [the] scope of financial promotions rules and the exchange would have to be licensed,” Salmon explained. 

That might help explain the additional language in BitMEX’s new notice: By using HDR Group’s services, it says, a customer acknowledges that they are doing so “without solicitation or inducement by HDR Group,” and that they “have the necessary knowledge and experience to understand the risks involved.”

When asked whether BitMEX is planning to get registered with the FCA, the company’s spokesperson declined to comment. Earlier this year, the FCA issued a warning against BitMEX, saying that the exchange is “not authorized” to operate in the country.

FTX founder and CEO Sam Bankman-Fried told The Block that his exchange faces a similar situation in the U.K. as BitMEX does. The exchange is “not actively promoting in the U.K.,” he said.

In March, Deribit co-founder and CEO John Jansen, shared a similar response with The Block: “The only thing Deribit (or any other non-regulated exchange) is not allowed to do is to actively seek clients in the U.K. (actively promote the exchange in the U.K. or to operate from the U.K.). Deribit is not doing this, so there is no problem at all.”

It is not clear whether Deribit has changed its regulatory plans for the U.K. since March. The company declined to comment for this article.

Due to U.S. regulatory constraints, both BitMEX and Deribit block U.S. users on IP addresses, but that is not the case for U.K. users. Jansen recently told The Block: "The U.S. is more aggressive in the sense that their laws state that 'accepting U.S. clients on a non-U.S. regulated platform' can be seen as a crime."

Getting with the program

Meanwhile, major exchanges that do have a presence in the U.K. are preparing to register with the FCA. Obi Nwosu, CEO of U.K.-based crypto exchange Coinfloor, told The Block that getting registered is a “significant” priority for the exchange.

On June 17, Binance also announced that it is launching a regulated trading platform in the U.K. When asked whether the exchange has already received authorization from the FCA, a Binance spokesperson told The Block:

“Binance acquired EddieUK (now Binance Markets Limited - Company number 09510915), an FCA regulated entity and the Change of Control of the entity has been approved by the FCA, and the name change on the FCA register will be made in due course.”

Other high-profile exchanges, such as Coinbase and Kraken, also serve clients in the U.K. Coinbase declined to comment and Kraken didn’t respond to a query by press time.

Earlier this year, the FCA issued a warning against Kraken as well, but it was later removed. Last year, Kraken acquired U.K.-based futures trading platform Crypto Facilities, which is authorized by the FCA.

The Block submitted a query to the FCA via a Freedom of Information Act request and learned that as of June 2, the regulator has received nine applications from existing crypto-asset businesses for a priority review check. It did not reveal the firms’ names.

The consequences

Given the stricter rules, will the U.K. lose crypto businesses?

Earlier this year, we saw some firms shuttering their doors in response to EU’s AMLD5 rules. Most recently, Japan enacted stricter laws for the crypto sector, and in response, BitMEX and Deribit began blocking users from the country. 

“The larger exchanges and custodian wallet providers are likely to comply,” said Salmon. “For smaller firms, the operational costs for compliance may end up being too high to maintain, and they may have to cease operations or move to a jurisdiction that does not apply these rules.”

Diego Ballon Ossio, a senior associate at London-based law firm Clifford Chance — which advises crypto and blockchain firms — shared a similar view. Further, he predicted that the increased compliance cost would lead to consolidation in the industry.

“Some of the very small players in the U.K. market are likely not going to get registration because it's going to be too expensive for them, or they're going to be sucked up into the bigger ones because it's an opportunity for the bigger ones to just get rid of them,” Ballon Ossio said.

Exchanges that seek to attract professional investors will be likely to embrace regulations and get themselves registered, he said. In that market, “having a registration with the FCA is also a little bit like a badge of honor,” said Ballon Ossio.