The UK Financial Conduct Authority (FCA) has issued its Policy Statement PS23/11 (PS) which provides guidance on trading. Companies need an FCA trading venue license if they are in what is known as a "multilateral system" (see "Unpacking the Definition of a Multilateral System" for our definition and discussion). The definition of a multilateral system is the focus of this guide.
Inclusion in the definition of a multilateral system determines whether a trading venue must be authorized by the FCA. Further classification of a trading venue as a regulated market, multilateral trading facility or organized trading facility, depending on the nature and scope of the activity as well as the type of financial instrument, determines how the trading venue is regulated.
The guidance, which takes the form of new questions and answers in the FCA Edge Guidance module of the FCA Rules and Guidance Handbook, will come into force on 9 October 2023.
Breaking down the definition of a multilateral system, the FCA recognizes the general distinction between providers/technology solutions providers and trading venue operators, with only the latter requiring trading venue approval. Providers/providers of fintech technology solutions should welcome this recognition, although additional regulatory analysis is required when engaging in other regulated activities.
Since the multilateral system is by definition limited to financial instruments, the PS and Guidelines do not apply to crypto assets not classified as financial instruments. Future Financial Services Regulatory Regimes for Crypto Assets Questions about the future financial services regulatory regime for crypto assets (see our alert 'Trading in Crypto Assets and Services in and UK: Changing Regulatory Areas' for more information), HM Treasury ( HMT ) indicated that crypto Subsequent rules for trading venues for assets will be based on the Regulations for Trading Venues. This guide also provides an interesting explanation of Decentralized Finance (DeFi), which HMT advises on.
The PS and the Guide declare, among other things, that:
- A crowdfunding platform is not a multilateral scheme if the corporate funding interests of the issuer of the securities disclosed in that issuer's offering are aligned with those of the investor.
- A bulletin board, such as one used to announce or post a business interest, or to categorize or summarize potential contracts, will not be a multilateral system unless the business interests within the system can interact.
- An investment manager's internal matching system is not a multilateral system unless there is a direct link between the system's internal matching and the portfolios it manages.
Breaking the definition of the multilateral system
The FCA currently defines a multilateral system as a system or facility through which multiple third parties who have a business interest in buying and selling financial instruments can communicate within the system, taking the definition from EU law. This guideline identifies the following key elements of a multilateral system:
- It features a trading system or facility .
- These are various purchases and sales of third party business interests .
- It allows commercial interests to interact within the system .
- Business interest in a financial instrument .
This guide goes into detail about each of these components. The following should be mentioned:
- Trading systems or facilities include markets that consist of a set of rules and a trading platform, as well as those that have only one set of rules. These rules may be reflected in contracts and/or operational procedures. A system for this purpose is therefore technology-neutral.
Therefore, common communication systems such as websites and chat rooms are not commercial arrangements or facilities. - Some third party providers may be systems where two people trade with each other on the system. This does not make the system bilateral rather than multilateral. What matters is whether the system can allow interaction with many other people (besides the operator) at one person's access point.
- Interactions between systems occur when the system is aligned with the business interests of the system or enables a user to act on the business interests of other users of the system, including communicating, negotiating, or agreeing to significant terms of transactions. .
- Financial instruments include instruments such as stocks, bonds, options and swaps, but exclude instruments such as spot currencies and, as discussed below, currently "unregulated" crypto assets such as Bitcoin.
Good news for technology providers?
PS is useful because the FCA claims that its order management system and execution management system are "inevitably" multilateral systems. As mentioned above, the FCA also recognizes the general differences between technology solution providers/providers and trading venue operators, with only the latter requiring trading venue authorisation. The guidelines clearly state that operating the platform requires more than just providing technology or software.
The FCA's amendments to its guidance on the definition of multilateral systems further reflect this by referring to "providers" of general purpose communications systems and "providers" of websites as opposed to "operators" of multilateral systems. .
The role of compensation in determining whether the company is trapped
More generally, the factors determining the existence or non-existence of a trading system include the determinants of the trader's reward and are related to the interaction of trading interests in the system's financial instruments.
This suggests that the way the technology is paid for reflects the company's role with the technology: whether the remuneration paid to the company is related to the volume and/or size of the transaction, for example in the form of a commission, indicates that the company is an operator of a multilateral system and not a provider. . Technology used in the system. Of course, the scope definition needs to be examined on a case-by-case basis.
Are the activities of technology providers regulated as "service companies"?
In its guidance, the FCA points out that by making technology available to operators or users of multilateral schemes, providers may engage in regulated activities, particularly the regulated activity of entering into investment transaction arrangements.
Therefore, the FCA is emphasizing its regulation of service providers and the FCA has made a number of technical changes to this regulation through the PS. The utility regime is intended to be a simpler and more personalized regulatory regime for market participants providing order routing, post-trade processing and similar services that help them manage their investments or regulate (ie execute) transactions in investments between them.
A service firm is an organization whose activities are limited to the brokerage of investment transactions and which agrees to conduct regulated activities. Their regulatory approval should be limited to transactions involving "professional clients" and "eligible employees" and by definition should exclude retail client services.
See where you can trade cryptocurrencies
As noted above, the PS does not discuss where crypto assets should be traded, stating that crypto assets "such as Bitcoin and other currently 'unregulated' non-financial instrument crypto assets" fall outside the scope of a multilateral system's definition.
However, Her Majesty's Treasury, Advice on the Future Financial Regime for Crypto Assets in "Future Regulatory Regime for Financial Services for Crypto Assets" sets out the proposed regulatory approach for venues trading crypto assets and notes that Her Majesty's Treasury Department is a pre-authorised department. Want to create a regulatory framework. It is currently based on the activities of regulated trading venues.
Accordingly, the PS and Guidance should be relevant when considering the type of technology to be classified as future crypto asset trading venues and regulated under the UK crypto asset regulatory regime.
Crypto and DeFi advice
One aspect to consider is the impact of the guidelines on DeFi, which HMT Crypto Consulting uses as an umbrella term for financial services provided without the use of traditional financial intermediaries.
In this context, cryptocurrencies use the description of smart contracts as sets of hard-coded, open-source rules that automatically execute and record transactions on the blockchain when certain parameters are met, noting that smart contracts are immutable once implemented. , which allows the equil. - Transactions between peers without central decision-making by intermediaries.
Similarly, the EU Commission regulates crypto assets within the EU market framework (see our alerts "Crypto Asset Trading in and Between Europe: MiCAR, EU's New Unified Crypto Code" and "Doing Crypto Business in Europe: MiCAR, EU's New Unified Crypto Code) “New, Part 2”), which will produce a report on DeFi evaluations by the end of 2024, involves a request for evidence rather than identifying a set of regulatory findings on HMT crypto questions.
Nevertheless, there is evidence of HMT preference in the crypto question. In this context, HMT acknowledges the spectrum of decentralization among current DeFi offerings and states that their goal is not to control software development activities, but as a software development system for regulated financial activities, for maintenance, administration and operations (for example, exchanges or loans), then They must be subject to financial services regulations.
Impact of the guidelines on DeFi?
HMT's comments on DeFi bring you back to the guide to what a multilateral system means and to that end the characteristics of a trading system or facility, and the aforementioned words that running a platform requires more than just deploying technology. . or software. The FCA statements in the guidelines that, among other things, check that (a) the system is designed to allow any type of transaction between users; and (b) system-related awards relating to the interaction of business interests in the financial instruments of the system may indicate that the FCA intends to treat the DeFi offering as a multilateral system and the DeFi provider as a trader because there is no one else, such as a trading venue operator, who fulfills this role. .
In this case, the HMT may not be concerned with whether a DeFi provider should be regulated - cryptocurrencies suggest that this is the HMT's choice. Rather, HMT's problem is how to manage DFI providers. A proportionate approach must be adopted that avoids imposing appropriate regulatory burdens on DeFi providers on trading venue operators when that burden is not justified regardless of the trading functionality provided by the provider's solution. HMT's exploration of DeFi-specific regulated activities in cryptocurrency, such as "establishing or maintaining logs" as part of a bespoke regime for DeFi providers, has become increasingly important in light of these policies.
[See source.]