What are the consequences of UK and European regulatory divergence on crypto ETPs?

Regulators across Europe allowing crypto ETPs to be launched

Jamie Gordon

a red pin on a map

Cryptocurrency exchange-traded product (ETP) issuers warn the UK’s steadfast approach to regulating digital assets is increasingly at odds with the European mainland – a disparity with potential financial and economic consequences.

Last October, the Financial Conduct Authority (FCA) set out its hardline stance by banning UK retail investment in crypto ETNs and warning those that put money into digital assets should prepare to “lose all their money”.

Then in June, the regulator doubled down by banning popular crypto exchange Binance from conducting regulated activity in the UK.

Supporting the FCA’s suspicion of crypto investments, Laith Khalaf, financial analyst at AJ Bell, highlighted how some investors were engaging in risky behaviours.

Not only are crypto assets highly volatile, Khalaf noted, but 14% of UK retail investors with crypto exposure had borrowed money to finance their investments.

“Around one in five crypto buyers said they were driven by FOMO which is never a good motivation for financial decisions,” Khalaf said. “A similar proportion said they were buying crypto instead of shares or other investments, which suggests some consumers are leapfrogging traditional assets which can help to build long-term wealth.”

While noting the risks associated with the burgeoning asset class, regulators on the European mainland have taken a different stance, choosing to loosen restrictions to allow digital asset investment to proliferate at a pace they set.

For some time, crypto ETP issuers have chosen to set up shop in Switzerland while German venues have become an established hotspot for ETP listings.

Earlier this month, Luxembourg’s financial regulator authorised a subsidiary of Azimut to manage funds investing in crypto assets. From next month, German regulator, BaFin, will expand the range of investments open to institutional funds to include crypto assets – up to a cap of 20% of their respective assets.

Protecting retail investors

Bradley Duke, co-founder and CEO of ETC Group, a crypto ETP issuer, noted BaFin’s “pragmatic” approach to digital asset regulation. 

Duke said owning a physically-backed, unleveraged crypto product is about as close as an investor can get to owning an underlying crypto asset. This is evidenced on some of ETC Group’s own products, that offer physical delivery, which BaFin treats the same as gold ETCs or underlying crypto assets themselves in taxation terms – meaning no capital gains tax is paid if an asset is held for more than a year.

“With an ETP, investors do not have to think about private and public key encryption, losing those keys and managing a wallet which can put you in danger of losing your money,” Duke added. “An ETP structure allows somebody to buy and sell and then everything gets stored and all the complexity gets handled by the broker and the issuer further upstream.”

Despite acting to protect retail investors’ best interests, Duke said the FCA’s move to prevent retail access to crypto ETPs leaves them less protected and left to fend for themselves with direct investments on exchanges.

“These exchanges themselves are either unregulated or not regulated nearly in the same way to the same extent as the Deutsche Boerse or the London Stock Exchange where there are decades of regulation that prevents market abuse,” Duke said.

Laurent Kssis, managing director at 21Shares, added: “According to a recent research conducted by the FCA, retail crypto ownership moved from 3.9% to 4.4% and that will have been from direct investments in crypto assets via what could be (up to now) unregulated venues or intermediaries.”

Because of the block on retail entry, Duke argued the uptake of crypto ETPs to be “considerably lower” for some time as large asset managers also face obstacles.

“For the large asset managers, they are often investing on behalf of pension funds and ultimately there is a retail investor there,” Duke continued. “So, this is an asset class that is going to be unavailable in pension funds.”

A source of irony for issuers and external commentators alike is while the FCA points to crypto assets’ volatility as a justification for its tough stance, it seems to take less issue with retail investors having access to leveraged ETPs, CFDs and trackers for commodities such as lumber, softs and oil.

Competitive disadvantage

Another point to note on the UK’s regulatory tangent are its potential political and economic implications.

Given the touch-and-go discussion of financial equivalence between the UK and EU post-Brexit, the UK’s direction on crypto regulation puts it at odds with many EU member states – and not a direction that offers financial advantage.

From a neutral perspective, Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, said the UK’s approach to crypto regulation adds another layer of competitive disadvantage with trading activity already moving to venues other than London due to Brexit.

Kssis added: “Blocking crypto ETPs to a UK retail audience is not a wise move now that the UK is out of the EU and we are seeing an increase in European exchanges accelerating their admissions program to include crypto ETPs on their regulated venues.

“I would not be surprised if Italy, Scandinavian markets and some eastern European exchanges are next to admit more crypto ETPs. This is inevitable and the market has been longing for this.”

Duke said another consideration are the jobs provided by new crypto businesses in the US, Europe and some parts of Asia.

“These new companies will not want to open up shop in the UK if they feel that there is a regulator with an unfavourable view of the asset class and ultimately, there will be hundreds if not thousands of jobs that will go elsewhere – whether it is Germany or the Netherlands or Sweden or Switzerland,” Duke continued.

Regarding recent listings by ETC Group and 21Shares on the Aquis Multilateral Trading Facility (MFT) – which means crypto ETPs have been listed in London for the first time via a Swiss clearing house – this may have been companies taking advantage of a loophole with more symbolic than strategic significance.

Looking ahead, Psarofagis said he sees some opportunity for the UK and crypto ETP roll-out but added there is sense in adopting a cautious approach.

“There is a big opportunity not even compared to the rest of Europe but versus the US and the Securities and Exchange Commission (SEC),” Psarofagis continued. “They have been so slow to approve and if the SEC approve before the FCA I think that is the death knell from an optics standpoint.

“On the flip side, I like the cautious approach. They know an ETF functions fine but it is more of a suitability issue. In the US, for example, does the market really need 15 bitcoin ETFs? Probably not.”

Further reading


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