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

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

Last October, the Financial Conduct Authority (FCA) expressed its firm position in banning UK retail investments in crypto ETNs and warning those who invest in digital assets to prepare to ‘lose all their money’ .

Then, in June, the regulator doubled down by banning the popular crypto exchange Binance from carrying out regulated activities in the UK.

Supporting the FCA’s suspicions of crypto investments, Laith Khalaf, financial analyst at AJ Bell, highlighted how some investors engage in risky behavior.

Not only are crypto assets very volatile, Khalaf noted, but 14% of UK retail investors exposed to crypto had borrowed money to fund their investments.

“About one in five crypto buyers said they were motivated by FOMO, which is never a good motivation for financial decisions,” Khalaf said. “A similar proportion said they were buying crypto instead of stocks or other investments, suggesting that some consumers are moving beyond traditional assets that can help build long-term wealth.”

While noting the risks associated with the burgeoning asset class, regulators in mainland Europe have taken a different stance, choosing to ease restrictions to allow investments in digital assets to proliferate at the pace. that they fixed.

For some time, ETP crypto issuers have chosen to locate in Switzerland, while German sites have become an established hotspot for ETP listings.

Earlier this month, the Luxembourg financial regulator authorized a subsidiary of Azimut to manage funds investing in crypto assets. Starting 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.

Protect retail investors

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

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

“With an ETP, investors don’t have to think about encrypting private and public keys, losing those keys, and managing a wallet that can put you in danger of losing your money,” Duke added. . “An ETP structure allows someone to buy and sell, then everything is stored and all the complexity is handled by the broker and the issuer further upstream.”

Although he acted to protect the best interests of retail investors, Duke said the FCA’s decision to block retail access to crypto ETPs left them less protected and left to fend for themselves with investments. direct on the stock exchanges.

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

Laurent Kssis, Managing Director of 21Shares, added: “According to recent research conducted by the FCA, retail cryptocurrency ownership has increased from 3.9% to 4.4% and that will have been direct investments in crypto assets through what may (so far) be unregulated venues or intermediaries.

Due to the blocking of entry into retail, Duke argued that the adoption of crypto ETPs was “considerably lower” for a while, as large asset managers face hurdles as well.

“For large asset managers, they often invest on behalf of pension funds and, at the end of the day, 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 is that while the FCA cites the volatility of crypto assets as the justification for its firm stance, it appears to pose less of a problem for retail investors with access to ETPs, CFDs and effect trackers. leverage for raw materials such as lumber, softwood and oil.

Competitive disadvantage

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

Given the direct discussion of financial equivalency between the UK and the EU after Brexit, the UK’s focus on crypto regulation puts it at odds with many EU member states – and not an orientation which offers a financial advantage.

From a neutral standpoint, 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 shifting. to sites 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 outside the EU and we are seeing an increase in European exchanges speeding up their admission program to include crypto ETPs on their regulated sites.

“I wouldn’t be surprised if Italy, the Scandinavian markets and some Eastern European exchanges are next to admit more crypto ETPs. It is inevitable and the market has been waiting for it for a long time.

Duke said another consideration was the jobs provided by new crypto companies in the United States, Europe and parts of Asia.

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

As for the recent listings of ETC Group and 21Shares on the Aquis Multilateral Trading System (MFT) – which means that the crypto ETPs were first listed in London through a Swiss clearinghouse – it s Perhaps it was companies taking advantage of a loophole with more symbolic values. as strategic importance.

Looking ahead, Psarofagis said he sees an opportunity for the UK and ETP crypto rollout, but added that it makes sense to take a cautious approach.

“There is a big opportunity not even against the rest of Europe but against the United States and the Securities and Exchange Commission (SEC),” Psarofagis continued. “They’ve been so slow to approve and if the SEC approves before the FCA, I think it’s the end of the line from an optical point of view.

“On the other hand, I like the cautious approach. They know that an ETF works well, but it is more a question of adequacy. In the United States, for example, does the market really need 15 bitcoin ETFs? Probably not.”

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