UK authorities are taking further steps to bring crypto businesses into the regulatory perimeter. As of August 30, 2022, crypto-asset exchange and custodial wallet providers are required to comply with reporting requirements implemented by the Office of Financial Sanctions Implementation (“OFSI”). Crypto firms are now required to notify the OFSI as soon as possible if they know or reasonably suspect that someone is subject to sanctions or has committed an offense under financial sanctions regulations. Failure to comply with a financial penalty is a criminal offense in the UK, punishable by up to seven years in prison and/or a monetary penalty.
This development is very significant as there are fears that Russia is using crypto-assets and exchanges to evade financial sanctions imposed following its invasion of Ukraine by the UK, US, Russia. European Union, Canada and Japan. The UK action reflects recent moves by the Biden administration. In August, the US Office of Foreign Assets Control penalties imposed over a crypto-asset “mixing service” that allegedly laundered more than US$7 billion over the past three years and follows a Executive Decree signed earlier this year that strengthened the ability of the US government to restrict the use of crypto-assets in illicit finance.
Given the tragic human cost of the ongoing conflict in Ukraine and the intensity of government, media, and regulatory attention on financial sanctions, it seems highly likely that the crypto sector will be targeted for further investigation and investigation. enforced by authorities on both sides of the Atlantic. . Crypto businesses with a connection to the UK (including branches) should ensure they have the appropriate systems and controls in place to comply with these new requirements.
On July 19, 2022, the British government tabled in Parliament the two Sanctions (Leaving the EU) (Miscellaneous Amendments) Regulations 2022 and Sanctions (Leaving the EU) (Miscellaneous Amendments) Regulations 2022 (No. 2) (together, the “Amending Regulation”) which amended reporting requirements set out in legislation enacting various sanctions regimes, including Russia, Iran and Syria.
This amending regulation came into full effect on August 30, 2022. If providers of crypto-asset exchanges or custodial wallets do not comply with the requirements, they are likely committing a criminal offense. Under the rules, affected companies must act immediately if they suspect that one of their customers is subject to sanctions or if they suspect a violation of sanctions.
A relevant business is required to inform the OFSI as soon as possible if it knows, or has reasonable grounds to suspect, that a person (i) is a designated person, or (ii) has committed an offense under the regulations on financial sanctions, when this information is received in the exercise of their activities.
The Amending Regulations defined a crypto-asset exchange as “a firm or sole practitioner who, in a professional capacity, provides one or more of the following services, including when the firm or sole practitioner does so as the creator or issuer of one of the crypto-assets concerned:
exchanging, or arranging or arranging for the exchange of crypto-assets for cash or cash for crypto-assets,
exchange, arrange or arrange for the exchange of one crypto-asset for another, or
operate a machine that uses automated processes to exchange crypto-assets for cash or cash for crypto-assets”.
A custodial wallet provider was defined by the amending regulations as “a business or independent practitioner who, in a professional capacity, provides services to protect, or to protect and administer—
crypto-assets on behalf of its clients, or
private cryptographic keys on behalf of its clients in order to hold, store and transfer crypto-assets”.
Failure to comply with financial penalties is a serious criminal offense in the UK. The OFSI can respond to a potential violation of financial sanctions in several ways, depending on the facts of the case. The OFSI has a range of responses, including: (i) issuing a warning, (ii) directing regulated professionals or bodies to their competent professional body or regulator in order to improve their compliance with financial sanctions, (iii) publishing information regarding an offense even when no monetary penalty is imposed, if it is in the public interest, (iv) by imposing a monetary penalty, and (v) by referring the matter to law enforcement for a criminal investigation and possible prosecution.
The most serious offenses relating to the main prohibitions in the UK financial sanctions carry a maximum sentence of seven years in prison. Financial penalties may also apply, ranging from 50% of the total breach up to £1 million, whichever is higher. The OFSI guidelines (link below) explicitly state that voluntary disclosure of the violation will likely result in a reduced penalty.
Since June 2022, the OFSI has also been able to impose pecuniary sanctions in the event of non-compliance with financial sanctions on the basis of strict liability. The Economic Crimes (Transparency and Enforcement) Act 2022 lowered the threshold for imposing a civil monetary penalty. For more details on this development, please see our note entitled Sanctions Watch UK Authority Outlines Powers to Impose Strict Liability Civil Sanalties.
In addition to financial sanctions, it is always important to consider the significant reputational damage that can be caused by negative publicity resulting from sanctions violations. Any enforcement action will likely be published by the OFSI and the trade media.
Details of recent enforcement action taken by OFSI are published on the UK Government website.
On September 6, 2022, the director of the OFSI announcement plans to double the agency’s workforce by April 2023, with a particular focus on law enforcement and intelligence. This development is likely to herald increased enforcement activity as the agency expands its resources to better investigate potential sanctions violations.
The recently updated general guidelines for financial sanctions states that crypto-asset exchange and custodial wallet providers fall under the mandate of the Anti-Money Laundering and Sanctions Act 2018 because “companies concerned”. Crypto-assets are also explicitly included in the non-exhaustive list of examples of “funds and economic resources”.
All natural and legal persons located or carrying out activities in the UK must comply with UK financial sanctions. In addition, all UK nationals and legal persons incorporated under UK law, including their branchesmust also comply with UK financial sanctions regardless of where they operate.
To assist with compliance, the OFSI maintains two lists of persons subject to financial sanctions. The first is the consolidated list of asset freezing objectiveswhich lists the persons, entities and vessels subject to sanctions known as “designated persons”. The second list is persons named in connection with financial and investment restrictions. Persons on the second list may also be on the consolidated list.
Increase in UK regulation of the crypto industry – a clear trend
Since January 2020, the Financial Conduct Authority (“CIF“) was the Anti-Money Laundering and Terrorist Financing Supervisor of UK crypto-asset businesses under the Money Laundering, Terrorist Financing and Transfer of Funds Regulations 2017 ( payer information) (as amended, the “MLR”). All crypto-asset businesses conducting crypto-asset business under MLRs in the UK must be FCA registered and compliant. Firms that are already registered or authorized with the FCA for other activities are additionally required to register with the FCA if they engage in relevant crypto-asset activities.
In August 2022, CAF published new rules on the marketing of high-risk investments 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 crypto-assets. These rules make not however, currently apply to crypto-asset promotions, as crypto marketing is currently outside the purview of the FCA. In January 2022, the Treasury confirmed its intention to legislate to bring certain crypto-assets within the scope of the financial promotion regime. Once this is resolved, the FCA expects to regulate crypto marketing and “follow the same approach as for other high-risk investments”.
These developments are consistent with the trend of increasing regulatory oversight in the crypto-asset sector. It is highly likely that the UK will see new restrictions and obligations put in place to further align crypto-asset regulation with other regulated markets such as the financial services sector.
© Copyright 2022 Cadwalader, Wickersham & Taft LLPNational Law Review, Volume XII, Number 251