They are looking in the wrong place

Written by Ben Mason, Founder, My Compliance Centre

Arguably the biggest regulatory scandal since the credit crunch cost UK consumers £237m and has resulted in a significant tightening of the regulatory regime for firms that were already compliant. Ben Mason argues that the authorities are looking in the wrong place. Failures outside of the regulated sector are costing much more than those within it.

£237m.  $9bn.  $33bn.  £130bn.  Remember these numbers. 

They all relate to financial services disasters – direct losses to investors and consumers. Just two of them relate to crypto. 

The mystery is why the UK authorities have acted so aggressively in response to the smallest of these failures but appear to be doing next to nothing about the bigger ones, over an extended period of time.

The Biggest Regulatory Scandal Since The Credit Crunch?

A balanced evaluation of the various UK regulatory scandals since the credit crunch would probably see London Capital and Finance (LCF) come out ‘top’. This is not because of the amounts involved, but because of the handwringing and actions that followed the scandal. 

LCF sold unregulated mini-bonds to unsuspecting investors, marketing them as ISAs and using its cover as a regulated firm to make the mini-bonds look authentic. £237m was lost by investors when it turned out that the money was used to fund associated companies and not put to proper investment use.

Dame Gloster was appointed to investigate the scandal and concluded that the regulator had failed in its duties in numerous ways.  The fallout has been a significant – and at times throttling for regulated firms. There has been a significant tightening of the FCA’s risk appetite, with innovative firms finding it much more difficult to get authorised and regulated firms having to live with a more intrusive regulator. Life has become really tough for the ‘good guys’, with the perennial problem that firms that want to comply and do the right thing face crippling compliance costs compared to those that take a different path.

That all sounds like a big deal – so what is my point? 

£237m is Small Fry

Devastating though it was for those that lost money, the £237m lost in the LCF scandal is microscopic compared to some of the failures in the crypto market in 2022. 

FTX, the cryptoasset exchange, hit the front pages in the Autumn when it lost $9bn of customers money. A staggering amount.  However, Chainalysis highlight that this is far from the biggest crypto scandal of 2022. 

The depegging of Terra’s UST token realised losses for investors of $20 billion. The collapse of Celsius and Three Arrows Capital (3AC) caused a mountainous $33 billion investor loss, all of which dwarves the damage done by the FTX scandal.  And you do not have to dig too much further to discover many other crypto failures, scandals and scams which have delivered additional huge losses to investors. The famous Mt. Gox theft and scandal was as far back as 2014. This is not new.

The FTX fiasco reads like an incredibly long list of schoolboy-esque failures of internal systems and controls. I don’t believe this scale of failure would happen in any normal UK regulated firm (without deliberate fraud); I also don’t believe that the people responsible would get authorised in the UK. All of this would lead to the conclusion that this is why FTX were based off-shore: to duck on-shore regulation. But, in fact, FTX’s primary business activities are still not regulated in the UK specifically or in a number of other of major jurisdictions.

Analysis by Chainalysis also highlights that it is ordinary investors and consumers who have been losing money, albeit from around the world and not necessarily UK based. But, with over 2m people in the UK owning cryptoassets, each global failure will have an impact here as well. A properly regulated local cryptoasset industry would help address this specific risk – that risk being that consumers lose huge quantities of money due to terrible corporate governance within their service provider, which proper regulation would fix to a large degree. 

The danger that we could have a failure of significant scale in the UK still exists and is not mitigated by regulation at the moment.

Why should the UK act?  And why has it not to date?

Let’s be clear on the current position: the UK already regulates trading in all derivatives, including cryptoasset derivatives. It also requires crypto firms to register under the Money Laundering Regulations and applies a much more stringent approval process then it might otherwise do to those applying for this registration. (At the point of writing, 41 crypto firms are registered under the Money Laundering Regulations, of which 12 were registered in 2022.)

And some further actions are now underway: a government enquiry into crypto has been ongoing for a few months; Stablecoins are to be regulated within the Payments regulatory framework and the promotion of cryptoassets is to be regulated in 2023. 

What is ‘surprising’, however, is that the basic activities of dealing in cryptoassets and the associated safeguarding of them, are only likely to be the subject of a future consultation – there are no concrete plans as yet. All of the consumer and market safeguards that would come with such regulation are to be further delayed. 

The other surprise about the current government enquiry is that the Treasury Select Committee has already carried out an expensive enquiry into cryptoassets in 2018, that looks incredibly similar to the one currently underway. Its recommendations were crystal clear. 

This is what the Rt Hon. Nicky Morgan MP, Chair of the Treasury Committee, said on 19th September 2018:

‘Bitcoin and other crypto-assets exist in the Wild West industry of crypto-assets. This unregulated industry leaves investors facing numerous risks.

Given the high price volatility, the hacking vulnerability of exchanges and the potential role in money laundering, the Treasury Committee strongly believes that regulation should be introduced.

It's unsustainable for the Government and regulators to bumble along issuing feeble warnings to potential investors yet refrain from acting.

At a minimum, regulation should address consumer protection and anti-money laundering. If the Government decides that crypto-asset growth should be encouraged, appropriate and proportionate regulation could see the UK become a global centre for this activity.’

That was over 4 years ago. What could be clearer? 

I am at a total loss. Given the scale of crypto failures, and the panic that sets in when there is a regulatory failure in the UK with a much less severe financial consequence, why are the British authorities not terrified that they might end up with a major, major failure on their hands, that dwarfs LCF and makes them look incompetent?  Particularly when the Select Committee has made such a clear recommendation previously. 

Surely, it is time to act decisively?

You mentioned £130bn but have not explained it. Where did that come from?

Having said all of the above, there are greater thefts, frauds and scandals still. 

Richard Lloyd, as interim Chair of the FCA, stated that fraud costs the country ‘over £130bn a year’ and laments the massive under resourcing from the authorities into preventing it and begs the authorities to legislate and resource anti-fraud measures effectively.  £130bn a year. Just incredible. 

(By comparison, ‘just’ £88bn is laundered in the UK every year, making fraud a worse problem if viewed purely from a financial perspective.)

Overall, I question whether the measures the authorities take in aggregate are truly proportionate to the risks the country faces and the damage done when these risks are not adequately addressed. The damage done outside the regulatory system dwarves the damage done inside it. 

For more information, please contact Ben Mason at [email protected]

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