Ashurst Briefing on the Law Commission's Final Report on Digital Assets

The Law Commission, which recommends reforms to laws in England and Wales, has published its much-anticipated Final Report on Digital Assets. Almost a year after the Commission launched a public consultation on the status of crypto-tokens and other Digital Assets, it has concluded that only limited statutory changes are required to accommodate Digital Assets in the existing legal framework. Although the report makes only four recommendations and states only nine conclusions, it is a ground-breaking paper that will have a significant impact on the development of the legal framework for Digital Assets in England and Wales.

In recent years, there have been a number of cases in common law jurisdictions, addressing the ownership of Digital Assets . One of the seminal questions to be answered by the courts has been whether they constitute a form of personal property. Although it seems obvious – at least, to those trading them – that objects which are traded for value are a species of property because they treat them as such, there have been questions raised about the legal position of Digital Assets by analogy to software and other forms of data. Although protected by intellectual property laws, the intangible nature of the latter has prevented the English courts from allowing claims and remedies based on possession (eg, conversion, where a database has been unfairly retained by a client of the developer). Digital Assets which comprise data objects linked to distributed ledger technology (DLT), such as Bitcoin, have presented a further challenge, because they are designed to be independent of any one person's technical system.

Digital Assets as a "Third" Form of Personal Property

The legal problem has been posed this way: If a digital asset is not capable of possession (because it is an intangible data object), and it does not represent a claim against another person (because it is a data object on a system which exists independently of any possible claims), then how does it fit into the classes of personal property traditionally recognised by English law? 

The answer of the Law Commission is that, rather than trying to stretch the rules of property law to specifically encompass Digital Assets, it would be preferable to recognise them as part of a new, "third" class of personal property. The statements of the courts, to the effect that personal property must either be capable of possession or represent a claim against another person, were made before the creation of Digital Assets based on DLT, but they were not intended to exclude new assets from recognition as a species of property. This is also the conclusion of the UK Jurisdiction Taskforce, which looked at the problem in its landmark 2019 opinion.¹ 

In recent years, courts in various common law jurisdictions have been called upon to make orders with respect to misappropriated Digital Assets. They have consistently recognised Digital Assets as a species of property, to which existing laws and remedies apply, without definitively resolving the philosophical question about the class of property to which they belong. Soft questions about the nature and existence of Digital Assets have not prevented the courts from dealing with hard facts: something of value has been created, satisfying the basic indicators associated with personal property; it has been transferred from one person to another; and judicial action has been required to prevent or address an injustice arising from that transfer. The Law Commission takes account of the flexibility shown in these cases to support treating Digital Assets as a distinct class of personal property.

In the Commission's view, the courts should develop the law of Digital Assets, rather than Parliament. The scale of this undertaking should be self-evident to any law student with a copy of a textbook on, eg, bailment – it has taken centuries for different issues to be addressed and legal principles to be settled with respect to moveable, tangible property in the English courts. The reality is that market forces, rather than judicial precedents, will be the principal engine for the development of rules; and software developers, rather than barristers, will be the strongest influence on the direction that the law develops. Undoubtedly, principles will be adapted from the existing body of personal property law, but their application will depend on the ways that Digital Assets are created and used.

Recommendation 1: Statutory Intervention

The Law Commission had initially shied away from statutory intervention to crystallise this position as a constituent of English law. After considering responses to its consultation, however, the Commission was persuaded that Parliament should take limited action to eliminate uncertainty. The Commission's first recommendation, therefore, is:

statutory confirmation that a thing will not be deprived of legal status as an object of personal property rights merely by reason of the fact that it is neither a thing in action nor a thing in possession.

We welcome this recommendation, in order to create a stable platform for the development of the law of Digital Assets. The Law Commission's confidence in the ability of the courts to develop the common law is not misplaced, but experience shows that cases argued by parties with conflicting interests take time and do not always lay down consistent principles which can be applied easily by others. The rapidly-evolving Digital Assets sector requires a solid foundation to reassure investors and service providers, and the power to create it rests in Parliament.

At the same time, we would encourage the statutory framework for Digital Assets to provide guidelines for the demarcation of Digital Assets which require different treatment; eg, to distinguish so called 'native' tokens like Bitcoin from digitally native securities. There are significant differences between trades in Bitcoin and trades in tokenised bonds, and part of the regulatory challenge is to distinguish between them and adapt laws according to their characteristics. The Law Commission's Final Report recognises the issue, but there is still work to be done in conjunction with the financial services regulators (the PRA and the FCA) to get this right. The Financial Services and Markets Bill is expected to pass into law shortly, and power will be delegated to the regulators to develop an appropriate taxonomy and clarify the regulatory perimeter. The issue is core to the creation of a legal regime for Digital Assets that is harmonious with parallel forms of personal property, including with respect to the transfer, securitisation, and tax and accounting treatment of them. There is still a role for Parliament to play, in that respect.

With respect to custody arrangements, the Law Commission decided against recommending a statutory presumption of trust. In our view, this is unfortunate, as the presumption of trust has a number of merits. First among them is the clarity and consistency that would be afforded investors using Digital Assets custody services. If the Government is minded to introduce legislation along the lines proposed by the Law Commission, we would encourage this area to be looked at with the aim of creating such a presumption.

Recommendation 2: Expert Panel

The Law Commission proposes that the common law should be allowed to develop in the normal way (ie, primarily through the rulings of courts in legal proceedings). To assist in applying the law to Digital Assets, it recommends that an expert advisory panel should be constituted; bringing together:

industry-specific technical experts, legal practitioners, academics and judges to provide non-binding guidance on the complex and evolving issues relating to control (and other issues involving digital objects more broadly).

We  welcome this recommendation, which accords with our submission to the Law Commission. While the opinions of such an expert panel would not be decisive, they would allow for emerging and contentious problems to be explored from a variety of perspectives in order to develop "best views." The UK Jurisdiction Taskforce "Legal Statement on Digital Securities,"² confirming that there are no insurmountable obstacles to the issuance of digital securities under English law, is a good example of a reasoned position which can be adopted by market participants, practitioners, and the courts. Further work is  required to examine challenges and use cases  which would not be addressed by the courts in the absence of appropriate disputes argued before them.

Recommendation 3: Financial Collateral Arrangements

Because UK financial services law has been written to address legacy assets, such as cash and financial instruments, inevitably there will need to be technical amendments to certain rules to support Digital Assets that do not constitute financial securities. The Commission has identified issues with the Financial Collateral Arrangements Regulations (FCARs), which exempt certain security arrangements from the formal filing requirements for charges under English law. The Final Report sets out several proposals for reform, so that the FCARs can better address the nature of certain Digital Assets:

1. Clarify when Digital Assets meet the definition of "cash" under the FCARs and are relevant to the definitions of "money in any currency," "account," and "similar claim to the repayment of money."
2. Confirm that a digital asset which falls within the definitions of a financial instrument or credit claim is not affected by being "on-chain."
3. Confirm that, where an "off-chain" financial instrument or credit claim is linked or stapled to an "on-chain" digital asset, the latter will have the same status as the former.

In our view, there remains a need to go further and address the treatment of composite Digital Assets, which could consist of combinations of "on-chain" and "off-chain" assets of different types, including traditional asset types – whether under the FCARs or otherwise. Prescribing the nature of one asset by reference to another might work in certain cases, but it is unlikely to assist in others.

The Law Commission also recommends further work to review UK companies laws to support "the use of crypto-token networks for the issuance and transfer of equity and other registered corporate securities." The UK Jurisdiction Taskforce and the Law Commission have identified some areas where technical changes could be made to allow transfers of shares on DLT-based registers, and further work in this area would be welcome. We would also support work to address any legislative or regulatory barriers preventing Digital Assets from being placed on level footing with financial instruments and cash in other contexts, subject to any public policy considerations to protect investors and monetary policy.

Recommendation 4: Cryptoasset Collateral Arrangements

The Law Commission's final recommendation is that:

the Government sets up a multi-disciplinary project to formulate and put in place a bespoke statutory legal framework that better and more clearly facilitates the entering into, operation and enforcement of (certain) crypto-token and (certain) crypto-asset collateral arrangements.

This recommendation addresses concerns raised by participants in the Commission's consultation that the existing framework for secured transactions is based on concepts of possession and control which do not align completely with the nature of Digital Assets or the markets for them. Whether the existing system works as intended for book-entry (ie, dematerialised) securities is sometimes a question (eg, in relation to the custodian's lien), but the introduction of Digital Assets has brought the need for reform into plain relief.

Conclusion

The Law Commission's Final Report is a huge leap in the right direction, and its recommendations and conclusions generally have our strong support. The renovation and reform of English law to accommodate Digital Assets is a pressing issue, and the Government's commitment to make the UK an attractive centre for innovative technology will be tested by its willingness to move quickly on the Commission's proposals. At the same time, it should be kept in mind that the work of the Law Commission was framed in a way that leaves untouched questions of tax, data protection, conflicts of laws, the status of decentralised networks, and other matters including regulatory classification essential to the development of the law of Digital Assets. Further work in these directions, both at the Law Commission and in the work of HM Treasury, will help to establish the UK as a leading centre for Digital Assets.

_{1. UK Jurisdiction Taskforce, "Legal Statement on Cryptoassets and Smart Contracts" (November 2019), <https://lawtechuk.io/insights/cryptoasset-and-smart-contract-statement>.}
2. UK Jurisdiction Taskforce, "Legal Statement on Digital Securities" (February 2023), <https://lawtechuk.io/insights/ukjt-digital-securities>.