Thought For The Week: Key takeaways from the Law Commission's Final Report on Digital Assets

In recent years, courts in various common law jurisdictions have recognised Digital Assets as a species of property, to which existing laws and remedies apply, without definitively resolving the question about the class of property to which they belong.

The Law Commission's Final Report on Digital Assets concludes 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. This is also the conclusion of the UK Jurisdiction Taskforce, which looked at the problem in its landmark 2019 opinion (https://lawtechuk.io/insights/cryptoasset-and-smart-contract-statement). In this TFTW, we give you a summary of what you need to know about the Law Commission's recommendations.

Recommendation 1: Statutory Intervention

The Law Commission's first recommendation is that Parliament should provide:

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. 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, which received Royal Assent on 29 June 2023, delegated power 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.

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 would offer clarity and consistency to investors using Digital Assets custody services.

Recommendation 2: Expert Panel

The Law Commission proposes 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."

Recommendation 3: Financial Collateral Arrangements

Inevitably there will need to be technical amendments to the body of UK financial services law in order 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.

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 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.

Conclusion

The Law Commission's Final Report is a huge leap in the right direction. 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. Meanwhile, of course, the Courts continue to serve the business community by making practical and consistent judgments.

This is the end of the beginning. 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 regulatory classification. Further work in these directions is necessary, and urgent.