The invention provides a UPFC control system based on an observer and an MMC and a control method thereof. The control system comprises an alternating current side power control module, three direct current side control modules, three reference voltage generating modules, a bridge arm ring current calculating module, a signal modulation module and an MMC sub-module drive unit; the direct current side control module consists of a VC observer module, a ring current command generating module and a ring current control module; and the control method is used for specifically carrying out corresponding function of each system module. According to the control system and method provided by the invention, data collection for bottom layer sub-module units in a traditional method is omitted, accurate estimation for bridge arm voltage can be quickly realized according to output voltage/current parameter and bridge arm ring current value, so that data conversion between direct control side control and the bottom layer sub-module units is eliminated, and the real-time control frequency of the system is greatly improved.