By Sam Pearse
The UK Government has launched a Consultation regarding cryptoassets, focussing on whether unregulated cryptoassets should fall within the financial promotions regime, thereby affording protection for consumers. There is no immediate impact on cryptoasset businesses, but the regulatory landscape is changing.
The UK Financial Services and Markets Act 2000 sets out restrictions on the communication of invitations or inducements to engage in investment activity, such as investing in securities. In brief terms, only those persons who are authorised by the Financial Conduct Authority (FCA) may make such communications, or persons who are making a communication which as been authorised by an authorised person. Incidentally, the ‘approved communications’ exemption is also being reviewed by HM Treasury and our article about that can be found here.
At its core, the restriction on financial promotion is intended to protect consumers from being mis sold products, whether by virtue of being provided with insufficient information or by fraudulent activity or investing in immature or inadequate market infrastructures.
As financial products evolve it is increasingly difficult to fit the latest offerings into legislation which was nearly two decades old. The sharp rise of cryptoassets has proved to be particularly challenging.
The UK Government (via Her Majesty’s Treasury), the FCA and the Bank of England formed a ‘Cryptoassets Taskforce’ in 2018 to set out the UK’s policy and regulatory approach to cryptoassets and distributed ledger technology, culminating in publishing a Report.
The FCA issued a Policy Statement in 2019 (PS19-22) setting out how security tokens fell within the regulatory framework. All other tokens, such as exchange or utility tokens but excluding e-money tokens (which are separately regulated), were deemed to not be in scope and therefore continued to escape regulation.
FCA research in 2020 found that 2.6 million Britons held unregulated cryptoassets, compared to 1.5 million in 2019, and there is a higher number of older consumers investing in unregulated cryptoassets. Of all current and previous tokenholders, some 35% claimed that advertising made their purchase more likely. There continues to be misunderstandings and incorrect assumptions regarding the nature of the underlying asset, including whether it is regulated.
Unregulated Digital Cats
In order to address the increasing ownership of unregulated cryptoassets and the potentially significant risk they pose to consumers, the proposal is that cryptoassets are brought within the definition of “controlled investments” for the purposes of financial promotion. The consequence of doing so is that the marketing of cryptoassets would be subject to the same restrictions as advertising investments in securities.
The proposed definition of a “qualifying cryptoasset” is:
“…any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and which —
(a) is fungible;
(b) is transferable or confers transferable rights, or is promoted as being transferable or as conferring transferable rights;
(c) is not any other controlled investment as described in this Part;
(d) is not electronic money within the meaning given in the Electronic Money Regulations 2011; and
(e) is not currency issued by a central bank or other public authority.”
The definition is consistent with that used in the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. From 10 January 2020 cryptoasset exchange providers and custodian wallet providers have been brought within the scope of these regulations and required to register with the FCA for supervision.
The definition goes further, however, as the UK Government places emphasis on the need for the cryptoasset to be both fungible and transferable, explaining these are core characteristics of money and regulated products such as stocks and bonds. As such, consumers might expect such assets to hold or rise in value, and to be easily transferable due to the size and liquidity of the market.
Whilst any stablecoins previously out of scope would be caught by the definition, the consultation specifies that digital collectibles, such as Cryptokitties, would not be caught by reason of not being sufficiently fungible. Cryptoassets that are only redeemable with the issuer, such as supermarket customer loyalty points, are not transferable and similarly out of scope.
The UK Government also intends to amend the list of “controlled activities” such that activities include the buying, selling, subscribing for or underwriting qualifying cryptoassets. The consultation specifies that cryptoasset exchanges, ATMs and airdrops as a means of distribution will all be in scope.
Other Considered Amendments
The consultation notes the UK Government considered making engaging in certain activities regarding cryptoassets (as opposed to promoting cryptoassets) a regulated activity, meaning a person undertaking that activity would need to be authorised. That approach is not being pursued at this time, although it may be considered later. The UK Government also considered whether “codes of conduct” or “industry standards” would be sufficient, but it decided such lighter touch would be inconsistent with its approach to other areas of similar risk to consumers.
Impact on Cryptoasset Businesses
The consultation itself does not change the regulatory landscape. However, it serves as a clear signpost that this area will become regulated soon. Promoting cryptoassets will require businesses to either become authorised, find an authorised person to approve the content of the communication or to try to fit the communication within one of the exemptions to the restriction on financial promotion.
Achieving and maintaining FCA authorisation is rightly an onerous, complex and expensive task. Coupled with the proposed changes to the approved communications regime, the new law should bring higher standards of professionalism and consumer protection to the sector.
The consultation closes at midnight on 25 October 2020. Note that this will not be the only consultation on cryptoassets this year, with the UK Government committing to a consultation on the UK’s broader regulatory approach later in 2020.