Draft rules published to bring cryptoassets within the UK financial promotions regime
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On 18 January 2022, HM Treasury published its response to its consultation on bringing cryptoassets in scope of the UK financial promotions regime, having initially consulted on these changes in 2020 (the Consultation Response). The Financial Conduct Authority (FCA) followed up shortly after on 19 January 2022 with a consultation paper which aims to streamline the current UK financial promotion regime and classifies cryptoassets as a high risk investment for the purposes of this new regime, and restricts the ability of authorised firms to approve financial promotions. Together, these developments will have significant implications on the marketing of cryptoassets in the UK.
We provide analysis of the new restrictions and regime below.
Background
Under section 21 of the Financial Services and Markets Act 2000 (FSMA), a person is prohibited from issuing a financial promotion unless it is:
a. issued by a FSMA authorised firm;
b. approved by a FSMA authorised firm; or
c. falls within an exemption under the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO),
(known as the Financial Promotion Restriction).
The UK Financial Promotion Restriction applies only to ‘controlled investments’ and to ‘controlled activities’. A list of each can be found in the FPO.
Financial promotions are broadly defined because it relates to any invitation or inducement to engage in investment activity and captures any communications which are capable of having an effect in the UK.
As it currently stands, crypto-assets are not specifically categorised as “controlled investments” and they are not referenced to any “controlled activities” under the FPO. Only a narrow subsection of cryptoassets fall within the existing UK regulatory perimeter with these broadly being securities or other financial instruments that have a crypto-wrapper. These include security tokens, which have characteristics of shares, debt instruments or collective investment schemes, and e-money tokens. There are also separate registration requirements for cryptoasset service providers (such as exchanges or issuers) and custodian wallet providers under the UK anti-money laundering regime.
HM Treasury – inclusion of qualifying cryptoassets in the FPO, and new controlled activities
The UK government is proposing to define “qualifying cryptoassets” as a controlled investment to be brought within the scope of the FPO. The Consultation Response does not provide a precise statutory definition but indicates that it will define “qualifying cryptoassets” as “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable”.
The government further intends to exclude other controlled investments, e-money under the Electronic Money Regulations 2011, central bank money, and cryptoassets that are only transferrable to one or more vendors or merchants in payment for goods and services.
Notably, the definition does not mention distributed ledger technology or blockchain, so as to future-proof the definition and scope of the requirements against innovation in the underlying technology of cryptoassets. Further, the fungibility requirement would likely remove many non-fungible tokens (NFTs) from the scope of the FPO, the reasoning being that the NFT market resembles a digital collector item more than a financial services product. Clarity will be needed for certain hybrid tokens that share unique characteristics with other tokens (for example, digital collectibles). HM Treasury has indicated that they will continue monitor this space and the appropriateness of the scope of the definition. The FCA will also be expected to provide guidance in this area on what constitutes a fungible token.
The UK government also proposes to amend the controlled activities list under the FPO to apply to qualifying cryptoassets. These activities would include: dealing, arranging deals, managing, advising, and agreeing to carry on a specified kind of activity. Also, although there are certain exemptions in the FPO that are commonly used by firms for unlisted securities, these will not be extended to qualifying cryptoassets, including those for high net worth individuals and self-certified sophisticated investors.
The UK government has proposed a six-month transitional period for both the finalisation and publication of the new FPO and the accompanying FCA rules. The UK government has stated that legislation will be laid before Parliament but the legislative timetable is unclear. It is possible that the UK government aims to align these changes with the broader FPO changes proposed by the FCA as set out below.
FCA – changes to FPO marketing restriction product categories
In parallel, the FCA has proposed to streamline its financial promotion regime into three new marketing restrictions product categories. This is relevant to authorised firms that will issue or approve financial promotions relating to qualifying cryptoassets.
Qualifying cryptoassets fall under the category of “Restricted Mass Market Investments”. The relevant requirements include:
a. the provision of enhanced risk warnings, with new prominence and specified information requirements;
b. a prohibition on inducements to invest, such as new joiner bonuses and refer a friend bonuses;
c. conducting appropriateness tests, which the FCA proposes to further enhance; and,
d. record keeping requirements.
In relation to cryptoassets, the FCA intends to publish final rules in summer 2022 and for the rules to apply from the date that the government’s changes to the FPO become effective.
FCA – restrictions on authorised firms approving or communicating financial promotions
As discussed above, unless exemptions apply, financial promotions need to be either communicated by a FSMA authorised firm, or approved by a FSMA authorised firm. The latter is sometimes referred to sometimes as an “s21 approver”.
The FCA has observed inadequate due diligence by s21 approvers and proposes to strengthen the regime by requiring imposing a new Financial Promotion Requirement on existing and newly authorised firms that prohibits them from approving financial promotions for unauthorised persons, other than persons in the same group or an Appointed Representative. To be able to approve financial promotions for authorised persons, s21 approvers will need to further apply for a variation of permission under part 4A of the FSMA.
There will also be new requirements for s21 approvers. These include (i) providing a date stamp for communications that they have approved, (ii) monitoring approved promotions for the lifetime of the promotion and (iii) conducting a self-assessment on whether the firm has the necessary competence and expertise (C&E) in an investment product or service before communicating or approving a relevant promotion.
Next steps for cryptoasset firms operating in the UK
Taken together, the changes proposed by the UK government and the FCA will prove a significant barrier to firms dealing in cryptoassets and operating in the UK. The changes to the FPO mean that many firms will need to seek out s21 approvers, which are already limited in the UK and, now subject to enhanced requirements, may refuse to approve communications for firms dealing in cryptoassets. In the absence of this, firms will need to consider their regulatory position in respect of marketing cryptoassets in a way that complies with the UK financial promotion regime.
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