On 18 January 2022, HM Treasury (HMT) published its response to its July 2020 consultation paper on cryptoasset promotions. This was followed today by the FCA’s consultation on strengthening its financial promotion rules for high risk investments, including cryptoassets.
The response and consultation will be relevant to those developing and offering new cryptoassets, those offering cryptoasset related services (such as Bitcoin brokers) and the investors in cryptoassets.
In the response, HMT confirmed its intention to reform the law on the promotion of cryptoassets. HMT plans to make the reform through secondary legislation that expands the scope of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO). This will add the financial promotion restriction, breach of which carries criminal penalties, to the general criminal law, including the Fraud Act 2006, protection for the investing public. It will also supplement other regimes, noting that the Advertising Standards Authority recently upheld complaints on seven different adverts relating to cryptocurrencies.
The fact that an FCA authorised firm can make or approve a financial promotion bring otherwise unregulated cryptoassets closer to the general regulation of financial services and regimes for the protection of investors in financial instruments. (Money laundering registration requirements, while important, are peripheral in addressing a narrow regulatory concern, i.e. the reduction of financial crime.)
The FCA’s proposals in its consultation complement HMT’s proposals. They bring in-scope cryptoassets under a more general regulatory umbrella, and list them alongside high risk investments, such as non‑readily realisable securities and non‑mainstream pooled investments, but include them in the category of “Restricted Mass Market Investments”. This would mean that, in practice, the mass‑marketing of cryptoassets to retail consumers would be permitted but be subject to the requirements of the FCA’s financial promotion rules, including special requirements for “direct offer financial promotions”. This is good news for crypto providers in that the inclusion of in-scope cryptoassets in the category of “Non‑Mass Market Investments”, the other new category of investment introduced in the consultation, would have limited their promotion to high-net-worth or sophisticated investors and others excluded from the financial promotion restriction.
Expanding the FPO: definitional coherence?
The planned expansion to the FPO examined in the HMT response will result in:
- the addition of ins-scope cryptoassets known as "qualifying cryptoassets" (QCAs) to the list of “controlled investments” in the FPO; and
- linking QCAs to the “controlled activities” of dealing, arranging, managing, advising and agreeing in the FPO.
HMT does not plan to add any specific exemptions for QCAs, noting in the response that the approach to QCAs should be consistent with that for other controlled investments.
The final drafting for the QCA definition is still under development but the response indicates HMT’s thinking in this regard with it looking to define QCAs as “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable”.
Some points on the QCA definition and the controlled activities connected with QCAs are noteworthy and highlight the fact that HMT is seeking to set down general definitional principles.
- The definition will exclude: other controlled investments; electronic money under the Electronic Money Regulations 2011; and central bank money. The FPO already applies to controlled investments such as shares, bonds or fund units held on a blockchain.
- The “transferability” requirement will result in the exclusion of tokens such as travel passes, lunch passes and supermarket loyalty schemes that are cryptographically secure. HMT emphasises that tokens with these characteristics do not typically give rise to consumer protection risks. The transferability requirement will also distinguish between those tokens that are used specifically and only for payment to a vendor (not in scope), and tokens which can also be traded between users for speculation or other purposes (in scope).
- The “fungibility requirement” will result in the exclusion of non-fungible tokens (NFTs) from the regime. HMT note that NFTs may represent a wide array of different assets which might constitute non-financial services products. Further, the NFT market is evolving rapidly and remains at an early stage of development with the result that there is not yet sufficient information on risks and use-cases. The necessary implication is this may change if risks arise.
- The definition does not refer to distributed ledger technology or blockchain, with HMT noting that this will future-proof the definition for innovations in the underlying technology that cryptoassets utilise. This technology agnostic definition is in line with HMT’s consultation on the regulatory treatment of stablecoins.
- The controlled activities do not include cryptoasset lending activities or Decentralised Finance (DeFi) activities HMT suggesting that this would result in unnecessary and disproportionate amendments to the regulatory perimeter; the activities of crypto wallet providers, i.e. the safeguarding and administration of QCAs, will also not be included as there is no clear case of consumer harm.
The FCA’s new rules: a first taste of investor protection requirements?
The FCA state that the financial promotion regime will only apply to QCA promotions – it will not affect the regulatory status of the underlying activity. This means that, to the extent that an activity relating to QCAs is unregulated today; it will remain unregulated once the new financial promotion rules apply. The primary impact of the rules appears, therefore, to be on the FCA authorised firms who approved QCA promotions. That said, the proposed rules, together with the concepts introduced in the HMT response, contribute to the foundation for a future regulatory regime for QCA providers.
The general rules on financial promotions, including rules introduced in the consultation, will apply to QCA promotions and include the following.
- Rules for QCAs aligned with existing rules for other high‑risk investments and classified as Restricted Mass Market Investments that place additional restrictions on firms communicating or approving relevant promotions.
- Rules on categorising and imposing an appropriateness test for firms communicating or approving “Direct Offer” financial promotions of QCAs.
- “Positive frictions” rules, i.e. personalised risk warnings and cooling off periods for first time investors in QCAs.
- Aligning exemptions for QCAs with other exemptions, such as the high-net-worth investor exemption.
- Rules for those who approve QCA promotions.