Approximately 15 years ago, the pseudonymous author Satoshi Nakamoto published a whitepaper detailing the specification for the Bitcoin system. Since that paper was published the current market value of all Bitcoins has reached approximately half a trillion US Dollars, many other Bitcoin-like cryptocurrencies have been developed and there have been countless use cases for the underlying technology upon which Bitcoin is based (such as blockchain-based smart contracts).
Regulators have struggled to keep pace with these new technologies and the challenges and risks which they pose. The regulatory environment in the UK is still quite limited with cryptoassets only being subject to regulation:
- under a bespoke anti-money laundering regime (which is solely designed to prevent the use of cryptoassets for illicit purposes); and
- the UK’s traditional financial services regime but only if cryptoassets fall into an existing category of regulated investment (such as shares, debt instruments or units in a collective investment scheme) and so it does not apply to most cryptoassets (for example, Bitcoin).
This limited approach is, however, likely to significantly change in the short to medium term future. The UK Government and the FCA are consulting extensively on the future regulation of cryptoassets and there are many new regulatory regimes which are being proposed (often in parallel). This article addresses one of those new regulatory regimes – bringing cryptoassets into the scope of the UK’s financial promotions restriction.
What is the UK’s financial promotions restriction?
The financial promotions restriction (the FPR) is one of the core elements of the UK’s traditional financial services regime (the other being the “regulated activities” regime). In essence, the FPR restricts non-authorised firms (firms not regulated by the FCA or PRA) from making promotions about certain “controlled activities” and “controlled investments”. It is possible for non-authorised firms to make such promotions if an authorised firm approves the promotion under section 21 of the Financial Services and Markets Act 2000 (FSMA) (referred to as a section 21 approval).
A “financial promotion” is any communication of an invitation or inducement which, if acted upon, would lead a person to carry on a controlled activity in relation to a controlled investment or acquiring, disposing or converting rights under a controlled investment. The communication could be in any form (for example, an email, a website page, a presentation at a seminar).
The “controlled activities” and “controlled investments” (which the FPR restricts non-authorised firms from making promotions in respect of) are specified in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (or the FPO). So, for example, the sale of shares is a controlled activity (and relates to a controlled investment) and so generally non-authorised firms must not promote the sale of shares.
Currently, the FPO does not list any cryptoassets as controlled investments. This means that the FPR currently does not restrict the promotion of cryptoassets (unless the cryptoasset resembles a traditional financial instrument such as a share or a debt instrument). However, as set out below, the FPO is being amended to bring promotions concerning certain types of cryptoassets into the scope of the FPR.
How is the FPO being amended in relation to cryptoassets?
The FPO is being amended to:
- include “qualifying cryptoassets” as a new controlled investment; and
- amend the definition of certain existing controlled activities so that they include those activities when carried on in relation to qualifying cryptoassets.
The new rules are due to come into force 4 months from the day after the date on which they were made (7 June 2023). We thus expect the rules to come into force on 8 October 2023.
What is the definition of a “qualifying cryptoasset”?
- The definition is complex but in summary it is:
a “cryptoasset”;
Sub-Definition: “any cryptographically secured digital representation of value or contractual rights that— (a) can be transferred, stored or traded electronically, and (b) uses technology supporting the recording or storage of data (which may include distributed ledger technology)” - which is fungible and transferrable; and
- which is not an excluded cryptoasset.
Excluded cryptoassets includes inter alia cryptoassets which are (i) electronic money, (ii) digitally issued fiat currency and (iii) a cryptoasset which is already a controlled investment.
The definition of “cryptoasset” is very similar to (but not identical to) the definition under the UK Money Laundering Regulations. However, the definition of a qualifying cryptoasset is narrower than that under the UK Money Laundering Regulations as (i) there is an explicit fungibility requirement and (ii) certain types of cryptoasset are excluded.
Obviously, it will be important to examine the characteristics of a cryptoasset to see whether it falls into the scope of the FPR. Considerable care should be taken when relying upon any argument that a token is not fungible given that the term “NFT” can be applied quite liberally.
The effect of this definition is that many unregulated tokens will become controlled investments. So, for example, Bitcoin will become a controlled investment.
What controlled activities are being amended?
The definitions of the following controlled activities:
- dealing in controlled investments;
- arranging deals in controlled investments;
- managing controlled investments; and
- advising upon controlled investments.
are being amended so that they capture persons carrying on these activities in relation to qualifying cryptoassets. This means that persons promoting these activities, when the activities will be carried on in relation to qualifying cryptoassets, will be subject to the FPR (unless an exemption applies or there is some other reason why the FPR does not apply – see below).
Are there any exemptions when promoting cryptoassets?
The only exemption introduced specifically for promotions concerning cryptoassets is an exemption for promotions of cryptoassets by persons who are registered cryptoasset service providers under the UK’s Money Laundering Regulations. This exemption was introduced as registered cryptoasset service providers would otherwise not be able to promote cryptoassets (due to the fact that such providers do not have a traditional financial services authorisation which permits them to make promotions under the FPR). The FCA does, however, have the power to make rules which registered cryptoasset service providers must comply with when making cryptoasset promotions (and many of the FCA’s rules summarised at the end of this article apply to such providers).
There are already a number of general exemptions under the FPO and it may be possible for persons to rely upon these exemptions but this will require considerable care given the regulatory scrutiny directed towards cryptoasset promotions. It should be noted that the general exemption for promotions to high net-worth individuals (HNWIs) has been specifically disapplied in relation to cryptoasset promotions.
What is the territorial scope of the new rules?
The existing territorial scope of the FPR is unaffected. This means that if a cryptoasset promotion is “capable of having an effect in the UK” then it will be subject to the territorial scope of the FPR. This is potentially significant given that many cryptoasset providers offshore their activities so that a registration is not required under the Money Laundering Regulations – these types of argument will be much more difficult for cryptoasset promotions subject to the FPR.
What should cryptoasset providers do?
By bringing promotions concerning cryptoassets into the scope of the FPR, there is a significant risk that many cryptoasset providers, who are currently outside of the scope of the UK regulatory regime, will be adversely affected.
Each case will need to be considered individually but the following is likely to be a useful starting point for firms without an authorisation from the FCA or PRA when considering making a communication about a cryptoasset:
- Is the communication a “financial promotion”? A “financial promotion” is an existing regulatory concept which the FCA has provided guidance upon. In some cases, it will be obvious when a communication amounts to a financial promotion but in other cases it will be less clear.
- If so, is the promotion about “qualifying cryptoassets” as defined above?
- If so, is the promotion about a controlled activity in relation to the qualifying cryptoassets?
- If so, do any exemptions apply to the promotion?
- If not, is the promotion capable of having an effect in the UK?
Obtaining a section 21 approval
If a financial promotion is subject to the FPR then it will need to obtain a section 21 approval from an FCA or PRA authorised firm. Under this approach, the authorised firm will review the communication to ensure it complies with the FCA’s rules (see below) and then approve the communication.
We expect that this will be a difficult approach because:
- regulated firms will be very cautious about giving an approval in relation to investments (such as cryptoassets) subject to such a high degree of regulatory scrutiny; and
- separately, the FCA is changing its rules so that it will become more difficult for authorised firms to give a section 21 approval in respect of promotions made by unauthorised firms.
FCA’s rules about financial promotions
In parallel with the changes to the FPO, the FCA is in the process of updating its rules (that apply to FCA and PRA authorised firms) so that they set out rules for how cryptoasset promotions are to be made. These rules will apply to cryptoasset promotions (i) made by an authorised firm itself (for example, a bank in promoting its cryptoasset product) or (ii) made by a third party firm which the authorised firm is giving a section 21 approval in respect of.
The FCA has set out these rules in Policy Statement 23/6. The rules are quite detailed and so we can only give a very high-level overview of the rules in this article:
- a risk warning must be included in the promotion;
- a rule against promoting cryptoassets by providing incentives to invest (for example, a new joiner bonus);
- a cooling-off period of 24 hours for a first-time investor with a firm;
- the requirement to assess the appropriateness of cryptoasset investments for clients;
- a rule that “direct-offer financial promotions” concerning cryptoassets are only made to certain categories of investor (for example, HNWIs);
- the application of the FCA’s “Consumer Duty” to cryptoasset promotions.
Most of these rules will be set out in COBS 4 of the FCA Handbook.
The UK’s changes to its financial promotions regime does not give much time for crypto-asset firms, platforms and exchanges to review changes needed to their customer promotions and user flow and to make changes to get ready for compliance.
Our Payment Services Regulatory team will be monitoring next steps and shall keep you up-to-speed with the latest developments. We are here to help, so please do get in touch with the team if you have any questions.
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For further information, please contact:
Gavin Punia, Partner, Bird & Bird
gavin.punia@twobirds.com
