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Treasury and FCA move to regulate the marketing of cryptoassets in a similar way to high risk investments.

Treasury and FCA move to regulate the marketing of cryptoassets in a similar way to high risk investments.

Feb 04, 2022
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Summary

In a widely-anticipated development, HM Treasury (“HMT”) has announced its intention to widen the scope of the financial promotions regime in so far as it applies to cryptoassets. Hot on its heels, the Financial Conduct Authority (“FCA”) published Consultation Paper CP22/2 on strengthening its rules for marketing high-risk investments, which includes proposals rationalising the classification of high-risk investments and subjecting “qualifying cryptoassets” to similar financial promotions rules as currently apply to non-readily realisable securities and peer-to-peer loans. BCLP considers what these changes will means for firms operating in this space.

On 18 January 2022, HMT published its Cryptoasset Promotion Consultation Response paper, setting out its intention to bring forward secondary legislation, with a six-month lead-time, extending the financial promotions regime to “qualifying cryptoassets”. To complement this work, the FCA is intending to include these qualifying cryptoassets within the new category of “restricted mass market investments” (“RMMI”) for the purposes of the financial promotions regime.

Interested parties have until 23 March 2022 to respond and the FCA intends to publish a policy statement and amendments to its Handbook rules in the summer, so firms can expect these changes to take effect this autumn.

Which cryptoassets will be caught by the proposals?

While some types of cryptoassets are currently within the regulatory perimeter (for example, security tokens), the proposed amendments to the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 would add the following to the list of controlled investments:

“cryptographically secured digital representation of value or contractual rights which is fungible and transferable” (“Qualifying Cryptoassets”)

The result is that previously unregulated cryptocurrencies and cryptoassets will be brought into the financial promotion regime for the first time.

This definition is provisional at this stage and could change by the time we see it in the statutory instrument which is actually laid before Parliament.

It is of note that HMT excluded non-fungible tokens from the definition, citing a lack of sufficient information on risk and use-cases due to their constantly evolving and early developmental state. The transferability exclusion will exclude from the regime tokens such as supermarket loyalty schemes that are cryptographically secure. In addition, despite earlier indications, there is no intention to require cryptoassets to use distributed lender technology (“DLT”) in order to future-proof the regime against rapidly evolving technology.

How will financial promotions of Qualifying Cryptoassets be restricted?

To complement the work by the Treasury, the FCA, (via CP22/2), is intending to include Qualifying Cryptoassets within the new category of “restricted mass market investments” (“RMMI”). RMMI will also include instruments that provide rights to or interests Qualifying Cryptoassets, “non-readily realisable securities” (“NRRS”), such as, shares or bonds in a company not listed on an exchange, and peer-to-peer agreements. These will be distinguished from the other two categories of high-risk investments, namely: “readily realisable securities” (“RRS”) and “non-mass market investments” (“NMMI”). Into the latter category fall things like investments in unauthorised funds.

Through its categorisation as RMMI, the FCA is not going so far as to ban mass-marketing of cryptoassets for retail investors, instead, such marketing will be permitted but subject to certain restrictions.

Also, this would have no impact on the underlying activity itself – just the financial promotion around it. Accordingly, there are currently no proposals for a UK authorisation regime for cryptoassets activities that currently fall outside the regulatory perimeter, other than the HMT consultation on stablecoins which HMT is still considering. 

What would this mean for firms currently operating in the cryptoasset space?

Financial promotions relating to Qualifying Cryptoassets would need to comply with existing financial promotion rules, including the requirements for the promotion to be clear, fair and not misleading, as well as other rules generally applicable to financial promotions contained in Chapter 4 of the Conduct of Business Sourcebook (COBS 4). The consultation doesn’t stop there. The FCA is proposing various changes to the regime itself, in pursuit of its consumer-protection agenda, including but not limited to: requiring that all financial promotions for RMMI contain a compliant risk warning; banning incentivising these investments (including incentives paid in cryptoassets); and mandating pop-up risk warnings and 24 hour cooling-off periods (“interventions”) for first-time investors. The cumulative impact of the proposals is likely be considerable.

The requirement for promotions to be approved by authorised firms

Critically, cryptoasset firms, unless they are authorised in their own right, will need to have their financial promotions approved by authorised firms before they can be released. HMT plans to introduce legislation which will effectively impose a “requirement” on all existing and newly authorised firms. This requirement will prevent authorised firms from approving financial promotions for unauthorised persons (“Financial Promotion Requirement” or “FPR”) unless they are in the same group or an appointed representative of the authorised firm. This will create a regulatory gateway (“s21 gateway”) whereby the firm will effectively need to seek FCA consent to the removal of this requirement before they can approve financial promotions for unauthorised persons.

This will not only cause delays but the regulator is likely to scrutinise applications to vary or cancel the FPR very carefully (further guidance can be expected on this in due course). In their current form, the rules contain no specific restriction on firms approving financial promotions for products or services where they lack relevant expertise but this is clearly likely to change under the current proposals. The FCA itself recognises that authorised firms with sufficient competence and expertise to approve cryptoasset promotions are few and far between.

A further concern is that those firms that do have the experience and expertise, may be extremely cautious in their approach to approvals while this new promotions regime is still in its infancy.

It is also important to note that a firm that is registered under the money laundering regime for crypto exchange services and / or crypto custodian services, but is not a fully authorised person, will not be able to approve financial promotions under this proposed regime.

As a result, obtaining approval for cryptoasset financial promotions is likely to be difficult, costly and time consuming.

The introduction of a ban on incentives

The FCA proposes banning inducements to invest in high‑risk investments (including cryptoassets) and therefore limit the scope of any monetary and non‑monetary benefits that incentivise investment activity. This is likely to restrict the ability of some cryptoasset businesses to obtain access to investment.

Changes relating to the nature of the investors themselves

Under the FCA proposals, direct offer financial promotions relating to cryptoassets will only be permitted to certified high net worth individuals, certified sophisticated investors and restricted investors – promotions to self-certified sophisticated investors will not be permitted. In basic terms, in this context, a direct offer financial promotion will be a financial promotion which contains an offer by one person to deal in (e.g. buy or sell) a Qualifying Cryptoassets to any person who responds to the promotion.

Further, direct offer financial promotions will need to comply with an appropriateness assessment, which the FCA is proposing to enhance for all RMMIs. This will require those making or approving promotions to gather information on an investor’s knowledge and experience in the relevant investment field, so as to ensure the relevant promotion is appropriate for that person. The FCA has also suggested that “positive frictions” be introduced into the customer journey, such as mandatory pop up risk warnings for direct offer financial promotions.

For cryptoasset businesses and those approving their promotions, this will be the first time they have had to assess cryptoasset customers with such a high degree scrutiny. Given the complexity of the rules in this area, external advice is likely to be required to effectively navigate this regulatory minefield for direct offer financial promotions.    

Record keeping

The FCA is keen to gather the data to say whether its objectives have been met and therefore is proposing that firms record the outcome of the interventions e.g. whether consumers proceed to access the investment after receiving a risk warning or pop-up, or whether they click the mandated ‘take 2 mins to learn more’ links. Such data-capture and record-keeping requirements come with cost, resourcing, data-processing and privacy implications that may act as a deterrent to disruptors in a market.

Cross border implications

It is important to note that these rules will apply to cryptoasset businesses making promotions from outside the UK to customers in the UK (that is, where the promotion is capable of having an effect in the UK).

Conclusion

These proposed rules are technical and convoluted and therefore careful consideration will be required as to how they will apply to each business model. Cryptoasset businesses and the firms approving their promotions will need to make operational adjustments to implement the required systems and controls to be compliant. Compliance is likely to be a costly exercise, particularly in circumstances where many cryptoasset businesses are unaccustomed to operating in a more highly regulated environment. It remains to be seen whether these proposed rules, if implemented in full, will put the brakes on the crypto industry in the UK, or whether the industry will respond with sensible solutions to evolve in light of these requirements.  


Lex Townsley contributed to this article.

Related Practice Areas

  • Fintech

  • Finance

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