Crypto firms have until 8 October 2023 to fall in line within UK financial promotion regime

The UK Government and the Financial Conduct Authority (“FCA”) continue to take definitive steps to regulate the crypto industry.  On 7 June 2023, Parliament passed the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (the “FPO Amendment”) and in doing so expanded the scope of the UK’s financial promotion regime to cryptoassets with effect from 8 October 2023.

Some firms operating in the crypto space will thus far have only ever operated in an unregulated environment and may now need to make significant changes to their business practices.  At the same time, there are few authorised firms and persons in the crypto sector who are able or willing to approve the financial promotions of unauthorised crypto firms.

There has been a resulting concern that the new legislation will operate as a de facto ban on the marketing of cryptoassets.  The Government has said that this is not the intention, but we wait to see how the industry will react and in particular whether those crypto firms marketing into the UK from overseas will continue to do so.

FSMA & the FPO

The Financial Services and Markets Act 2000 (“FSMA”) is the centrepiece of the framework for regulating financial services in the UK.

Section 21 of FSMA says that a person “must not, in the course of business, communicate an invitation or inducement to… engage in investment activity…” unless that person is an authorised person (i.e., by the FCA) or “the content of the communication is approved for the purposes of this section by an authorised person.”  Section 21(5) allows for the specification of exemptions.

The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “FPO”) defines the investments and activities that are caught by section 21 and sets out the exemptions to it.

Sanctions for those in breach

A breach of section 21 is a criminal offence, with the person making the communication liable to an unlimited fine and/or up to two years’ imprisonment. Further, agreements entered into by customers as a result of illegal financial promotions are unenforceable against that customer.

If there is a reasonable likelihood of section 21 being breached, the FCA may also apply to the Courts for an injunction to restrain the breach or to require the person responsible for the breach to take such steps as the Courts may direct to remedy it.

Regardless of whether a communication is in breach of section 21, the FCA has powers to take various kinds of disciplinary action against issuers of financial promotions that are unfair, unclear or misleading, including requiring firms to withdraw or amend a misleading financial promotion with immediate effect and to announce that it has taken disciplinary action.

These sanctions and the FCA’s appetite for intervention are likely to extend to breaches of the new regulatory regime for cryptoassets. As the FCA says in its policy statement: “[w]e will take robust action against firms breaching these requirements. This may include, but it is not limited to, requesting take downs of websites that are in breach, placing firms on our warning list, placing restrictions on firms to prevent harmful promotions and enforcement action. Firms illegally communicating financial promotions to UK consumers will be committing a criminal offence punishable by an unlimited fine and/or 2 years in jail”.

Cryptoassets to date are unregulated in the UK

Currently, promotions of unregulated cryptoassets have not been caught by section 21 (and are not included in the prescribed list of investments in the FPO).  Hitherto, advertisements of many crypto tokens and coins have proliferated in an unregulated environment across the internet and social media in particular.

That is not to say that crypto regulations are untouched by other regulation: the Advertising Standards Authority has, for instance, sought to clamp down on misleading advertisements. Cryptoassets that are securities – such as security tokens of various kinds, having the features of equity or debt securities – are already caught by the FPO.

Regulatory concern in the UK

Back in 2018, the Cryptoasset Taskforce (“CATF”) published a report that paved the way for the UK’s policy and regulatory approach to cryptoassets. The report identified the key risks of cryptoassets and the underlying technology (such as consumer harm, market integrity, and threats to financial stability) and concluded with recommendations and next steps for developing meaningful financial regulation to mitigate such risks.

2019 then marked a series of consultations and guidance from the FCA – including consultation CP19/3 and policy statement PS19/22 (responding to the CP19/3 consultation) – which aimed to clarify the FCA’s expectations for firms carrying on activities in the cryptoasset space in the UK and to provide guidance for market participants as to the proposed scope of the regulatory perimeter.

In July 2020, the Government released a consultation on cryptoasset promotions, which sets out its proposals to bring certain cryptoassets into the scope of the FPO – this involved introducing a definition of “qualifying cryptoassets” to be added to the list of controlled investments in the FPO subject to the financial promotion regime.

Following that 2020 consultation and further consultation on the regulatory approach to cryptoassets, stablecoins and distributed ledger technology, the Government announced in January 2022 that it would proceed along the lines of its proposals, and the FCA around the same time initiated a consultation on its draft rules for the marketing of cryptoassets.

That now leads us to the FPO Amendment, FCA’s policy statement P23/6 setting out their “near final” rules on cryptoassets promotions, and the FCA’s guidance consultation GC 23/1 on the requirement that cryptoasset financial promotions be “fair, clear and not misleading”. These are discussed further below.

Extension of section 21 to cryptoassets

The FPO Amendment extends the restriction on financial promotions in section 21 of FSMA to “qualifying cryptoassets” – that is, any cryptoasset which is “fungible” and “transferrable”. The FCA explains this definition to comprise “any cryptographically secured digital representation of value or contractual rights that is transferrable and fungible”, though excluding cryptoassets which meet the definition of electronic money (which are regulated under the Electronic Money Regulations 2011) or an existing controlled investment (such as security tokens).

This definition therefore brings most of the previously unregulated cryptoassets (including utility tokens and exchange tokens like Bitcoin and Ether) into the financial promotion regime.

What about NFTs?

As per prior consultation and the draft explanatory memorandum to the FPO Amendment, the intention is for non-fungible tokens (“NFTs”) to be carved out from the regime on the basis that NFTs are akin to digital collectibles (where sales depend largely on the utility or unique value the NFT gives the holder) rather than financial investments.

Amendments to controlled activities

The FPO Amendment also amends existing “controlled activities” (which are subject to the financial promotion regime) to incorporate activities relating to the buying, selling, subscribing for or underwriting of qualifying cryptoassets. Consequently, businesses carrying out the following activities in the UK relating to qualifying crytoassets will need to be authorised by the FCA:

• dealing in securities and contractually based investments;
• arranging deals in investments;
• managing investments;
• advising on investments; and
• agreeing to carry on specified kinds of activity.

RMMIs

Further, the FCA has expressed its intention to categorise cryptoassets as Restricted Mass Market Investments (“RMMIs”). This means that cryptoassets can be mass marketed to UK consumers subject to certain restrictions which are set out at Chapter 4.12A of the FCA Conduct of Business Sourcebook.

The proposed restrictions and requirements include (non-exhaustively):

• clear risk warnings and risk summaries, including personalised risk warnings for first-time investors;
• prohibition on monetary and non-monetary incentives to invest (such as giving away free cryptoassets or awarding referral benefits);
• a 24-hour cooling off period for first-time investors;
• client categorisation (checks needed to be carried out by firms in relation to information from customers who are certified as high-net-worth individuals (“HNWIs”), “sophisticated investors” or who are certified as “restricted investors”);
• adherence to more onerous rules for direct offer financial promotions (“DOFPs”) (i.e., financial promotions which contain or specify a manner of response by which a recipient of the promotion may make or accept an offer to enter into a controlled agreement); and
• appropriateness assessments to be performed prior to customers being presented with any DOFPs.

FCA says that customers “should be prepared to lose all their money”

Despite these proposed restrictions and the greater consumer protection this new regime is intended to achieve, the FCA has nonetheless cautioned that “[c]onsumers should only invest in cryptoassets if they understand the risks involved and are prepared to lose all their money. Consumers should not expect protection from the Financial Services Compensation Scheme (FSCS) or Financial Ombudsman Service (the ombudsman service) if something goes wrong”.

Dearth of authorised firms and persons

The effect of the section 21 is that an unauthorised person must have its financial promotions approved by an authorised person unless an exemption applies. Notably, firms only authorised under the Electronic Money Regulations or the Payment Services Regulations are not considered authorised persons for these purposes and so cannot approve financial promotions.

It is generally slim pickings for those firms looking for an authorised person to approve the marketing of cryptoassets, as this would involve that authorised person assuming some responsibility for the content of such marketing (and few firms have shown the appetite to do this in our experience). In addition, firms that wish to approve financial promotions of qualifying cryptoassets must assess if they have sufficient competence and in‑house expertise in the product / service relating to the financial promotion before they approve it.

And to further heighten that hurdle to obtaining approval by an authorised person, the Government is considering introducing a “regulatory gateway” that authorised firms will need to pass through before they can approve financial promotions for unauthorised persons.

Reliance on exemptions (although some of the usual ones don’t apply)

Therefore, firms will presumably look to rely on applicable exemptions in order to market cryptoassets. Existing exemptions set out in the FPO could apply to the promotion of cryptoassets, save for the exemptions for HNWIs (Article 48 of FPO) and self-certified sophisticated investors (Article 50A of FPO). Given that these tend to be some of the most commonly relied on exemptions, there is potential concern over the feasibility of lawfully advertising cryptoassets in line with the financial promotion regime.

That said, the Government has introduced a bespoke exemption in the FPO Amendment for firms already registered with the FCA for anti-money laundering purposes under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (“MLR”). MLR-registered firms would therefore likely be able to continue marketing cryptoassets to prospective UK customers even after the FPO Amendment comes into force.

FCA letter to overseas firms

On 4 July 2023, as we were writing this piece, the FCA published a letter to overseas firms setting out its expectations regarding compliance with the cryptoasset financial promotion regime. In this letter, the FCA rehearses the “four routes” for lawful financial promotions of cryptoassets (which we have discussed above):

• the promotion is communicated by an authorised person;
• the promotion is made by an unauthorised person but approved by an authorised person;
• the promotion is communicated by a cryptoasset business and registered with the FCA under the MLR; and
• the promotion is otherwise exempt under the FPO.

The FCA also urges all cryptoasset firms to consider their preparation for the financial promotions regime that will come into play this 8 October 2023. In particular, the FCA says that unregistered or unauthorised cryptoasset businesses marketing to UK consumers should:

• “Consider which of the four legal routes they will use to make their financial promotions, how they will meet the requirements of that route and the associated FCA rules that apply to cryptoasset promotions set out in PS23/6.

• Carefully consider how they will deal with UK customers if they are unable to communicate financial promotions to them. We expect firms to clearly communicate any changes to services they will provide to UK consumers and give consumers adequate time to respond to any changes before they go into effect.

• If firms decide to no longer provide services to UK consumers, we expect them to have in place orderly wind-down plans to minimise any impact on UK consumers. Firms may find our Wind-down Planning Guide useful in considering their plans”.

Concluding thoughts

Clearly, firms that are marketing cryptoassets in the UK (whether from within the UK or from overseas) who have not yet thought about how to comply with regulation of financial promotions made in the UK have some serious catching up to do.  The race is on to be compliant well before 8 October 2023, giving firms an implementation period of four months (a drop from the six months proposed previously).

Crypto remains a divisive subject and, depending on which side of the fence they sit on, commentators may think that the new regulation is too restrictive or does not go far enough.  The FCA thinks that it has got the balance about right, but we wait to see how the industry reacts.

This piece was written by Henry Humphreys and Samantha Cheong, with input from Winston Penhall. If you have any questions about the regulation of crypto as an asset class, then do please get in touch with the team.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

Humphreys Law