UK government looks to tighten red tape for crypto businesses

On 20th July 2020, HM Treasury (“HMT”) published a consultation paper seeking to:

• bring the promotion of certain types of cryptoassets within the scope of financial promotions regulation under the Financial Services and Markets Act (“FSMA”); and
• require persons conducting certain ‘controlled activities’ (such as dealing in, advising on, arranging and managing relevant cryptoassets) to become FCA authorised.

The title of the consultation paper is somewhat misleading as it refers only to ‘cryptoasset promotions’ but a detailed reading shows that HMT intends to require persons carrying on other relevant activities to be fully licensed.

The consultation period runs from 20 July 2020 to 25 October 2020. HMT hopes to receive constructive feedback from authorised firms that would be affected by the proposed policy in the consultation paper.

Back in March 2018, the government set up the Cryptoassets Taskforce (“Taskforce”) which it tasked with exploring the potential impact of cryptoassets in the UK, focussing on their impact on consumers and businesses.  Unsurprisingly, the Taskforce concluded that cryptoassets were a priority for the authorities and posed a risk to consumers and markets.

In 2019, the Taskforce found that many of the existing cryptoassets in the market exposed consumers to unacceptable levels of risk due to misleading advertising and a lack of suitable information available for consumers.

Financial promotions

Currently, the financial promotions restriction under section 21 of FSMA provides that a person must not, in the course of business, communicate an initiation or inducement to engage in investment activity.

The cryptoassets that currently fall under this restriction are security tokens and e-money tokens. This means other classes of cryptoassets can currently be freely marketed without restriction and in particular to ‘retail’ investors.

What constitutes a security token or an e-money token is a question of fact and quite often a difficult question to answer conclusively.  It requires detailed consideration of what constitutes a ‘share’, a ‘security’, a ‘derivative’ or “other ‘financial instrument’, and even then the answer may be elusive.

Further, different interpretations need to be undertaken with regard to the applicability of the relevant EU legislation (such as the Markets in Financial Instruments Directive (“MiFID”), the Alternative Investments Fund manager Directive (“AIFMD”) and the Prospectus Directive which often contain similar but subtly different definitions than those used in the FSMA.

Going forward, HMT is proposing – citing the significant instances of misleading information it has identified in relation to the promotion of cryptoassets – to recommend that certain types of currently unregulated cryptoassets are legislated to fall under the financial promotions regime.

HMT is currently proposing to only include cryptoassets that are both fungible and transferable to be brought within the ambit of section 21 of FSMA.

This appears to catch a significant part of the crypto community as most cryptoassets will be ‘fungible’ (meaning the each token is substantially identical to each other token such that one token can be exchanged for another without any difference in the rights attached); and ‘transferable’, meaning they can be freely bought and sold (whether or not listed or traded on exchanges).

Although the exemptions which apply to other financial promotions should be similarly available to promotions of newly covered cryptoassets, many of those exemptions are geared towards promotions to non-retail investors and so are unlikely to be available.  In practice this means promotions by unregulated issuers will indeed need to be approved by an FCA authorised firm.

HMT is separately proposing to tighten the rules under which unauthorised firms can have their financial promotions approved by FCA regulated firms.  They propose that FCA firms would have to obtain specific approval from the FCA to do so and that this would be designed to ensure the approving firm has the relevant expertise and systems and controls in place.

FCA authorisation of firms carrying on ‘Controlled Activities’ in relation to cryptoassets

The consultation paper goes much further than its title suggests and it is proposed that anyone carrying on ‘controlled activities’ in relation to relevant cryptoassets will need to be regulated by the FCA.

‘Controlled activities’ are, broadly, those that are already covered by FSMA – e.g. dealing in, advising on, arranging and managing specified instruments and which in future will include fungible and transferable cryptoassets.

Anyone involved in the issuance or sale of relevant cryptoassets will in future either need to be FCA authorised or operate within available exemptions.  Further still, as the buyers of cryptoassets are typically ‘retail’ investors, applicants will be subject to considerable scrutiny by the FCA whose rules are considerably more onerous when it comes to dealing with retail investors.

Martin Cornish, Senior Consultant of HLaw commented:

“Individuals and firms will need to be careful in their assessment of whether cryptoassets they are issuing or promoting or otherwise dealing in will fall within the scope of the proposed regulations.

Whilst issuers will likely not need to be regulated (just as ordinary companies issuing equity and debt securities are exempted), the marketing of cryptoassets (directly by the issuer or by third parties) will likely be considered a financial promotion and therefore will need to be carried out, and materials used will need to be issued or approved, by an FCA regulated firm. 

Moreover, the regulated activity of ‘arranging’ transactions is extremely broad and may require marketers to be separately regulated by FCA. 

Exchanges which enable parties to buy and sell such cryptoassets will also need to be regulated – currently only those listing ‘securities’ tokens are required to be regulated.

Given that HMT is not proposing to introduce a grace period before the amendments come into force, firms will need to assess whether cryptoassets they deal with are fungible and transferable.

A failure to comply with restrictions on financial promotions and undertaking activities which are regulated under FSMA without FCA authorisation carries hefty consequences, subjecting relevant individuals and firms to a fine or potential criminal prosecution.”

The consultation will end on 25 October 2020. At the end of the consultation period, HMT will then consider the feedback received and set out a further proposal.

This piece was prepared by Victoria Clement with input from Martin Cornish.

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.  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