Earlier this year, HM Treasury published two consultations proposing amendments to the UK regulatory framework for approval of financial promotions and with respect to cryptoasset promotions.
Overall, the consultation papers propose important changes to the way unauthorised persons communicate financial promotions more generally and also specifically in regard to cryptoassets.
Background: The FSMA financial promotions regime
A financial promotion is an invitation or inducement to engage in investment activity. The communication of financial promotions is governed by the Financial Services and Markets Act 2000 (FSMA). More specifically, section 21 of FSMA provides that an unauthorised person must not communicate a financial promotion, except where that promotion is approved by an authorised person or the communication is otherwise exempt.
The FSMA Financial Promotions Order (FPO) provides for certain exemptions to the section 21 restriction; for example, in cases where the recipient is an institutional or sophisticated investor.
The financial promotions regime applies in relation to certain specified investments, such as securities like shares and bonds. It also covers cryptoassets that function in a similar manner to securities (so called security tokens). However, a number of cryptoassets fall outside the financial promotions framework, which means they may be promoted to investors (including retail persons) without the relevant safeguards in place for security tokens.
Consultation on financial promotions approval regime
Currently, any authorised person may approve financial promotions for the purposes of section 21 FSMA. The first consultation seeks to change this by introducing a regulatory gateway that aims to increase Financial Conduct Authority (FCA) oversight in this area. In particular, according to the government's proposal, an authorised firm that wishes to be able to approve financial promotions must first obtain the consent of the FCA to be able to provide such service specifically.
The consultation discusses the various ways such a requirement could be introduced in the current framework. For example, the "approval of financial promotions communicated by unauthorised persons" could constitute a new regulated activity under FSMA for which a Part 4A permission would be specifically required. This means that not every authorised person will be able to approve financial promotions of unauthorised persons, but only those that have specific FCA permission to do so.
Consultation on financial promotions concerning cryptoassets
The second consultation aims to bring into the scope of the financial promotions regime certain cryptoassets that are currently unregulated, but nevertheless have similar characteristics to regulated cryptoassets, such as security tokens. According to the government, this gap in regulation exposes consumers to "unacceptable levels of risk." The consultation proposes to add the list of controlled investments which are subject to the financial promotions regime a new category of "qualifying cryptoassets."
A "qualifying cryptoasset" would be defined as "any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and which:
- is fungible;
- is transferable or confers transferable rights, or is promoted as being transferable or as conferring transferable rights;
- is not any other controlled investment;
- is not electronic money within the meaning given in the Electronic Money Regulations 2011; and
- is not currency issued by a central bank or other public authority."
According to the consultation, the majority of so called stablecoins that do not already qualify as electronic money or security tokens would be caught under this new category of "qualifying cryptoassets."
The new regulated category would only cover cryptoassets that are both fungible and transferable. This would exclude, for example, cryptoassets used within a closed system where the only redemption option is via the issuer, rather than transfer to other users. This means that arrangements such as a blockchain supermarket customer loyalty scheme which uses tokens analogous to loyalty points would fall outside the scope of the financial promotions regime.
The consultation also proposes to add a new FPO exemption to allow vendors that merely offer to accept cryptoassets in exchange for their goods or services, and buyers that merely offer cryptoassets to pay for goods or services in the same manner as they would use fiat currency, to continue doing so without needing to comply with the financial promotions restrictions. The new exemption would provide that "the financial promotion restriction does not apply to any communication which merely states that a person is willing to accept or to offer qualifying cryptoassets in consideration for the supply of goods or services."
The consultation closes on 26 October 2020, and we note that it will affect large numbers of cryptoasset service providers who deal with cryptoassets, including payment tokens such as bitcoin and ethereum, in the UK. The existing definitions around what constitutes a “financial promotion” are broad and we will be assisting our clients with understanding the potential consequences as the FCA looks at expanding the regulatory perimeter to cover otherwise unregulated cryptoassets in these respects.