This article discusses the application of the UK financial services regulatory regime to cryptoassets and outlines the main UK policy developments. It explains how the UK regulatory perimeter and financial promotions framework applies to market participants carrying on activities (both regulated and unregulated) relating to the different types of cryptoassets.
Introduction
UK legislators and regulators recognise that clarity and certainty for market participants as to the rules that apply to cryptoassets is essential to encourage and support future innovation in the financial services sector, as well as ensuring optimal consumer outcomes. Currently, UK legislators and regulators have applied the existing regulatory framework and legislation to cryptoassets as it would apply to other financial products and services but are they contemplating the development of a bespoke framework for crytpoassets. This article outlines the current regulation of cryptoassets within the UK. It explains what is regulated by the UK regulators, where regulation applies and how this impacts on firms and whether a person carrying on activities relating to cryptoassets can promote its activities in the UK. It also provides an overview of the key legislative and regulatory proposals.
Overview of key provisions
a. FCA perimeter
The Financial Conduct Authority (FCA) perimeter, determines which activities require FCA authorisation and what level of protection consumers can expect for the financial services and products they purchase. The perimeter is decided by the Government and Parliament through legislation. The perimeter includes specified activities and investments set out in FSMA1 and the RAO2 or activities regulated by the FCA by virtue of other legislation.
b. The Cryptoassets Taskforce and the FCA cryptoassets perimeter guidance
i. The UK government established a Cryptoassets Taskforce (the Taskforce), comprising the FCA, the Bank of England (BoE) and HM Treasury (HMT), to assess the policy and regulatory implications of cryptoassets, and the underlying technology in financial services. In the absence of an international consensus of the categorisation of cryptoassets, the Taskforce has established a framework for categorising cryptoassets3, which the FCA has subsequently used as a starting point for producing guidance on the extent to which different types of cryptoasset fall within the regulatory perimeter.
The Taskforce has defined cryptoassets as: “cryptographically secured digital representations of value or contractual rights that use [that is, are built on] some type of DLT [this includes blockchain] and can be transferred, stored or traded electronically.” It sub-divided them into distinct categories of tokens to reflect their specific characteristics:
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- Security tokens
- Exchange tokens
- Utility tokens
The Taskforce recognised that that cryptoassets have a range of features and a variety of uses that typically (although not mutually exclusive) are:
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- A means of exchange
- Investment
- Capital raising
ii. The FCA issued the Cryptoassets Perimeter Guidance (the Guidance)4 with the aim of clarifying whether the different types of tokens identified by the Taskforce are likely to fall within the existing regulatory perimeter. The Guidance considers both unregulated and regulated tokens. The FCA confirmed that security tokens fall within the regulatory perimeter whereas exchange tokens and utility tokens are generally considered unregulated. In addition to the tokens identified by the Taskforce, the FCA introduced e-money tokens and stablecoins. The FCA considers that e-money tokens are regulated tokens, whereas stablecoins may fall within the definition of an e-money token or a security token provided they meet all the conditions of security tokens and e-money tokens or fall outside the regulatory perimeter.
c. Understanding regulated and unregulated tokens
This section provides an overview of regulated and unregulated tokens, as set out in the Guidance.
i. Security tokens
A “security token” is any cryptoasset that provides rights or obligations that are akin to those specified investments, excluding electronic money, that are included in the RAO. In this sense, security tokens have characteristics of traditional securities, such that the rights and associated obligations for the holders of security tokens are largely, if not exactly, the same as those that would arise if they held traditional securities. Therefore, persons performing any specified activities as detailed in the RAO in relation to security tokens by way of business in the UK will likely need to be authorised by the FCA to do so.
ii. E-money tokens
Electronic money is defined as “electronically (including magnetically) stored value as represented by a claim on the electronic money issuer which (a) is used on receipt of funds for the purpose of making payment transactions; (b) is accepted by a person other than the electronic money issuer; and (c) is not excluded by regulation 3”5 An “e-money token” is considered by the FCA to be a cryptoasset that shares the characteristics of electronic money, such that the issuance of that “e-money token” constitutes a regulated activity for which authorisation is required if that activity is to be performed by way of business in the UK.
iii. Exchange tokens
With respect to exchange tokens, the FCA considers these to be forms of cryptoassets that facilitate transactions, either on a peer-to-peer basis or between consumers and businesses. The most common examples of exchange tokens are Bitcoin and Ethereum. It is acknowledged within the Guidance that exchange tokens may be held for speculative purposes, such that the holder may realise a profit or offset a loss from changes in the price of those exchange tokens, but the FCA does not consider that this is sufficient for such exchange tokens to become security tokens.
iv. Utility tokens
With respect to utility tokens, whilst the baseline position is that such forms of cryptoasset are typically classed as unregulated tokens, the exact position will depend on the nature and characteristics of the cryptoasset. A form of cryptoasset that gives its holders access to a current or prospective service or product is commonly cited as the example of what the FCA considers a utility token to be. Such utility tokens may have a reward element to them, such that the holder receives a discount or other benefits from holding the cryptoasset, such as early access to new features of a product or service. As with exchange tokens, the FCA has confirmed that, whilst it is aware that utility tokens may be held for speculative purposes and traded on various exchanges, this does not necessarily result in utility tokens being classified as security tokens for regulatory purposes.
v. Stablecoins
The FCA notes within the Guidance that the regulatory position with respect to stablecoins is uncertain and that certain stablecoins may constitute security or e-money tokens. HMT confirmed on 4 April 2022 its intention to, among others, bring activities that issue or facilitate the use of stablecoins used as a means of payment into the UK regulatory perimeter6. Stablecoins that stabilise their value by referencing other assets such as commodities will be outside the perimeter. HMT stated that the rationale for doing this is that certain stablecoins have the capacity to potentially become a widespread means of payment including by retail customers, driving consumer choice and efficiencies.
vi. Traditional financial instruments referencing cryptoassets
It should be noted that traditional financial instruments that reference cryptoassets as an underlying asset are likely to be considered specified investments by the FCA under the RAO, as opposed to security tokens, meaning they fall within the regulatory perimeter as a form of specified investment and the Guidance would not be applicable.
Practical considerations for crypto-asset market participants
a. Marketing and sales of investment products referencing cryptoassets
The FCA has banned7 the marketing, distribution and sale to retail clients of derivatives and exchange traded notes (ETNs) referencing unregulated transferable cryptoassets. It does not relate to security tokens (that is, those that qualify as specified investments), which fall inside the FCA’s regulatory remit. Derivatives referencing security tokens are not within scope of the ban.
b. FCA registration for AML purposes
The FCA is the anti-money laundering and counter-terrorist financing (AML/CTF) supervisor of UK cryptoasset businesses and has imposed a registration requirement to firms (both regulated and unregulated) that carry certain cryptoasset-related activities in the UK. These activities include:
i. Exchanging, or arranging or making arrangements with a view to exchange cryptoassets for money or vice versa, or one cryptoasset for another cryptoasset
ii. Operating a machine which uses automated processes to exchange money for cryptoassets or vice versa
iii. Providing custodian services for:
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- cryptoassets on behalf of customers
- private cryptographic keys to hold, store and transfer cryptoassets
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As part of the registration process, the FCA will determine whether each applicant has the necessary systems and controls in place to comply with the MLRs8 on an ongoing basis. The registration form asks for information about the applicant, its business (eg. business plan, marketing plan, systems and controls, list of all cryptoassset public keys/wallet addresses controlled by the applicant) and all of the key individuals in the business.
Policy developments and upcoming changes
a. The FCA 2021/2022 business plan
In its most recent business plan9, the FCA reinstated that it is in dialogue with HMT and the BoE to develop a regime for cryptoassets that encourages innovation while protecting consumers.
b. HMT and FCA consultations
i. In January 2022 HMT published its response10 to its July 2020 consultation paper on cryptoasset promotions11. HMT confirmed that any adjustments to the regulation of cryptoassets must be incremental and phased, and proportionate to regulation that is sensitive to risks posed and responsive to new market developments but will encompass the promotion of certain types of unregulated cryptoassets.
The promotion of a financial service or product is not itself a regulated activity for which a firm needs to be authorised but FSMA imposes a general restriction on the communication of financial promotions unless the promotion has been made or approved by an authorised person or it is exempt. A financial promotion is a communication of an invitation or inducement to engage in, among others, an investment activity in relation to a controlled investment or controlled activity. HMT plans to expand the scope of the restriction to include “qualifying cryptoassets”. HMT’s definition of “qualifying cryptoassets” is technology-agnostic but “qualifying cryptoassets” must be transferable and fungible. The qualifying cryptoassets-related activities do not include cryptoasset lending activities or decentralised finance.
In parallel, the Advertising Standards Authority (ASA) retains oversight of issues of responsibility across all forms of cryptoasset advertising and it designated cryptoasset advertising as a “red flag” priority12. The ASA expects advertisers to, among others, make clear if cryptoassets are regulated and protect, make clear that value can go down as well as up and state the basis used to calculate any projections or forecasts13.
ii. The FCA launched a consultation in January 202214 to complement HMT’s proposals on financial promotion. The FCA is consulting on the Introduction of new financial promotion rules for high-risk investments, which includes “qualifying cryptoassets”. The consultation seeks to bring qualifying cryptoassets under a more general regulatory perimeter and to list them alongside high-risk investments, but to nevertheless include them in the category of “Restricted Mass Market Investments” accessible to retail consumers. The promotion of “qualifying cryptoassets” will be subject to the requirements of the FCA’s financial promotion rules, including special requirements for “direct offer financial promotions”. The consultation closed on 23 March 2022 and the FCA intends to publish a Policy Statement and final rules in summer 2022.
About the Author
Effie Stathaki is a lawyer in Norton Rose Fulbright’s financial services regulatory practice, based in the firm’s London office. She advises client on a range of UK and European legislative and regulatory matters, with a particular focus on securities and derivatives markets, financial market infrastructure and Fintech.
References
1. Financial Services and Markets Act 2000 (FSMA)
2.Financial Services and Markets Act 2000 (Regulated Activities) Order 2001/544 (RAO)
3. Cryptoassets Taskforce: final report , October 2018
4. Guidance on Cryptoassets, Feedback and Final Guidance to CP 19/3, Policy Statement PS19/22, July 2019
5. Regulation 2(1) of the Electronic Money Regulations 2011 (EMRs)
6. UK regulatory approach to cryptoassets, stablecoins, and distributed ledger technology in financial markets: in title heading: Response to the consultation and call for evidence, HMT, April 2022
7. Prohibiting the sale to retail clients of investment products that reference cryptoassets, Policy Statement, PS20/10, October 2020. The final rules, which came into force on 6 January 2021, are in the Conduct of Business (Cryptoasset Products) Instrument 2020 (FCA 2020/34).
8. Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, as amended (MLRs)
9. FCA Business Plan 2022/23
10. Cryptoasset promotions: Consultation response, HMT, January 2022
11. Cryptoasset promotions: Consultation, HMT, July 2020
12. ASA statement on crypto-assets, 23 November 2021
13. ASA non-binding guidance on Cryptoassets, February 2022
14. Strengthening our financial promotion rules for high risk investments, including cryptoassets, Consultation Paper CP22/2, January 2022
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