On 20 July 2020, HM Treasury (HMT) published a consultation paper proposing to bring the promotion of certain types of cryptoasset within scope of the financial promotions restriction. The proposed changes, together with those proposed in HMT’s parallel consultation on the financial promotions approval regime (see our earlier post here) would result in a significant expansion of the scope of the financial promotions regime. We set out key considerations for firms below.
The Rationale for Regulatory Change
HMT is concerned that cryptoassets pose unacceptable levels of risk to consumers, including among others the risk of consumers purchasing unsuitable products without having access to adequate information. The final report issued by the Cryptoassets Taskforce (consisting of HMT, the FCA and the Bank of England) in 2018 identified misleading advertising and a lack of suitable information as a key consumer protection issue in cryptoasset markets, particularly in circumstances where advertising is targeted at retail investors. Further research carried out by the FCA more recently indicates that advertising plays a key role in influencing purchasers’ decisions, underscoring the importance of promotions being candid about the risks involved (see our earlier post here for key findings from the FCA’s research).
To mitigate these potential risks, HMT proposes to bring certain unregulated cryptoassets within the scope of the financial promotions regime.
The Current Regulatory Status of Cryptoassets
Only cryptoassets that fall within the regulatory perimeter are subject to the restriction on financial promotions. Currently, security tokens that fall within the regulatory perimeter of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) are captured by the Financial Services and Markets Act 2000 (Financial Promotion) Order (FPO) 2005 as “controlled investments”, and e-money tokens are regulated separately under Electronic Money Regulations 2011. Promotion of either is subject to the financial promotions regime.
Unregulated cryptoassets – those that do not fall within the definition of a security token or e-money token – are not subject to similar regulation. Some cryptoassets, such as stablecoins, exchange tokens or utility tokens, are often, though not always, outside of the scope of the regulatory perimeter, and firms will need to consider their particular structure and arrangement to determine their regulatory status. The FCA’s guidance on cryptoassets sets out further information for firms to help determine whether a particular cryptoasset falls within the regulatory perimeter.
In order to bring the relevant activities into scope, HMT proposes to amend the FPO to include certain unregulated cryptoassets as new “qualifying cryptoassets” in the list of controlled investments, and to amend a number of the current controlled activities.
The proposed definition of “qualifying cryptoassets” includes only those cryptoassets that are both fungible and transferable. HMT believes that these two features make a cryptoasset significantly more likely to give rise to consumer protection concerns, because the cryptoasset could be seen as comparable to traditional financial services, such as shares. Consumers could, therefore, expect that the relevant cryptoasset can be easily transferable and will rise in value even if this is not the case. However, it should be noted that the FCA’s recent research concluded that the majority of purchasers understand that cryptoassets are largely unregulated and subject to price volatility.
The proposed definition excludes non-fungible cryptoassets, such as digital collectibles. Furthermore, the exclusion of cryptoassets that are “not transferable” nor which “confer transferable rights” would exclude cryptoassets used within a closed system where only redemption via the issuer, rather than transfer to other users, is possible.
HMT’s proposal would amend a number of controlled activities to incorporate the buying, selling, subscribing for or underwriting of “qualifying cryptoassets”; HMT considers that these amendments would also cover cryptoasset exchanges, cryptoasset ATMs and airdrops. However, vendors merely offering to accept cryptoassets in exchange for their goods or services, and buyers merely offering cryptoassets to pay for goods or services, in the same manner as they would accept pound sterling payments, would not be captured under the expanded regime.
Potential Impact on Cryptoasset Businesses
Should the new definitions come into force, not every type of cryptoasset will fall within the extended regime. Firms will need to consider if their cryptoasset is both fungible and transferable, and, if so, consider whether any changes to their processes and procedures are required to ensure that they comply with the restriction on financial promotions. Firms failing to comply with the financial promotions regime could be subject to FCA enforcement action. The FCA may require infringing firms to change or withdraw their marketing materials, or, in certain circumstances, subject the firm to a fine or prosecution.
Note that HMT does not propose to introduce a transitional period before the amendments come into force – firms promoting cryptoassets will therefore need to keep a close watch on the outcome of the consultation to ensure that they are ready to comply with any new requirements as soon as they are in force. The government also intends to consult on the broader regulatory treatment of cryptoassets later in 2020, which could lead to even more significant regulatory change for cryptoasset businesses.
Firms should also consider if they wish to respond to the consultation. The deadline for responses is midnight on 25 October 2020. Should firms wish to engage in the consultation, or have any queries around the current scope of the regulatory perimeter on cryptoassets, please get in touch with your usual Baker McKenzie contact.