The “regulatory perimeter” describes the boundary between regulated and unregulated financial services activities. If a firm carries out activities falling within the “regulatory perimeter” in the UK as part of a business, it will usually need to be authorised by the FCA (and, in some cases, the PRA) unless it can rely on an exclusion. Similarly, a firm cannot issue a “financial promotion” (i.e. inviting persons to engage in investment activity, such as inviting customers to buy regulated cryptoassets) without FCA authorisation or a person authorised by the FCA approving the content of such communication.
Types of cryptoassets
In order to fall within the FCA’s regulatory perimeter, a person must be carrying out a “specified activity” in relation to a “specified investment”. The FCA has provided guidance on whether different types of cryptoassets shall constitute a “specified investment” and so fall within the regulatory perimeter.
The FCA sets out that there are two broad categories of unregulated tokens: exchange tokens and utility tokens; and two broad categories of regulated tokens: security tokens and electronic money (“e-money”) tokens.
The Guidance sets out that exchange tokens, which the FCA describes as tokens (not recognised as legal tender) that typically do not grant the holder any rights associated with specified investments and are decentralised with no central issuer obliged to honour any contractual rights, fall outside the regulatory perimeter. Examples of exchange tokens include Bitcoin, Ether, and XRP. As exchange tokens fall outside the regulatory perimeter, so do activities carried out in respect of such tokens.
However, the FCA reminds firms to be aware of the Fifth Anti Money Laundering Directive (“5AMLD”) and the Government’s intention to “gold-plate” the requirements of 5AMLD by extending UK anti money laundering regulation to include, amongst other things, exchange services between cryptoassets, cryptoasset ATMs, the transfer of cryptoassets, and the issuance of new cryptoassets (e.g. through an initial coin offering (“ICO”)).
The Guidance sets out that utility tokens, described as tokens providing consumers with access to a current or prospective service or product, similar to a pre-payment voucher, fall outside the regulatory perimeter.
The FCA provides a number of case studies with examples of circumstances where a token constitutes a utility token and is unregulated. For instance:
- issuing a token that is fully transferable and used to access products and services within a firm’s own network / ecosystem, but that cannot be used as a means of exchange across other networks;
- using a token as a settlement token to improve the speed of back-office functions through a permissioned distributed ledger technology (“DLT”) system, provided the token is used within the firm’s own internal network and accounting system and not used as a means of payment in any other network or ecosystem; and
- issuing a transferable token that gives the token holder storage rights on a network.
The Guidance states that security tokens, described as tokens that provide rights and obligations akin to specified investments other than e-money (e.g. shares), will fall within the regulatory perimeter. The FCA considers that this depends on the function of the token and is irrespective of the labelling of a token in a whitepaper.
The FCA provides examples of rights provided by a token which will make it likely to constitute a security token:
- If tokens represent ownership rights (e.g. through the payment of dividends and capital distributions) or control (through voting) it is likely to constitute a security token.However, tokens may also give voting rights on direction without it being considered control; for instance, providing the token holder with the right to vote on future ICOs the firm will invest in but no other rights would not constitute control.
- If a token represents debt owed by the issuer, it is likely to constitute a security token.
- If a token gives its holder the right to subscribe to a future security token, it is likely to constitute a security token.
- If a token acts as a vehicle through which profits or income are shared or pooled (e.g. profits from hiring out artwork held by the vehicle), provided the token holders do not have day-to-day control over the asset held by the vehicle (such as the artwork in the previous example), it is likely to constitute a security token.
The Guidance sets out that e-money tokens, described as tokens which meet the definition of e-money under the Electronic Money Regulations 2011 (“EMRs”), will fall within the regulatory perimeter.
E-money is defined under the EMRs as electronically stored monetary value as represented by a claim on the e-money issuer which:
- is issued on receipt of funds for the purposes of making payments;
- is accepted by a person other than the e-money issuer; and
- does not fall within an exclusion under regulation 3 of the EMRs.
The Guidance clarifies that “stablecoins”, described as tokens stabilised through being backed by fiat currency, cryptoassets, other tangible assets, algorithms, or a combination thereof, may fall to be regulated or remain outside the regulatory perimeter subject to their structure and the stabilisation method used. The FCA sets out that any token pegged to a currency such as USD or GBP, or other assets, and used for the payment of goods and services on a network could potentially fall within the definition of e-money and therefore be within the regulatory perimeter. However, such a token will also have to meet the other criteria of the definition of e-money as set out above.
Potential activities requiring authorisation
The FCA provides a high-level overview of different categories of market participants and activities they typically carry out, which are likely to be subject to regulations (e.g. the Prospectus Regulation) or otherwise require authorisation for the provision of services such as advising on investments, dealing, arranging, operating an OTF or MTF, safeguarding and administering investments, and the sending of dematerialised instructions. These include:
- Issuers of tokens – issuing tokens including through ICOs;
- Advisers and other intermediaries – providing advice to consumers and helping to facilitate the purchase of tokens;
- Exchanges and trading platforms – facilitating transactions between market participants;
- Wallet providers and custodians – provide the secure storage of tokens; and
- Payment providers – enabling customers to pay merchants in fiat currency or transfer fiat currency via a cryptoasset.
If a firm is inviting customers to engage in an investment activity, such as encouraging customers to purchase a certain type of security token, such communications may fall under the financial promotion regime.
The FCA expects market participants to act in accordance with the financial promotions rules when a financial promotion is made. The FCA also places particular emphasis on firms ensuring that they do not, in any way, communicate that their authorisation extends to unregulated cryptoassets, and communications must be transparent to ensure customers are aware which activities the firm is authorised for.
In addition, the FCA sets out that the issuer of a security token which will be offered to the public in the UK or admitted to trading on a regulated market must publish a prospectus unless an exemption applies.
The Guidance provides long awaited clarity for market participants and will help new and established companies to better understand the regulatory treatment of cryptoassets and their regulatory obligations when carrying out activities in respect of cryptoassets. Whilst FCA guidance is not binding on courts, firms are generally deemed to have complied with FCA requirements where they act in accordance with FCA guidance. Market participants are therefore well advised to take full note of the Guidance and, if necessary, seek expert advice where uncertainties remain. At the same time, the Guidance is also a potentially useful tool for consumers to better understand cryptoassets and whether they may benefit from any regulatory protections when dealing with cryptoassets. The ultimate success of the Guidance will become apparent over time once it has been more widely used and relied upon by market participants.
The FCA’s Guidance also marks the first milestone in ongoing initiatives to further develop and implement the UK’s regulatory approach to cryptoassets. The following initiatives are work in progress:
- the FCA’s consultation on potentially banning the sale of derivatives relating to certain types of unregulated cryptoassets to retail customers which is due to close on 3 October 2019 with a subsequent policy statement expect in Q1 2020;
- a consultation by the Treasury on whether further regulation is required in the cryptoasset market, in particular with regard to unregulated cryptoassets; and
- work relating to the transposition of 5AMLD which is scheduled to be implemented by 10 January 2020.