- On 18 January 2022, HM Treasury (“HMT”) published a Consultation Response (the “HMT Response”) following their Consultation Paper on Cryptoasset Promotions in July 2020 (the “HMT Consultation Paper”) (please see our previous article on this consultation paper). The HMT Consultation Paper and HMT Response set out new rules which will bring cryptoassets within the scope of the financial promotion regime. This will create new rules for the marketing and advertising of certain cryptoassets and related activities in the UK.
- On 19 January 2022, the Financial Conduct Authority (“FCA”) published a Consultation Paper which outlined proposals to strengthen the financial promotion rules that apply to high-risk investments, which will include marketing rules relating to cryptoassets (the “FCA Consultation Paper”). The FCA Consultation Paper has been published further to its previous Discussion Paper (DP21/1) of April 2021, which set out proposals to limit the promotion of high-risk investments (see our article on the topic available here).
This article summarises both of these developments and how they will impact firms that are involved in marketing cryptoassets in the UK.
What is the financial promotion regime?
In summary, a “financial promotion” is any invitation or inducement that is communicated in the course of business to engage in investment activity. The financial promotion regime applies to communications in respect of certain activities involving "controlled investments", such as shares, bonds or derivatives. Financial promotions that are capable of having an effect in the UK must:
- be issued by an FCA/PRA-authorised person;
- be approved by an FCA/PRA-authorised person; or
- fall within an exemption from the financial promotion regime.
The HMT Response
Types of cryptoassets that will fall within the financial promotion regime
To expand the financial promotion regime to include cryptoassets, the HMT Response refers to adding a new type of controlled investment, being “qualifying cryptoassets”. While the exact definition of "qualifying cryptoassets" has not yet been confirmed, the current proposed definition refers to any cryptographically secured digital representation of value or contractual rights 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 within the definition of electronic money; and
- is not currency issued by a central bank or other public authority.
This definition is broad and should include the majority of cryptocurrencies and cryptoassets that are not already within the scope of the financial promotion regime. As a result, when the new regime enters into force, financial promotions that are capable of having an effect in the UK, which relate to these cryptocurrencies and cryptoassets, will no longer be permitted unless they fall within (a), (b) or (c) above.
HMT has emphasised that the proposed definition of “qualifying cryptoassets” remains under review and, as such, further changes or clarifications are possible. For example, HMT has considered the complexity of the terms “fungibility” and “transferability” but has not yet amended these aspects of the definition.
Key changes in the HMT Response
- Removal of Distributed Ledger Technology (DLT) from the definition of “qualifying cryptoassets” – the HMT Consultation Paper proposed a definition of “qualifying cryptoassets” which included a requirement for the cryptoasset to use DLT. The HMT Response states that this reference to DLT will be removed from this definition, which should future proof the definition in light of evolving technologies.
- Removal of the proposed exemption relating to accepting cryptoassets as a means of payment – the HMT Consultation Paper proposed introducing an exemption for promotions that simply state that a vendor is willing to accept or offer qualifying cryptoassets in exchange for goods and services. This exemption has now been removed on the basis that such statements are already outside of the financial promotion regime, so this exemption is not required (given that such promotions do not amount to an “invitation” or “inducement”).
- Transferability exclusion – a new exclusion has been added to address concerns that the transferability criteria could include tokens that do not typically give rise to consumer protection risks. For example, travel passes, lunch passes and supermarket loyalty schemes that are cryptographically secure shall be exempt.
Key clarifications in the HMT Response
- Fungibility – fungibility will remain within the definition of “qualifying cryptoassets”. Therefore, non-fungible tokens (NFTs) will not fall within the scope of the financial promotion regime once these changes enter into force.
- Wrapped tokens – whether fungible tokens wrapped in NFTs would result in such NFTs falling within the definition of "qualifying cryptoassets" shall be decided on a case-by-case basis.
- Hybrid tokens (tokens capable of having features associated with both regulated security tokens and unregulated tokens) – whether or not this type of token will fall within the definition of "qualifying cryptoassets" will also be decided on a case-by-case basis. However, HMT expects that hybrid tokens will generally be considered as either qualifying cryptoassets or another controlled investment, therefore the financial promotion regime is likely to apply.
- Wallets – the provision of custody activities relating to cryptoassets will not fall within the financial promotions regime (due to the relatively low risk of consumer harm when compared with the buying and selling of cryptoassets).
- Existing exemptions from the financial promotion regime – HMT has clarified that the existing exemptions mentioned in (c) above will generally apply to financial promotions that relate to qualifying cryptoassets. However, one particular point to note is that the exemptions for certified high net worth individuals and self-certified sophisticated investors will not apply in relation to qualifying cryptoassets.
Transitional period and overall timing
Whilst there has been no exact date provided to indicate when the rules will be finalised and published, HMT has stated that the legislation implementing these changes will be brought forward once parliamentary time allows, therefore it should be expected shortly. HMT has also proposed a six-month transition period from the publication of the final rules and the corresponding amendments in the FCA rules.
The FCA Consultation Paper
HMT stated in the HMT Response that it expected the FCA to shortly publish its own consultation paper on changes to its rules in relation to cryptoasset promotions. Sure enough, the following day the FCA Consultation Paper was published!
As background, the FCA published a Discussion Paper setting out proposals for limiting the promotion of high-risk investments (see our article on the topic available here). Following on from this Discussion Paper, the FCA Consultation Paper proposes that “qualifying cryptoassets” are classified as “Restricted Mass Market Investments”, which would be a new category that is subject to the same marketing restrictions currently applicable to non-readily realisable securities (such as unlisted shares) and peer to peer loans. Overall, these restrictions would limit the marketing of cryptoassets to retail customers.
The Restricted Mass Market Investments restrictions consist of the following elements:
- restrictions on direct offer financial promotions to certain retail customer categories only;
- carrying out an appropriateness test on all recipients of any marketing;
- including risk warnings in any marketing; and
- including “positive frictions” in the sales journey.
We have discussed each of these elements below.
- Direct offer financial promotions
"Direct offer financial promotions” are any financial promotions which contain:
- an offer to (enter into an agreement to) purchase cryptoassets with persons who respond to the communication; or
- an invitation to persons who respond to the communication to make an offer to (enter into an agreement to) purchase cryptoassets.
Any general financial promotions should not fall within the scope of these new rules. However, should a financial promotion include, for example, an application form to purchase cryptocurrencies, this is likely to amount to a “direct offer” financial promotion.
It is also proposed that direct offer financial promotions for Restricted Mass Market Investments, including qualifying cryptoassets, may only be sent to the following particular categories of retail customers:
- certified high net worth individuals – individuals who have signed a statement and confirmed to the firm that they are high net worth individuals;
- certified sophisticated investors – individuals who have been certified as sophisticated investors;
- self-certified sophisticated investors – individuals who have signed a statement to self-certify that they are sophisticated investors; and
- “restricted” investors – individuals who have signed a statement confirming that they are not investing more than 10% of their net assets (excluding, amongst other things, their residence, insurance contracts, and pension monies) in the product.
- Appropriateness testing
This proposal requires firms to carry out an appropriate test to ensure that a retail customer has the relevant knowledge and experience in cryptoassets before they are able to purchase and deal etc. with qualifying cryptoassets. Firms should then consider whether a qualifying cryptoasset is appropriate for the customer.
The FCA has set out twelve factors which should be considered when determining whether a customer has the necessary knowledge to understand the risks associated with "qualifying cryptoassets" and indicates that the firm should consider asking clients questions to cover at least those twelve factors. These factors include, for example: the complexity, volatility and risk of loss of the qualifying cryptoasset; not being able to readily sell; not being comparable to traditional investments; FSCS compensation not being available (where this is the case), and the risk of loss as a result of a cyber-attack.
- Risk warnings and positive friction
The FCA has also proposed that risk warnings are sent to customers and positive friction is introduced into the customer journey.
The proposed risk warnings should set out the risks of investments in cryptoassets and must be contained in financial promotions to customers. There should also be a personalised risk warning “pop up” for customers following any direct offer financial promotions.
The proposed positive friction includes a 24-hour cooling off period for first-time investors in qualifying cryptoassets.
The FCA invites comments on the proposed rules set out in the FCA Consultation Paper, which should be submitted before 22 March 2022. The FCA then intends to publish its final rules in summer 2022. Firms will then have three months to comply with the new requirements.
These are major new developments in cryptoasset regulation in the UK which will impact any firm involved in marketing qualifying cryptoassets in the UK (whether the marketing originates from within the UK or overseas). When considering this new regime, cryptoasset firms should be particularly aware of the following:
- The regime has an extensive territorial scope – the financial promotion regime applies to communications “capable of having an effect in the United Kingdom” and therefore includes communications created overseas which are then capable of doing so.
- Approval of financial promotions – most UK firms in the cryptoasset industry do not themselves have the relevant FCA authorisation to issue their own financial promotions as set out in (a) above, and the exemptions mentioned in (c) above are unlikely to allow them to carry on their business as they wish. This means that these firms will need to identify an FCA/PRA authorised firm, with the relevant permissions which is willing to approve its financial promotions, as set out in (b) above. This is likely to lead to additional costs and will have timing implications.
- Likely to be a limited number of FCA authorised firms that can approve a financial promotion relating to qualifying cryptoassets – the HMT Response overlaps with the separate proposal to introduce a new regulatory gateway (see our article on the topic available here), which states that FCA authorised firms may only approve financial promotions for unauthorised firms if they have been assessed by the FCA to be suitable to do so. Firms approving financial promotions will have to assess whether they have sufficient expertise in the product that is the subject of the financial promotion before approving it. The FCA expects that there will be a limited number of firms who will be able to approve financial promotions for cryptoasset firms under the new regime. However, the FCA has indicated that it will nonetheless apply the rules under the proposed gateway to financial promotions relating to qualifying cryptoassets in the same way that they will apply to financial promotions that relate to other investment products
Co-authored by Hannah Manning.