Jake Pope – D2 Legal Technology Ltd.
As Cryptoassets become increasingly more commonplace in global financial systems, regulators across the world face many challenges of regulating an asset which is relatively unknown, and which continues to evolve. One of these challenges comes from the increase in popularity of cryptoassets amongst retail investors. A report published by the FCA in 2018 found that retail ownership of cryptoassets has risen, while the level of understanding of cryptoassets is declining. In 2021, the FCA’s estimate for the number of consumers holding cryptoassets rose to 2.3 million, a rise from 3.9% of the population to 4.4% of the population. One of the suspected causes of this increase is that crypto advertising often overstates the benefits of cryptoassets and rarely highlights the risks involved.
The UK Financial Promotion Regime
On 18th January 2022, HM Treasury published its Response to its consultation on bringing cryptoassets in scope of the UK Financial Promotions Regime. The Response confirmed that “Qualifying Cryptoassets” will be included in the Financial Promotion Order (FPO).
What does this mean? To begin with, the FPO is a piece of legislation that governs the financial promotions in the UK. Financial promotions have a significant influence in the investment decisions of individuals and therefore it is important to have appropriate safeguards in place to protect consumers. Adding “Qualifying Cryptoassets” to the FPO means that these assets will be brought within scope of the Financial Promotion Restriction under Section 21 of the Financial Services and Markets Act 2000 (FSMA).
Section 21 provides that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity or to engage in claims management activity unless the promotion has been made or approved by an authorised person or is exempt, or the content of the promotion is approved by the FCA or Prudential Regulation Authority . For the purposes of Section 21 an authorised person is an individual or business that is authorised by the FCA or Prudential Regulation Authority.
It is a criminal offence to communicate a financial promotion in breach of Section 21 under Section 25 of FSMA. The FCA has the potential to direct the authorised firm to address the breach, which can include directing the firm to withdraw its approval of the promotion or lead to an enforcement action if serious misconduct has occurred.
The Financial Promotion Restriction only applies to ‘controlled investments’ and to ‘controlled activities.’ These activities are:
- Dealing in qualifying cryptoassets;
- Arranging deals in qualifying cryptoassets;
- Managing qualifying cryptoassets;
- Advising on qualifying cryptoassets;
- Agreeing to carry on specified kinds of activity.
In the consultation, the government set out that these controlled activities best reflect the activities that cryptoassets businesses conduct in the UK and are activities most associated with misleading cryptoassets promotions identified by the FCA. This means that any of these activities which involve qualifying cryptoassets will be caught under Section 21.
The government intends to define the scope of ‘qualifying cryptoasset’ as “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable”. This definition is by no means final and may be subject to change before being presented to Parliament. Interestingly, the government deliberately decided not to include distributed ledger technology (DLT) or blockchain in the definition. As already mentioned, cryptoassets are an evolving asset and the decision to not include these characteristics is to ensure that the definition can withstand any future evolution of cryptoassets where perhaps blockchain and DLT are no longer a defining feature.
Further, the fungibility aspect of the definition means that many NFTs will not be in scope of the FPO. This is because the consultation found that NFTs are more akin to a digital collector’s items than a financial services product.
There are several exemptions found in the FPO. The exemptions listed in Part IV of the FPO apply to all qualifying cryptoassets. If the ‘controlled activities’ listed above are communicated to investment professionals, journalists or overseas recipients they are exempt. Whereas the exemptions listed under Part VI will apply to certain controlled activities and the proposal suggests that some will apply to cryptoassets promotions, whilst others will not.
The changes to be implemented by the UK government and FCA will create a significant barrier to firms dealing in cryptoassets in the UK. This is because those firms that are not exempt and are not authorised will need to seek out an authorised approver for their promotions that come within scope of Section 21 approvers. The problem is that there are only a limited number of authorised approvers and the vast majority of UK cryptoasset firms are not authorised. As a result, authorised firms could face an unmanageable caseload of requests and may refuse to approve certain communications.
A communication that is found to be in breach of Section 21 can also have significant reputational impact on cryptoasset firms, as it implies that a firm is producing misleading advertising to the ordinary consumer. This is of course, bad for business.
The Government will introduce a sixth month transition period before the changes come into effect following the publication of the final changes to the FPO and the accompanying FCA Rules. In the wake of this tighter regulatory scrutiny, cryptoasset firms will need to rethink the way in which they make communications and ensure that they are consistent with the FPO. Given that a breach of Section 21 is a criminal offence, unauthorised firms should not take these regulatory changes lightly.
 Ibid 1.