This will mean that financial promotions relating to "qualifying cryptoassets" must be made or approved by a UK authorised person (that is, someone authorised in the UK by the Prudential Regulation Authority ("PRA") or the Financial Conduct Authority ("FCA")) or fall under an existing exemption under the financial promotions regime. Anyone who is not regulated in the UK – even if based in another country – is likely to find it very difficult to promote qualifying cryptoassets to UK-based customers.
What has happened?
- HM Treasury has indicated that it will extend the restriction of financial promotions set out in section 21 of the Financial Services and Markets Act 2000 ("FSMA") to apply to a newly defined category of "qualifying cryptoassets" which will be added to the list of controlled investments set out in the FSMA (Financial Promotion) Order 2005 ("FPO").
- Secondary legislation will implement these changes when parliamentary time allows; once the FCA has also published its own updated rules there will be a six-month transition period before the extended financial promotions regime comes into force.
- On 19 January 2022, the FCA published a consultation paper (CP22/2: "Strengthening our financial promotion rules for high risk investments, including cryptoassets") which outlines its proposed rules to implement HM Treasury's extended regime. As the FCA is consulting in parallel with the legislative process, the new regime could be finalised and introduced relatively quickly.
What will change?
In the UK, regulated investments – such as shares, funds, derivatives and insurance – are subject to the "financial promotion" restriction, which means that it is illegal to promote such investments to UK customers, other than in certain specific circumstances (described further below).
The financial promotions regime will now extend to unregulated cryptoassets that fall within the category of "qualifying cryptoassets" with the aim of protecting consumers.
Financial promotions can take many forms, including adverts in print, broadcast or online media, marketing brochures, emails, websites or social media posts.
As the FCA warns on its website, most cryptoassets are currently unregulated. The FCA classifies cryptoassets into four types of token, two of which are already regulated investments and two of which are not:
- security tokens (regulated), which meet the definition of a "specified investment" in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001;
- e-money tokens (regulated), which meet the definition of "electronic money" in the Electronic Money Regulations 2011;
- exchange tokens (unregulated), which have no central issuer and are used as a means of exchange such as bitcoin; and
- utility tokens (unregulated), which can only be redeemed for goods or services by the issuer – which includes loyalty schemes represented with tokens.
The financial promotions regime currently only covers tokens which are already regarded as regulated investments.
However, HM Treasury has concluded that many unregulated tokens also "expose consumers to unacceptable risk". HM Treasury is now proposing to extend the financial promotions regime to cover a much wider category of unregulated tokens, defined as "qualifying cryptoassets".
This comes as the FCA and the Advertising Standards Authority move firmly against misleading crypto advertising. The FCA announced an £11m campaign to educate investors about the risks of crypto investing in July 2021. In December that year, the Advertising Standards Authority banned seven crypto advertisements from crypto exchanges and crypto trading platforms. The latest announcement from HM Treasury puts further pressure on the industry to represent the risks accurately.
How will the extended regime work?
Subject to some exclusions, the government intends to define the scope of "qualifying cryptoassets" as any cryptographically secured digital representation of value or contractual rights which is fungible and transferable. Therefore, most types of unregulated tokens will fall within the perimeter of the financial promotions regime, with the notable exception of cryptoassets that are non-fungible or non-transferrable.
Notable exceptions to the definition of "qualifying cryptoassets" will include:
- Non-fungible cryptoassets: If something is fungible it is interchangeable, like money - a £1 coin is the same as any other £1 coin. A painting cannot be interchanged in this way and is therefore non-fungible. Non-fungible tokens ("NFTs") are unique cryptoassets that may represent, for example, the only authentic version of a digital piece of art. As NFTs are not interchangeable, they are not qualifying cryptoassets. It is possible, however, to "wrap" a fungible token within an NFT and HM Treasury has acknowledged that these circumstances may result in relevant tokens being qualifying cryptoassets, subject to a case-by-case assessment.
- Non-transferable cryptoassets: HM Treasury has proposed a "transferability exclusion" applying to "travel passes, lunch passes and supermarket loyalty schemes", among other cryptoassets within a closed system. Cryptoassets which can only be redeemed by one vendor are more likely to fall within the exclusion. Those that can be traded between users are more likely to be considered qualifying cryptoassets.
- Electronic money and currency issued by a bank or public authority: Neither of these will be captured, meaning any central bank digital currency would not fall within scope.
Instruments that provide rights to or interests in qualifying cryptoassets will also be caught by the new rule.
HM Treasury emphasised that the proposed definition is provisional at this stage and final drafting when the statutory instrument is laid before Parliament may be subject to change.
The financial promotion regime regulates the ability of any person – whether in the UK or not – to communicate a "financial promotion" – meaning an invitation or inducement to engage in investment activity in relation to a regulated investment. Qualifying cryptoassets will now be added to the list of regulated investments.
Where the financial promotion restriction applies, it is illegal to communicate a financial promotion that is capable of having an effect in the UK unless:
- the person issuing the promotion is UK authorised person;
- the promotion is covered by an exemption in the regime; or
- (for written communications only) the promotion has been signed off by a UK authorised person as complying with the relevant FCA rules.
There are only limited exemptions, which are set out in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. These mostly relate to promotions which are made to institutional investors and certain categories of sophisticated investor.
If no exemption applies, the promotion has to be either issued or signed off by a UK authorised person – which is intended to prevent false or misleading promotions that could harm consumers. HM Treasury acknowledges the possibility that the pool of UK authorised persons willing to approve the promotions of unauthorised firms may not be large, but it considers this risk is justified.
Existing investment activities and exemptions are applied to qualifying cryptoassets. HM Treasury clarified what can qualify as an "investment activity" relating to qualifying cryptoassets for the purposes of the restriction. Declining to create new categories of controlled activities specific to qualifying cryptoassets, HM Treasury stated that the following activities under the existing financial services regime will be equally applicable to qualifying cryptoassets:
- dealing in investments – which includes buying and selling;
- arranging deals in investments – which includes passing orders for execution, or making introductions to someone with a view to transactions in investments;
- managing investments – that is, making discretionary investment decisions on behalf of a customer;
- advising on investments – that is, advising a person on the merits of buying or selling an investment; and
- agreeing to carry on any of the activities listed above.
The restrictions may apply to communications that are made originally outside of the UK. If an invitation or inducement originating from outside the UK is capable of inducing a UK-based consumer to participate in an investment activity (such as, for example, exchanging fiat currency for a qualifying cryptoasset), then those promotions will fall within the scope of the regime. This means the cryptoasset firms based in other jurisdictions, as well as UK-based cryptoasset firms, will need to be mindful of any marketing activity that may be captured.
What does the FCA propose?
The FCA intends to generally apply the same rules to cryptoassets as currently apply to particular categories of regulated investments – namely "Non‑Readily Realisable Securities" and "Peer‑to‑Peer agreements". Under the consultation proposals, collectively this category will be newly referred to as "Restricted Mass Market Investments".
Financial promotions relating to cryptoassets will need to comply with the FCA's existing financial promotion rules, including the requirements for the promotion to be clear, fair and not misleading, and new requirements which are being proposed in the consultation paper. These include, for example, a ban on inducements to invest (such as "refer a friend" bonuses and "new joiner" bonuses) and including prescribed risk warnings.
"Direct offer financial promotions" (which, in general terms, means a promotion that specifies how consumers should respond or includes a form for them to respond immediately) relating to qualifying cryptoassets can only be made if certain requirements are met, such as firms complying with the FCA's proposed rules on positive frictions, client categorisation and appropriateness assessments. As a result, firms communicating or approving direct offer financial promotions will need to ensure clients are both categorised appropriately and an appropriateness test is undertaken, including when the direct offer financial promotions are marketed to existing customers wanting to engage in further investment activity.
In addition, under the FCA's proposed rules, it will only be possible to make direct offer financial promotions to investors categorised as:
- "restricted" – investors who have signed a declaration to say they have not invested in the last 12 months, and will not invest in the next 12 months, more than 10% of their net assets (excluding certain assets) in "Restricted Mass Market Investments";
- "high net worth" – consumers who sign a statement certifying they have: (i) an annual income of at least £100,000; or (ii) net assets of £250,000 or more, excluding primary residence, pensions and rights under qualifying contracts of insurance. This statement must have been signed in the 12 months immediately prior to the promotion being made; and
- "certified sophisticated" – persons who have: i) a certificate signed in the preceding three years by a UK authorised person (not party to the investment activity relating to the financial promotion) stating that they are sufficiently knowledgeable to understand the risks associated with the relevant type of investment; and ii) themselves signed a certificate in the preceding 12 months stating they qualified for this exemption and understood the implications.
Who can approve a financial promotion?
While a UK authorised person can approve a financial promotion, the FCA expresses concern about firms approving financial promotions without adequate expertise relating to the product being promoted.
The FCA emphasises that firms should be considering their competence and expertise before communicating or approving a financial promotion under its existing rules, but to make this clearer it proposes new rules to "focus firms' attention on whether they have the in-house skills, knowledge and experience to understand the product or service before potentially communicating or approving a financial promotion which may not meet the requirements of our rules".
Where a UK authorised firm approves a financial promotion for high-risk investments unrelated to the regulated activities for which the firm was authorised, the FCA takes the position that it is unlikely the firm would have the relevant expertise. Even where a firm has the relevant permissions relating to the financial promotion, approving firms must still consider if it has the competence and expertise in the underlying product to meet the FCA's requirements, "particularly if the promotion is for an innovative or emerging product".
The FCA recognises that the population of UK authorised firms with sufficient competence and expertise to approve cryptoasset financial promotions is likely to be limited at first but believes the changes are crucial to ensure an appropriate level of consumer protection.
In June 2021, HM Treasury confirmed the government intends to legislate to introduce a new regulatory gateway for firms approving promotions for unauthorised persons ("s21 gateway") when parliamentary time allows. This will result in all UK authorised persons having a restriction on their authorisations preventing them from approving financial promotions. To approve financial promotions for unauthorised persons, the UK authorised person will have to apply to the FCA for a variation or cancellation of this "Financial Promotion Requirement" ("FPR").
Therefore, when introduced, the "s21 gateway" will tighten the financial promotion regime even further. Once the legislation is in place for this, the FCA will consult on further guidance for firms on the FPR.
- Following its consultation, the FCA must produce its own more detailed rules. Its separate consultation is open for comments until 23 March 2022, with a view to publishing a policy statement and final rules in summer 2022.
- Once the updated legislative regime and complementary FCA rules have been published, the government intends to put in place a transition period of approximately six months before the extended financial promotions regime comes into force.
- The FCA's consultation is open for comments until 23 March 2022. The FCA intends to publish its final rules in summer 2022 and proposes that the changes it introduces apply to promotions of qualifying cryptoassets from the date they are brought within the financial promotion regime.
- HM Treasury will additionally respond "shortly" to its parallel January 2021 consultation on the regulatory treatment of cryptoassets and stablecoins which addresses the wider regulatory framework.
The thresholds used to define the high net worth exemption in the FCA Handbook are the same as those which appear in the FPO high net worth exemption. The FPO thresholds are currently subject to a separate HM Treasury consultation and may be increased in due course. The FCA indicates that, depending on the outcome of HM Treasury's consultation, it may consider changing the threshold for the high net worth exemption in its rules. HM Treasury's consultation closes on 9 March 2022.
“While it is understandable that the FCA and HMT want to assert some control on misleading advertisements related to the sale of cryptoassets, this does seem to be a complicated way of achieving this. Applying a regime to unregulated assets which was designed for regulated investments is unusual, and you can see from the preliminary analysis here how complex this regime is going to be. It will be very difficult for cryptoassets businesses to navigate this regime and a number of aspects to clarify – such as, the types of token, who is authorised to sign off and which category the potential customers might fall within. It does point to the fact that a more all-encompassing regime to address cryptoassets, which uses the principles of the existing regime, would be more simple and effective.”
Authored by John Salmon, James Sharp, Alex Nicol, Dominic Hill and Yvonne Clapham.
Hogan Lovells has extensive experience advising cryptoasset firms and platforms from the inception of their businesses and keeping abreast of regulatory developments and change. If you would like to discuss the impact of these proposals on your organisation, please get in touch with one of the named contacts above.