Government proposes to regulate crypto-asset advertisements

The Government has published a consultation paper  proposing to bring the promotion of unregulated cryptoassets within the financial promotion rules.  This would ensure that cryptoasset promotions are held to the same high standards for fairness, clarity and accuracy that apply to the traditional financial services industry.

This would be another significant step towards regulating the cryptoasset community.  Authorised firms with crypto offerings should not be materially impacted, given they should already have systems and controls in place to comply with the financial promotion rules.  But for unregulated crypto exchanges, ICO issuers and others persons who promote crypto and other token offerings, this will be a noticeable change.

Separately, the Government is consulting on proposals to establish a regulatory 'gateway', which an authorised firm must pass through and obtain FCA consent before it is able to approve the financial promotions of an unauthorised firm (for more information, see our briefing here). 

The Government's proposals in relation to cryptoassets would also fall within these broader proposals. Therefore if unregulated cryptoassets are brought within the financial promotion regime, unregulated cryptoasset providers will be required to have their financial promotions approved by another authorised firm before they are communicated or rely on one of the exemptions, which will limit boundless retail marketing which has been customary in some parts of the crypto industry since its inception.  

The financial promotions regime and the regulation of cryptoassets so far

The financial promotions rules provide that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless: (a) the communication is made by an authorised person; (b) the content of the communication is approved by an authorised person; or (c) the financial promotion otherwise meets the conditions of an exemption within the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 ("FPO").

A person will be engaging in investment activity if they: 

• enter, or offer to enter, into an agreement the making or performance of which by either party constitutes a controlled activity; or 
• exercise any rights conferred by a controlled investment to acquire, dispose of, underwrite, or convert a controlled investment.

Schedule 1 to the FPO sets out a list of controlled investments and controlled activities. Currently, most cryptoassets are not "controlled investments", and activities with respect to most cryptoassets are not "controlled activities" because unregulated cryptoassets are generally not securities, and therefore do not fall within the financial promotions regime. 

There is no single, widely agreed definition of cryptoassets, but it is broadly a "cryptographically secured digital representation of value or contractual rights that uses some type of distributed ledger technology and can be transferred, stored or traded electronically".  This is also the definition under The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. The taxonomy of cryptoassets in the UK can be further divided into, security tokens, e-money tokens, and unregulated cryptoassets (the consultation introduces a new subset of unregulated cryptoassets, called "qualifying cryptoassets", which we discuss in more detail below).

Security tokens are those tokens that provide rights and obligations akin to shares, debentures, units in collective investment schemes, or other regulated products. These tokens are therefore regulated under The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("RAO") and are controlled investments under the FPO. E-money tokens are tokens which meet the definition of 'electronic money', which is not a controlled investment under the FPO but is regulated separately under the Electronic Money Regulations 2011 ("EMR"). Promotion of either is subject to the financial promotions regime.

The majority of stablecoins would be considered security tokens or e-money tokens.

Unregulated cryptoassets refer to all tokens that are not security tokens or e-money tokens and it is this category of cryptoassets that the consultation relates to.

The Government's proposals

The Cryptoassets Taskforce's joint October 2018 report noted that misleading advertising and a lack of suitable information was a key consumer protection issue in the cryptoasset market (see our briefing here). In particular, "adverts often overstate benefits and rarely warn of volatility risks, the fact consumers can both grow and lose their investment, and the lack of regulation. There are also examples of regulated firms marketing cryptoasset products without clarifying that this part of their business is not regulated". FCA research into consumer attitudes also showed that cryptoassets were poorly understood by consumers (see our briefing here).

The Government considers that the findings highlight the importance of firms being upfront about the risks involved in purchasing cryptoassets.  To this end, the Government is proposing to add "qualifying cryptoassets" as a new type of controlled investment, and to amend some of the current controlled activities in Schedule 1 to the FPO.

Controlled investments

The proposed definition of "qualifying cryptoasset" is "any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and which — (a) is fungible; (b) is transferable or confers transferable rights, or is promoted as being transferable or as conferring transferable rights; (c) is not any other controlled investment as described in this Part; (d) is not electronic money within the meaning given in the Electronic Money Regulations 2011; and (e) is not currency issued by a central bank or other public authority."

The definition carves out security tokens, and e-money tokens, and focusses on unregulated cryptoassets that are both fungible and transferable (i.e. both characteristics would be required). 

The Government stated that fungibility and transferability are core characteristics of money, as well as of a range of widely-used, regulated products, such as shares and bonds, and therefore will more likely to give rise to consumer protection concerns. For example, customers may expect cryptoassets which are fungible and transferrable, to hold a stable value, or rise in value, and they may expect that markets will be sufficiently liquid to allow them to sell their holdings easily and quickly. The fact that this is not generally the case in the cryptoasset market gives rise to risk.

Given the above proposed definition, and the regulatory focus, certain unregulated cryptoassets will remain outside the scope of the financial promotions regime. For example, digital collectibles, such as Cryptokitties, which are traded as "non-fungible tokens" on the Ethereum blockchain would not be caught according to the Government. In addition, cryptoassets used within a closed system where redemption can only be via the issuer, rather than by transferring the cryptoasset to other users, would also be excluded. The Government gave the example of a supermarket customer loyalty scheme which exists on a DLT system, which uses tokens as analogous to loyalty points.

Controlled activities

The Government intends to amend the controlled activities of: dealing in securities and contractually based investments, arranging deals in investments, managing investments, advising on investments, and agreeing to carry on specified kinds of activity, so that they incorporate activities relating to the buying, selling, subscribing for or underwriting of qualifying cryptoassets.

Exemptions

The Government is also proposing to add the following exemption to the FPO: "The financial promotion restriction does not apply to any communication which merely states that a person is willing to accept or to offer qualifying cryptoassets in consideration for the supply of goods or services."  This would exclude vendors offering to accept cryptoassets in exchange for their goods or services, and buyers offering cryptoassets to pay for goods or services.

The proposals contained in the consultation would require significant changes for unregulated cryptoasset businesses in the UK.  Such providers will not be able to communicate financial promotions, which including social media advertising, banner adverts, white papers for initial coin offerings etc., unless those promotions are approved by an authorised firm, which often includes paying a fee, or fall within an exemption (which by its nature limits the target market).

The consultation closes on 25 October 2020.

 Author: Emma Tran