March 7, 2023

Marketing Cryptoassets and Services in and Into the UK: Shifting Regulatory Sands

On 1 February 1 2023, HM Treasury (HMT) issued a further policy statement on cryptoasset promotions in the UK, "Government approach to cryptoasset financial promotions regulation policy statement”. It updates HMT’s January 2022 statement published in response to a July 2020 consultation paper. The statement sets out HMT’s proposal for an exemption to the proposed rules around the promotion of qualifying cryptoassets that will allow crypto exchanges and crypto custodians (e.g., wallet providers) that are registered with the Financial Conduct Authority (FCA) under the Money Laundering Regulations 2017 (MLRs) to promote their own services without the approval of a fully FCA-authorised firm (e.g., a broker-dealer). Noting industry feedback, HMT recognised that retaining an approval requirement would have resulted, in practice, in an effective ban on the promotion of cryptoasset services given the limited number of fully FCA-authorised firms that would have been available to approve cryptoasset-related promotions.

The statement is a further step towards defining the regulatory regime that will apply to those developing and offering new cryptoassets and cryptoasset-related services in the UK and demonstrates that the UK is committed to supporting the growth of the cryptoasset sector in a safe and competitive manner. The marketing regime, which will see an expansion of the current “financial promotion” legislative regime and related FCA rules to include most types of cryptoassets, will also be relevant to non-UK businesses marketing cryptoassets and services to investors and users in the UK.

The statement came at the same time as HMT’s general consultation on the cryptoassets, “Future financial services regulatory regime for cryptoassets” (the Crypto Consultation). As set out below, the regime governing the financial promotion of cryptoassets will be closely linked to the regime governing the carrying on of a regulated cryptoasset business. As it is unlikely that the general regulatory regime for cryptoassets will be finalised until at least Q4 2023, it seems unlikely that the marketing regime will be finalised before them. 

The current regulation of crypto marketing

General criminal law anti-fraud provisions, including those in the Fraud Act 2006, apply to all marketing communications, including those related to cryptoassets. This is also true of other general regulatory standards, including those issued by the Advertising Standards Authority, which has recently upheld complaints on adverts relating to cryptocurrencies.

The rules and regulations governing financial promotions and offers of securities, both administered by the FCA (discussed below), currently apply only where cryptoassets have the characteristics of regulated investments and/or transferable securities, such as shares or bonds. The FCA characterises these as security tokens under its current guidance on cryptoassets (see “Cryptoassets: our work”). Other types of cryptoassets, such as unregulated exchange and utility tokens, are currently not subject to the financial promotion regime; nor are services provided by FCA-registered crypto exchanges and crypto custodians (FCA Registered Crypto Businesses), provided always that such services do not involve the promotion of security tokens.

Expanding the financial promotion regime

HMT still plans to reform the law on the promotion of cryptoassets through secondary legislation that changes and expands the scope of the Financial Services and Markets Act 2000 (FSMA) (Financial Promotion) Order 2005 (FPO).

These changes supplement those planned to FSMA via the Financial Services and Markets Bill 2022 (FS Bill), currently making its way through the UK Parliament. The FS Bill seeks to extend the financial promotion restriction (the FP Restriction) in FSMA to include the definition “an asset, right or interest is, or comprises or represents, a cryptoasset”. (We discuss the definition of cryptoasset below.)

The FP Restriction is the cornerstone of the regulation of financial promotion of regulated investments, such as shares, bonds, and security tokens (as described above) as well as derivatives and fund interests, which the FPO identifies as “controlled investments” (except for security tokens, which are not identified as such but are recognised by implication). The FP Restriction applies alongside the FCA prospectus rules, which require consideration where there is a public offer of transferable securities, such as shares, bonds, or security tokens.

The FP Restriction also applies to any promotion that is “capable of having an effect in the UK”, thus making it relevant to anyone outside the UK whose advertisements can be accessed within the UK. The FP Restriction makes it a criminal offence for anyone to communicate an invitation or inducement to engage in investment activity unless it is an FCA-authorised firm or the content of the communication is approved by an entity that is.

The FP Restriction will add a focussed set of criminal penalties to protect the investing public supplementing the general criminal law and general regulatory standards, noted above.

The expansion of the regulated activities regime (discussed in the Crypto Consultation) to include the activities of making arrangements with a view to deals in cryptoassets and arranging deals in cryptoassets will also be relevant to the question of the regulatory status of someone who makes a cryptoasset promotion in or from a place of business in the UK. The proposed wording of these activities mirrors that for activities carried on in relation to investments such as securities, derivatives, and fund interests, and includes the marketing of those types of investments and gives an idea of how a person looking to market cryptoassets in or from a place of business in the UK will need to be regulated.     

Defining cryptoassets

The planned expansion to the FPO examined in the HMT response will result in the addition of in-scope cryptoassets known as qualifying cryptoassets (QCAs). In its first policy statement, HMT confirmed the criteria for a QCA, including that it is fungible, transferable, not electronic money as defined in the Electronic Money Regulations, and not a currency issued by a central bank or public authority. With the advent of the FS Bill and express reference to the term “cryptoasset” in the context of the FS Restriction, the proposed FS Bill definition will now need to be considered. It defines a cryptoasset as:

any cryptographically secured digital representation of value or contractual rights that— (a) can be transferred, stored or traded electronically, and (b) that uses technology supporting the recording or storage of data (which may include distributed ledger technology)

Some of HMT’s comments on the original QCA definition remain relevant:

  • The transferability requirement will result in the exclusion of tokens such as travel passes, lunch passes, and supermarket loyalty schemes that are cryptographically secure. HMT emphasises that tokens with these characteristics do not typically give rise to consumer protection risks.
  • The transferability requirement will also distinguish between those tokens that are used specifically and only for payment to a vendor (not in scope), and tokens that can also be traded between users for speculation or other purposes (in scope).

However, there are changes that both broaden and narrow the definition that was originally proposed:

  • There is no longer a “fungibility requirement”, with the result being that non-fungible tokens (NFTs) are capable of inclusion in the regime. Noting the central although not universal role of fungibility as a characteristic of the types of instruments, investments, and currency subject to regulation under FSMA, this leaves open the question of whether HMT will develop exclusions from the definition of cryptoassets for some or most types of NFTs.
  • The definition refers to distributed ledger technology but allays HMT’s fear about future-proofing the definition for innovations in the underlying technology that cryptoassets utilise by not limiting the technology to cryptography or DLT technology. It is, in any event, broader than the definition in the MLRs, which define a cryptoasset as “a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”.

The repurposed FPO

Although the QCA definition may have moved on, the linking of cryptoassets to FPO “controlled activities” remains and is noteworthy. “Controlled activities” under the FPO are nearly identical to “regulated activities”, i.e., the activities that, if a firm carries on by way of business in the UK, require that firm to become FCA authorised (or otherwise be exempt) under FSMA.

HMT links QCAs to the “controlled activities” of dealing, arranging, managing, advising, and agreeing in the FPO. The FPO already applies these activities to security tokens. The linking of existing regulated investment and risk management activities, as controlled activities, to cryptoassets as “controlled investments” under the FPO is consistent with the Crypto Consultation. The expanded list of controlled activities under the FPO is also likely to include issuance activities, exchange activities, and safeguarding and/or administration activities, all of which are identified as likely cryptoasset regulated activities in the Crypto Consultation.

HMT’s original statement that the controlled activities will not include cryptoasset lending activities or Decentralised Finance activities is, however, open to question given the inclusion in the Crypto Consultation of “lending, borrowing and leverage activities” on the menu of regulated cryptoasset activities.

The original statement also said that cryptoassets classified as electronic money under the Electronic Money Regulations 2011 (together with central bank money) would not be included as QCAs. This is consistent with the current list of controlled investments, as electronic money activities are not included in the list of controlled activities.

HMT had originally planned not to add any specific exemptions for QCAs but, as noted above, has now proposed an exemption that will allow FCA Registered Crypto Businesses to promote their own services without the approval of a fully FCA-authorised firm. HMT states that FCA Registered Crypto Businesses that rely on this exemption will not be able to approve financial promotions or to communicate their own financial promotions in relation to other controlled investments. The exemption will also not apply to FCA Registered Crypto Businesses that are also FCA authorised, as such businesses are already able to communicate their own financial promotions without the need for this exemption.

In addition to a QCA-specific exemption, those promoting QCAs should be able to rely on the general exemptions under the FPO such as the exemptions for promotions directed at investment professionals, high-net-worth investors, and sophisticated investors. This will align the position on the promotion of QCAs with that for other controlled investments.

Changes to the rules and regulations on offers of securities and market abuse

Unsurprisingly, there are no proposed changes that would expand the reach of the UK rules and regulations on offers of securities, including those on the need to publish a prospectus, to include QCAs. Security tokens that qualify as “transferable securities” are already subject to the securities rules.

An interesting development in the Crypto Consultation is the proposal for a cryptoassets market abuse regime based on that for traded securities and other financial instruments in the onshored Market Abuse Regulation (UK MAR). This would apply to cryptoassets traded on trading venues. Amongst the market abuse offenses identified in the Crypto Consultation is market manipulation, which includes disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument where the person who made the dissemination knew, or ought to have known, that the information was false or misleading.

Marketing communications are not typically used for the purpose of manipulating the price of financial instruments (although market abuse allegations have arisen in the context of false statements made in a prospectus). That being said; if a regime based on UK MAR is developed for traded cryptoassets, market manipulation risk will be relevant where any materials, including marketing materials, governing those cryptoassets contain information about the supply, demand, and price of the cryptoassets.

The FCA’s financial promotion proposals

At the same time that HMT issued its January 2022 policy statement, the FCA issued a consultation paper on amending its financial promotion rules, including those for cryptoassets, “Strengthening our financial promotion rules for high risk investments, including cryptoassets”. The FCA was looking to bring QCAs under a more general regulatory umbrella and list them alongside high-risk investments, such as non–readily realisable securities and non-mainstream pooled investments. Instead, it will look to include them in the category of Restricted Mass Market Investments (RMMI).

This would mean that, in practice, the mass marketing of cryptoassets to retail consumers will be permitted but subject to the FCA’s special requirements for “direct offer financial promotions”. The inclusion of QCAs in the category of Non Mass Market Investments (NMMI, the other new category of investment introduced in the consultation) would have limited their promotion to high-net-worth or sophisticated investors and others excluded from the financial promotion restriction. (See our previous alert on the financial promotion rules for non-mainstream pooled investments, “The Remaining New Financial Promotion Rules for UK Private Fund Managers: Less Than a Month Away”, which discuss the effect of the limitations on the promotion of NMMI.) As RMMI, QCAs will be capable of distribution to a wider investor audience than NMMI. This is good news for crypto providers.

The general rules on financial promotions, including rules introduced in the consultation, will apply to QCA promotions and include the following:

  • Rules for QCAs aligned with existing rules for other high-risk investments and classified as RMMI that place additional restrictions on firms communicating or approving relevant promotions.
  • Rules on categorising and imposing an appropriateness test for firms communicating or approving “direct offer” financial promotions of QCAs.
  • “Positive frictions” rules, i.e., personalised risk warnings and cooling-off periods for first-time investors in QCAs.
  • Rules for those who approve QCA promotions.

In August 2022, the FCA published its response to the January 2022 consultation, “Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions”, and indicated that it will publish its final rules for cryptoasset promotions once the changes to the FPO are made. This is likely to be later this year.

To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.