In our Alert Marketing Cryptoassets and Services in and Into the UK: Shifting Regulatory Sands, we noted the policy statement issued by HM Treasury (HMT) on cryptoasset promotions and the Financial Conduct Authority (FCA) consultation paper amending its financial promotion rules, including those for cryptoassets. Both publications were a further step toward defining the regulatory regime that will apply to those developing and offering new cryptoassets and cryptoasset-related services in and into the UK. This regime will apply both to UK and non UK firms, including those in the US and EU.
On 7 June 2023, the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (the Order) was published, and the provisions enabling the FCA to make financial promotion rules came into force on 8 June 2023. The rest of the Order comes into force on 8 October 2023.
On 8 June 2023, the FCA published its rules (the FCA Rules) as part of Policy Statement PS23/6, “Financial Promotion Rules for Cryptoassets”, together with a consultation on the accompanying guidance, GC23/1: Guidance on cryptoasset financial promotions, which closes on 10 August 2023. Like the Order, the FCA Rules come into force on 8 October 2023.
It will be necessary to consider these changes alongside HMT’s general consultation on cryptoassets, Future financial services regulatory regime for cryptoassets (the Crypto Consultation), launched on 1 February 2023.
Expanding the Financial Promotion Regime
With the FCA Rules, the Order expands the current “financial promotion” legislative regime to include most types of cryptoassets. This expansion is relevant to non-UK businesses marketing cryptoassets and services to investors and users in the UK.
These changes supplement those planned to the Financial Services and Markets Act 2000 (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”.
The FP Restriction is the cornerstone of the regulation of financial promotion of regulated investments, such as shares, bonds, and security tokens as well as derivatives and fund interests, which the FSMA (Financial Promotion) Order 2005 (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 will add a focussed set of criminal penalties to protect the investing public supplementing the general criminal law and general regulatory standards, noted above.
Non-UK Activity Caught
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. In this respect, the FCA’s view is this would include websites that a UK investor can access and social media promotions targeted at UK investors operated by non-UK firms.
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 FPO retains the “qualifying cryptoassets” (QCAs) definition originally consulted on, namely, any cryptoasset that is:
The definition excludes controlled investments, other than QCAs themselves, (which, as noted above, excludes security tokens), fiat currency, fiat currency issued in digital form, and certain types of utility tokens.
The FPO uses the “cryptoasset” definition in the FS Bill: “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)”. However, while non-fungible tokens (NFTs) could still be subject to the regulatory regime for cryptoassets under FSMA, subject to the finalisation of that regime, the marketing of NFTs will not be subject to the FP Restriction, the FPO, or the FCA Rules, which use the FPO definition of a QCA.
The Revised FPO
The most substantial FPO exemption is that which will allow crypto exchanges and crypto custodians (e.g., wallet providers) that are registered with the FCA under the Money Laundering Regulations 2017 (FCA Registered Crypto Businesses) to promote their own services without the approval of a fully FCA-authorised firm. 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 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.
The FPO amends two existing exemptions, article 51 (associations of high-net-worth or sophisticated investors) and article 61 (sale of goods and supply of services), to exclude QCAs. It does not, however, restrict other exemptions, such as those for investment professionals, and sophisticated investors, i.e. where a third part affirms the investor’s sophisticated status and these should include QCAs. Where an FPO exclusion does not apply and the approval of an FCA authorised firm or FCA Registered Crypto Businesses is required, the FCA Rules, noted below, will limit the promotion of QCAs made via a “direct offer financial promotion” to those investors classified under the FCA Rules as “restricted investors”, “high net worth investors”, and “certified sophisticated investors”. These tests are similar to but not the same as the corresponding tests in the FPO. The restricted investor definition does not have a FPO counterpart, restricts investors, and looks to a 10% restricted investor limit for other cryptoassets and other “restricted mass market investments” (discussed below).
The FPO adds QCAs to the list of instruments that bring the “controlled activities” of dealing, arranging, managing and advising, and agreeing within the scope of the FP Restriction. “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. 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 does not, however, 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.
In the boring but important category of change, the FPO had also expanded the FCA’s powers under FSMA, including the powers to issue fines and public censures, to FCA Registered Crypto Businesses. The FCA enjoys these powers over authorized firms but, because FCA Registered Crypto Businesses will be subject to the Crypto Financial Promotion Rules and other FCA rules, such as Principle for Businesses #7 governing communications with clients.
The FCA Financial Promotion Rules
The Financial Promotion Rules are the somewhat delayed response to the January 2022 FCA consultation paper CP22/2: Strengthening our financial promotion rules for high risk investments, including cryptoassets.
The Rules 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 means, 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, albeit with some restrictions. This is good news for crypto providers.
The general rules on financial promotions 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. This includes, amongst others, the requirements that
- before communicating a direct offer financial promotion to a retail client, the person making that communication take reasonable steps to establish that the retail client is certified as a “high net worth investor”, a “sophisticated investor”, or a “restricted investor”.
- where a firm considers that a recipient is unlikely to have a good understanding of the English language, a risk warning or risk summary required by the rules be provided in an appropriate language in addition to English.
- “Positive frictions” rules, i.e., personalised risk warnings and a 24 hour cooling-off period for first-time investors in QCAs. This will include the requirement for the words:
Don’t invest unless you’re prepared to lose all the money you invest. This is a high risk investment and you should not expect to be protected if something goes wrong
- Rules for those who approve QCA promotions, including the application of the FCA’s consumer duty noted, albeit in a different context, in our Alert The UK Consumer Duty: Next Steps For Private Fund Managers
The Draft FCA Guidance
Although the draft guidance applies to all cryptoasset financial promotions, its focus is promotions about cryptoassets and related models/arrangements that can claim to be stable and financial promotions for complex yield models such as cryptoasset borrowing, lending and staking models/ arrangements.
The guidance addresses, amongst other points, the following:
- Ensuring that cryptoasset financial promotions are fair, clear and not misleading in a way which is appropriate and proportionate. This will require consideration of both the substance and presentation of a promotion and factors such as clarity and comprehension, and omission and accuracy of information.
- For stablecoins, evidence that a firm has undertaken due diligence to ensure that claims regarding stability or links to a fiat currency are capable of being fair, clear and not misleading and genuine.
- For cryptoassets that claim to be backed by a commodity or an asset, evidence proof that any claim of commodity or asset backing is capable of being fair, clear, and not misleading, including information on the particular model/arrangement the cryptoasset uses, proof of ownership of the underlying commodity/asset, evidence of the custodian (if any) and any further reasonably foreseeable dependencies that may significantly impact the value or volatility of the underlying asset.
- For complex yield cryptoasset models or arrangements e.g. borrowing, lending and staking, evidence of how the advertised rates of return can be achieved, clear and prominent disclosure of any fees, default rates, commissions, or other charges, and clear and prominent disclosure of the legal and beneficial ownership of a consumer’s cryptoassets once they enter into an arrangement.
- Financial promotions on social media, noting that the financial promotion regime is technology neutral.
Changes to The Rules and Regulations on Offers of Securities and Market Abuse
As noted in our previous alert, the changes do 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 feature of the Crypto Consultation is the proposal for a cryptoassets market abuse regime based on the regime 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.
To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.