Crypto View - Cryptoasset Promotions Special Edition

> Sign up to Cryptoview here

We have an extra issue of Crypto View today, in light of HM Treasury’s release of the Regulatory Framework for Approval of Financial Promotions: Consultation Response (Consultation Response). As you will have noted from previous issues of Crypto View, we had concerns about the consequences of this consultation, and unfortunately it would seem that a number of those concerns will be realised. We outline below the key issues from the Consultation Response below. In particular, the concern is that this impacts cryptoasset firms globally, not just those based in the UK.

Overview

Following HM Treasury’s Consultation in July 2020, we have been waiting to see what it would propose. Both the FCA and ASA have been very critical of advertising in the cryptoasset space, with the latter calling it a “red-alert” issue, and so we had been expecting a strong response to the Consultation.

The Consultation Response has confirmed that “Qualifying Cryptoassets” will added to the Financial Promotion Order (FPO), the piece of legislation that governs the financial promotions in the UK. This means that Qualifying Cryptoassets will be brought within scope of the Financial Promotion Restriction under s.21 of the Financial Services and Markets Act 2000 (FSMA). Briefly, s.21 states that:

• A person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless that person is authorised (under Part 4A of FSMA, i.e. authorised by the FCA or PRA), the content of the communication is approved by an authorised person, or an exemption applies.
• For communications originating outside the United Kingdom, the restriction applies to the extent that the communication is capable of having an effect in the United Kingdom.

The effect of the proposed changes will be to require any promotion of cryptoassets or cryptoasset services specified in the FPO to be approved by an authorised person.

Qualifying Cryptoasset

HM Treasury have confirmed in the Consultation Response that the definition of Qualifying Cryptoasset will be “any cryptographically secured digital representation of value or contractual rights which is fungible and transferable.” HMT removed the inclusion of using DLT as part of the definition, but retained fungibility and transferability despite some responses. This means that NFTs will be out of scope from the Financial Promotion Restriction, as will non-transferable tokens such as travel passes, and certain loyalty schemes that are cryptographically secure. It will also exclude those tokens that are used specifically and only for payment to a vendor.

Controlled Activities

As well as the FPO applying to controlled investments, in which Qualifying Cryptoassets will now be included, it also restricts promotion of “controlled activities”. The government has stated that it will amend the following controlled activities to incorporate activities in relation to the buying, selling, subscribing for or underwriting of qualifying cryptoassets:

• dealing in securities and contractually based investments
• arranging deals in investments
• managing investments
• advising on investments
• agreeing to carry on specified kinds of activity

To be clear, this will not mean that these activities are regulated under the Regulated Activities Order when carried out in relation to cryptoassets, with the FPO being a distinct piece of legislation.

This is much broader than the FCA’s existing Registration Regime, bringing into scope activities such as dealing in cryptoassets as principal, managing cryptoassets, and advising on cryptoassets that are not covered in the Registration Regime. This looks like it will cover essentially any and all activities that might be carried out in relation to cryptoassets.

Inducements and Invitations

As noted, the definition of a Financial Promotion requires there to be an invitation or inducement. This is quite a complex and nuanced point, as there is no definition of what these terms mean. However, the FCA states in its Perimeter Guidance that:

• An invitation is something which directly invites a person to take a step which will result in his engaging in investment activity.
• An inducement may be described as a link in a chain where the chain is intended to lead ultimately to an agreement to engage in investment activity (though this does not mean that all the links in the chain will be an inducement or that every inducement will be one to engage in investment activity).

Whether something would be classed as an invitation or inducement to engage in investment (or indeed, cryptoasset) activity is not always straightforward to determine, and this may be something that cryptoasset firms should look into further.

Exemptions

Under the Financial Promotion Restriction, it is not necessary to have financial promotions approved if an exemption applies. These exemptions are found in the FPO, and from the Consultation Response, it would seem that the intention is for some of these to apply to cryptoasset promotions as well. The Part IV Exemptions in the FPO will all apply to cryptoasset promotions, these include exemptions for promotions to investment professionals, and by journalists for example. The Part VI Exemptions in the FPO apply certain controlled activities, and the proposal seems to suggest that some will apply to cryptoasset promotions while other key ones will not. For example, cryptoasset promotions to governments and central banks, certified sophisticated investors (this is a specific defined class of investor), and high-net worth companies would be exempt, however cryptoasset promotions to high net worth individuals self-certified sophisticated investors would not be exempt.

Issues

There are numerous issues with the Consultation Response:

• The territorial scope of the FPO is extremely wide. As mentioned above, for communications originating outside the United Kingdom, the restriction applies to the extent that the communication is capable of having an effect in the United Kingdom. This includes any website that can be accessed in the UK, that is to say, all websites. How this will work in practice remains to be seen, and the enforcement of this by the FCA will be difficult. However, it will technically have the power to enforce the Financial Promotion Restriction, which brings criminal liability, against any cryptoasset promotion globally. We would be happy to provide advice on dealing with this.
• The vast majority of UK cryptoasset firms are not authorised, which will prevent them from carrying out most cryptoasset promotions unless they can get those promotions approved, or be able to rely on certain exemptions. This will mean that cryptoasset firms will have to be particularly careful when carrying out marketing activities.
• The controlled activities bring into scope far more activities in relation to cryptoassets than are covered by the registration regime which will likely lead to confusion in the market. Further, it is not clear the extent to which exclusions from regulated activities in relation to securities will translate to those same activities under the FPO. For example there are a number of exclusions available under the Regulated Activities Order in relation to arranging deals in investments, which would take certain activities out of scope, which are not available to cryptoassets as these are not regulated investments. What does arranging in relation to cryptoassets entail (something that has not been clear since the Registration Regime came into force)? What does advising on cryptoassets include? We hope that the FCA will publish suitably detailed guidance when these rules come into force.
• The exemptions available are quite narrow. Excluding the HNW and Self-Certified Sophisticated Investor exemptions is frustrating. These would likely be well used exemptions for the marketing of cryptoassets and it does not seem clear why they have been excluded. The Consultation Response suggests that these were introduced for capital raising purposes, which suggests they should perhaps apply to ICOs, though this seems unlikely.
• Stablecoins that meet the definition of e-money are to be excluded, as e-money is not a controlled investment for the purposes of the FPO. This is good news, however it is not clear whether this will include tokens such as USDT, which while technically meeting the definition of e-money are not issued in the UK or EU and are not treated as e-money by the market.

Further Issues - Regulatory Framework for Approval of Financial Promotions Consultation Response

A further issue arises when reading the Consultation Response in line with another HMT consultation response, on the Regulatory Framework for Approval of Financial Promotion Restrictions (FPR Consultation Response). This confirms changes to the approval process for financial promotions. Currently, any authorised firm is able to approve a financial promotion on behalf of an unauthorised firm. The FPR Consultation Response confirms that a “regulatory gateway” will be introduced, whereby all new and existing authorised firms will be prohibited from approving the financial promotions of unauthorised persons, with a requirement to apply to the FCA to have this prohibition removed either entirely (allowing them to approve all types of financial promotions), or partially (allowing them to approve certain types of financial promotions).

The FCA have advised that permissions to approve financial promotions could be limited to a specific type or types of products or services, dependent on the firm’s expertise. Indeed, they state that permission to approve financial promotions should be limited to regulated activities authorised firms have permission to undertake. As mentioned, a vanishingly small proportion of authorised firms are involved in cryptoasset activities, and the crypto related activities aren’t regulated and so are not subject to authorisation in any event. This looks as though it could amount to a de facto ban on all cryptoasset promotions as it is not possible to be authorised for those activities to which the promotion restriction relates. This seems to be a terrible catch-22 for the industry.

Even if those authorised firms who engage in cryptoasset activities were able to approve financial promotions, there are very few of them, and it is unlikely that many would want to take on the responsibility of approving other firm’s promotions. This does seem as though it will prove impossible to carry out any promotion of cryptoassets outside of an exemption.

Practicalities, Timeline and Processes

The practical impact of bringing cryptoassets within the scope of the financial promotions regime will be strict limitations on how crypto firms communicate with UK customers. As noted, those limitations will also affect non-UK firms that make invitations or inducements that are capable of having effect in the UK.

As discussed above, the question of what constitutes an invitation or inducement is not always straightforward; FSMA does not contain any definition of the expressions, leaving them to their natural meaning. In its guidance the FCA has said that links to websites and banner advertisements on websites may constitute inducements caught by the restriction. Crypto firms, including those based outside the UK, will therefore need to undertake work to assess whether their marketing materials and websites will constitute invitations or inducements.

There will be a transitional period of six months before the changes come into effect following the publication of the final changes to the FPO and the accompanying FCA rules. It appears that the FCA may consult on the changes to its rules in parallel with the changes being made to the FPO, meaning that the transitional period may commence relatively quickly.

Communicating a financial promotion in breach of section 21 is a criminal offence on the part of a person who is not FCA authorised. Accordingly, the FCA may take action against firms it considers to be in breach, including seeking an order from the Court for restitution of profits. We know from a Freedom of Information response we received from the FCA that it has in the past 12 months referred 17 cases to the Advertising Standards Authority (ASA) regarding cryptoasset promotions, suggesting that the FCA is focused on crypto promotions and may seek to use its new powers under the FPO to take action against crypto firms. This could include the FCA taking action in those cases where the interpretation of what constitutes an “invitation or inducement” is central to whether there has been a breach or not, meaning that firms will need to be ready to defend their interpretation of the law.

If you have any questions or would like to discuss anything in relation to this further, please do not hesitate to reach out to the cryptoasset and digital currency team at Simmons & Simmons.