FCA publishes statement on cryptocurrency derivatives

On 06 April 2018, the FCA published a statement on the requirement for firms offering cryptocurrency derivatives to be authorised by the FCA. The statement does not reflect a change in position, but rather a restatement of the existing view of the FCA in this area.

The FCA notes that a growing number of UK firms are offering cryptocurrencies and cryptocurrency-related assets. Major exchanges such as Cboe Global Markets and CME Group have already introduced cryptocurrency futures contracts, while Intercontinental Exchange (ICE) has confirmed it may do so in the future. The FCA has already issued warnings to consumers on cryptocurrency contracts for differences (CFDs) and Initial Coin Offerings (ICOs), and intends to publish a discussion paper on cryptocurrencies in the third quarter of 2018.

What is a cryptocurrency derivative?

A cryptocurrency derivative is a financial instrument whose value depends on the price of a cryptocurrency, such as Bitcoin or Ether. Examples of cryptocurrency derivatives include:

• cryptocurrency futures - a contract where each party agrees to exchange cryptocurrency at a future date and at a price agreed by both parties.

• cryptocurrency CFDs - a cash-settled derivative contract in which the parties to the contract aim to secure a profit or avoid a loss by exchanging the difference in the opening and closing price of the cryptocurrency. The European Securities and Markets Authority (ESMA) recently published product intervention measures limiting the amount of leverage available on the opening of a cryptocurrency CFD to 2:1, amongst other measures. This requires that initial margin on cryptocurrency CFDs must be at least 50% of initial exposure.

• cryptocurrency options - a contract which grants the owner the right to buy or sell a certain amount of a cryptocurrency at a later date.

When is a firm offering cryptocurrency derivatives caught by regulation in the UK?

As highlighted in DP17/3, the FCA’s feedback statement on Distributed Ledger Technology, at present cryptocurrencies themselves are not regulated by the FCA provided that they do not form part of other regulated products or services. The FCA’s recent statement highlights that derivatives are regulated products and so cryptocurrency derivatives are subject to regulation, including as financial instruments under the Markets in Financial Instruments Directive (MIFID2).

As a result, the FCA takes the view that dealing in, arranging transactions in, advising on or providing other services that amount to regulated activities in relation to derivatives referencing cryptocurrencies or tokens distributed through an initial coin offering (ICO) in the UK will likely require authorisation under the Financial Services and Markets Act 2000 (FSMA).

What does authorisation entail?

Authorisation requires an application to the FCA, together with the payment of certain fees. This application process, which is the same as for investment firms offering traditional derivative products, is complex and involved. Applicants will be required to have in place specified processes, policies and procedures as well as regulatory capital. Certain key individuals will also need to be approved.

A complete application is typically approved within six months. If authorisation is granted, the regulated firm will need to pay an annual fee and comply with all applicable FCA rules on an ongoing basis.

What happens if not authorised?

In general, it is a criminal office for a firm to carry on a regulated activity without authorisation under FSMA. If a firm already has authorisation under FSMA, but that authorisation does not extend to regulated activities related to cryptocurrency derivatives, then they will be taken to have contravened a requirement imposed on them by the FCA (and will therefore be open to sanction by the FCA).