UK REGULATORY CONTEXT
The UK Government is moving forwards with regulating cryptoassets, ushering them into the fold of its established regulatory frameworks. This involves a multi-pronged approach, incorporating through adding powers to regulate cryptoassets through:
• the Financial Promotions regime;
• the Regulated Activities regime; and
• the newly created Designated Activities regime.
The Financial Services and Markets Act 2023 contains a number of provisions which will be used to create the new regulatory structures for cryptoassets, and amend the existing regimes to expressly accommodate the regulation of cryptoassets.
The intention of the UK Government is to create a level playing field between cryptoassets and existing financial services activities, while introducing additional consumer protections to a market which has seen significant volatility in recent years.
The industry will be hoping for a proportionate and agile set of rules that takes into account the different emerging business models within the sector. HM Treasury’s commitment to this ambition is fairly well reflected in their recent consultation document, which outlines the Government’s proposed approach to bringing different cryptoasset activities within the regulatory framework via a phased approach.
However, much of the detail is still to be defined. The industry continues to wait for further guidance from the Government and Financial Conduct Authority (FCA), who will be provided with the more substantive rule-making powers over the regulated activities, as well as a new secondary objective to facilitate the international competitiveness of the UK economy.
The role of the FCA
When it comes to the cryptoassets industry, there’s often a noticeable disconnect between the FCA and the Government’s perspectives. On one hand, there’s a clear commitment to fostering innovation and establishing the UK as a crypto hub. On the other hand, this enthusiasm collides with the reality of how consumer protections are implemented. Senior FCA executives have been outspoken critics of the sector, and there’s increased frustration over the slow progress in authorising crypto firms under the Money Laundering Regulations (MLRs).
At present, the development of regulations and rules aimed at creating a secure environment for crypto innovators and responsible players stands at a crucial crossroads. Striking the right balance in rules and regulations can either encourage a surge in investment and job opportunities or burden the UK crypto market with excessive requirements, hampering its competitiveness and hindering its growth potential.
One emerging concern centres around the financial promotions restriction, which threatens to disrupt the goal of establishing a well-proportioned regulatory framework for cryptoassets and underscores the potential discord in approach between the Government’s ambition and how the rules are actually designed by FCA.
Financial Promotions Legislation
HM Treasury recently brought “qualifying cryptoassets” in scope of the UK Financial Promotion Regime through secondary legislation. The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (FPAO), which amends the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO), was implemented on 08 June 2023. There will be a four-month period before it becomes effective as of 08 October 2023.
A ‘qualifying cryptoasset’ is any cryptographically secured digital representation of value or contractual rights that can be transferred, stored or traded electronically, and uses technology supporting the recording or storage of data (which may include distributed ledger technology), that is both fungible and transferable. Notably, it is likely to not capture Non-Fungible Tokens or custody services.
The financial promotion regime will only apply to cryptoasset promotions – it will not affect the regulatory status of the underlying activity. The FCA has outlined that qualifying cryptoassets will be treated within the Restricted Mass Market Investments (RMMI) product category, which allows marketing to retail consumers with certain restrictions.
What is a Financial Promotion?
A financial promotion is ‘an invitation or inducement to engage in investment activity or to engage in claims management activity that is communicated in the course of business.
A financial promotion is technology agnostic which means it includes most forms of communication (e.g., digital posters, celebrity endorsements, social media, website links, website banner ads, email marketing). The FCA has outlined that it intends to capture promotional communications only, distinguished from those which seek to merely inform or educate.
Notably, the financial promotion restriction will apply to any in scope promotion capable of having an effect in the UK, even where it is communicated by an overseas person.
All financial promotions that are capable of having an effect in the UK will be captured. In essence, anything that can be viewed by UK persons is within scope.
This applies even in the scenario that the UK person cannot access the product of the financial promotion. A financial promotion includes anything that is an invitation or inducement to enter into the controlled activity.
If overseas firms intend to continue marketing to UK consumers once the regime comes into force, they must consider which route they will use to lawfully communicate their promotions and how they will meet the relevant requirements of that route.
If firms decide to no longer provide services to UK consumers, the FCA expects them to have in place orderly wind-down plans to minimise any impact on UK consumers. Firms may find the FCA’s Wind-down Planning Guide useful in considering their plans.
QUALIFYING CRYPTOASSET FINANCIAL PROMOTION RULES
The FCA’s Policy Statement PS23/6 sets out the financial promotion rules for RMMI cryptoassets.
Risk Warnings and Associated Risk Summaries
PS23/6 introduces a crucial component of cryptoasset promotions: risk warnings and associated risk summaries. For digital media, the main risk warning is clear:
“Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment, and you are unlikely to be protected if something goes wrong. Take 2 mins to learn more.”
In non-digital media, there are nuanced variations, including the omission of the ‘Take 2 min to learn more’ link, which is specific to product risk summaries. Firms, however, have the flexibility to tailor risk summaries if needed, provided it is justified to prevent misleading or irrelevant information. Keeping these summaries accurate and aligned with market trends is essential.
For first-time investors engaging with a firm, a mandatory 24-hour cooling-off period is now in place. This means that consumers cannot proceed with a Direct Offer Financial Promotion (DOFP) until they reconfirm their intent after waiting at least 24 hours.
A DOFP is defined as a financial promotion that contains: i) an offer by the firm or another person to enter into a controlled agreement with any person who responds to the communication; or ii) an invitation to any person who responds to the communication to make an offer to the firm or another person to enter into a controlled agreement and which specifies the manner of response or includes a form by which any response may be made.
During the cooling-off period, other consumer journey processes, such as KYC/AML checks and client categorisation, can continue without additional delays if they extend beyond 24 hours.
Personalised Risk Warning Pop-Up
The FCA is also introducing personalised risk warnings for DOFPs aimed at first-time investors in cryptoassets: “[Client name], this is a high-risk investment. How would you feel if you lost the money you’re about to invest? Take 2 min to learn more.”
Before a DOFP can be issued for a cryptoasset, consumers must be categorised as Restricted, High Net Worth, or Certified Sophisticated investors. The Self-certified Sophisticated category is excluded. Investors must declare their eligibility, which is valid for 12 months, and firms will need to re-categorise consumers after this period to make further DOFPs.
Before processing a cryptoasset application or order in response to a DOFP, firms must assess its appropriateness for the consumer. This involves evaluating the consumer’s experience and knowledge regarding the specific product or service. These assessments often take place online, with the FCA updating guidance on necessary topics.
Banning Incentives to Invest
The FCA is taking a bold stance against incentives to invest in cryptoasset promotions. The ‘shareholder benefit’ exemption won’t apply, as incentives can unduly influence investment decisions. Intrinsic benefits tied to a cryptoasset’s function won’t be considered incentives (such as voting rights through a governance token), but external benefits used to motivate investments will likely be considered as an incentive e.g., buy one get one free, refer-a-friend.
Record Keeping Requirements
The FCA is extending record-keeping requirements to include client categorisation and appropriateness assessments for financial promotions in cryptoassets. While not mandatory, firms are encouraged to consider voluntarily recording additional data, such as consumer access to risk summaries linked from risk warnings.
Fair, clear and not misleading
In addition to the rules, financial promotions must be fair, clear and not misleading to an unintended audience. As such, promotions should be balanced and consideration given to substance and presentation of a promotion. The FCA provides specific examples in their recent GC 23/1 guidance that the stability of stablecoins should be bona fide with links to supporting evidence clear and prominent.
Finally, in relation to their approval or communication of a financial promotion, the FCA would, in particular, expect authorised firms to have due regard to their responsibilities under the Consumer Duty’s general obligations for firms and the consumer understanding outcome. The cross-cutting rules include obligations to act in good faith, avoid causing foreseeable harm, and enable and support retail consumers to pursue their financial objectives.
Financial Promotions on Social Media
Financial promotions now extend to all forms of communication, such as a meme or message in private platforms like Discord and Telegram are included.
Influencers used for financial product promotions on social media should understand the products, services, and regulations involved. Additionally, firms must take responsibility if affiliate marketers share financial promotions containing referral links.
To address the risk of consumers being directed to non-UK entities, firms are advised to maintain separate social media profiles for the UK market and implement geo-location techniques for automatic redirection. Ensuring prominent visibility of risk warnings on various social media platforms is crucial, and firms should pay attention to the demographics of influencer audiences to prevent vulnerable individuals from exposure to financial promotions.
QUALIFYING CRYPTOASSET FINANCIAL PROMOTION AUTHORISATION ROUTES
There are four distinct routes through which cryptoasset promotions will now be authorised and regulated.
Route A: FCA-Authorised Firms
Firms authorised under the UK Financial Services and Markets Act (FSMA), such as banks and UK-licensed investment firms, can freely communicate cryptoasset financial promotions.
Route B: Approval by an Authorised Person
Unauthorised entities can still promote cryptoassets, but these promotions must be approved by an authorised person in accordance with FCA-specified rules. However, there’s a significant catch – authorised firms will need explicit approval under a new Section 21 gateway from the FCA to continue this practice. This involves costs, acceptance of liability, and a demonstration of relevant knowledge and expertise in financial promotions.
Route C: Registered Cryptoasset Businesses (Temporary Measure)
Recognising the challenges posed by the Section 21 gateway, the government has introduced a temporary option. Cryptoasset businesses registered with the FCA under the MLRs can communicate financial promotions. However, this option has its limitations given the significant time and commitment it takes to register under the MLRs.
Route D: Existing Exemptions
Certain exemptions within the Financial Promotions order still apply to cryptoasset promotions. These exemptions can provide some flexibility in promoting cryptoassets.
• Overseas Exemption: Allows promotions to have an effect in the UK but targets persons outside the UK. Clear disclosures are required, and systems must prevent non-exempt individuals from accessing them.
• Non-Real Time Communications and Solicited Real-Time Communications
• Investment Professionals
• Communications by Journalists
While it’s possible to limit your communications to factual information, branding, or educational materials, financial promotions are hard to avoid in the cryptoasset space. To gain approval, you can either register under the MLRs or engage with a third-party approver, which may present practical difficulties for the crypto sector. Another more extreme option is geo-blocking specific promotions from UK customers.
The set of measures proposed addresses several areas, including personalised risk warnings and a mandatory 24-hour cooling-off period for cryptoasset investments. This cooling-off period appears disproportionate given the associated risks of different cryptoasset activities. This not only poses practical challenges but also risks undermining the UK’s international competitiveness.
Furthermore, the broad definition and application of a what amounts to a financial promotion to UK persons will undoubtedly capture a significant number of firms. While this can be beneficial to protecting consumers, it can also be perceived as too onerous given the limited options facing crypto firms in getting their promotions approved.
The FCA has recently hired more staff and invested in monitoring capabilities related to financial promotions, and commented that they ‘will take robust action where [they] see firms promoting cryptoassets to UK consumers […] this may include, but is not limited to, take downs of websites that are in breach, issuing public warnings and enforcement action’.
Enforcement ranges from the FCA writing or publishing ‘warning’ letters, putting notifications on their website that a firm may be carrying out activities in the UK without a license, to unlimited fines or/and up to two years imprisonment for senior executives. The FCA has taken action against overseas firms in breach of the existing financial promotion regime as it applies to securities. The FCA has also agreed to a significant number of multilateral and bilateral MoUs with international regulators to support the supervision of cross-border firms.
What is clear in the meantime, is the necessity for firms to proactively prepare and implement the necessary processes for compliance ahead of the deadline. It is expected the FCA will actively seek non-compliant promotions from international firms.
Looking ahead, there is optimism for the cryptoasset sector as it awaits the Future Financial Services Regulatory Regime for Cryptoassets. The FCA acknowledges that it may reassess the financial promotions requirements when the regulatory regime is developed. The hope is for a more nuanced and proportionate approach from the FCA as the cryptoasset industry continues to evolve.
If you would like a further discussion on any of the topics mentioned in this post, please reach out to [email protected].
Written by Joshua Townson,
Head of UK Policy at Digital Currencies Governance Group (DCGG)
Digital Currencies Governance Group (DCGG) is an advisory firm that represents digital assets issuers and service providers in both the UK and EU. Our mission is to facilitate an open dialogue and encourage communication between policymakers and digital asset experts to support the design of a sound and proportionate regulatory framework that ensures safety for all market participants. Our Members include Tether – currently the largest stablecoin issuer worldwide, Ledger – a leading technology service provider for self-custody, Bitfinex – a crypto-assets exchange, ZKV – a leading proof-of-stake validator, and Iden3 – a company working on self-sovereign identity management. Our team of former government officials, lawyers, and cryptoasset experts regularly engage with policy-makers and regulators both at the national and international level. For any general enquiries or to request information, please do reach out to [email protected].