It is a sign of the times that a consultation by the UK’s financial regulators that does not mention COVID-19 is a rarity. However, apart from a single passing nod to the pandemic, HM Treasury launched two consultations last week on proposals to alter how financial promotions are regulated in the UK.
Whilst the Cryptoassets Consultation considers the extending the universe of the products which should be subject to the regulations applicable to financial promotions, the Promotions Consultation considers changing the mechanisms applicable to financial promotions generally.
In order to understand the proposals for change, it is first necessary to understand the current regime. Broadly, under the Financial Services and Markets Act 2000 (“FSMA”), there are two relevant regimes. The first is known as the “general prohibition” and provides that no person may carry on a regulated financial service activity unless they are authorised or exempt. The financial services to which the general prohibition applies are set out in the “Regulated Activities Order” or “RAO”.
The second is a restriction on “financial promotions”, providing that a person must not, in the course of their business, communicate an invitation or inducement to engage in “investment activity”, unless that communication is made by a person authorised under FSMA; its contents are approved by such an authorised person; or the promotion is exempt). Importantly, the financial promotions regime covers a number of activities as “investment activities” which are not subject to the general prohibition.
So, HM Treasury was faced with a choice – does it amend the scope of the general prohibition to address cryptoassets or does it amend the financial promotions regime (or do both)?
In the Cryptoasset Consultation, HM Treasury comes down on the side of addressing the mischiefs posed by cryptoassets by extending the financial promotions regime. This is because the ‘mischiefs’ perceived by the regulators are those of misleading advertising and a dearth of suitable information on which consumers can base their investment decisions. This concern is not new; in its report of October 2018, the Crypto Assets Taskforce (comprising HM Treasury, the FCA and the Bank of England) highlighted the risks that cryptoassets pose to consumers and concluded that the regulators should prioritise dealing with those risks over, for example, any systemic risks that cryptoassets might pose to the banking system.
The regulators undertook to ensure that the UK’s regulatory framework addressed the risk posed by cryptoassets, whilst not stifling financial innovation. For the FCA’s part, it has already consulted on prohibiting the sale of cryptoasset-linked derivatives to retail consumers and clarifying which cryptoassets fall within the regulatory perimeter of the RAO. HM Treasury also committed to consult on whether that perimeter should be extended to include cryptoassets that currently sit outside the scope of FSMA. The Cryptoassets Consultation is part of that commitment.
The initial concerns set out in the Taskforce’s report were reinforced by the results of consumer research commissioned by the FCA in 2020Chief amongst the findings were that the number of consumers holding cryptoassets had increased by approximately one million since 2019, to 2.6 million, and that, of the 45% of cryptoasset investors who had seen an advertisement for cryptoassets, 35% considered that the advert increased the likelihood of them making a purchase.
Against this background, it is hardly surprising that the Cryptoassets Consultation proposes to amend the financial promotions regime to make it apply to certain cryptoassets. HM Treasury’s proposal is to add a new category of “qualifying cryptoasset” to the list of controlled investments. The definition of “qualifying cryptoasset” excludes security tokens (because the FCA considers that they are already caught by the financial promotions restriction). It also excludes electronic money (which already has its own regulatory regime) and currencies issued by a central bank (perhaps creating a placeholder for the introduction of central bank digital coins?). The other two limbs of the definition of “qualifying cryptoasset” are that the instrument must be “fungible” and that it is “transferrable or confers transferable rights” or is promoted as being so.
The reasoning behind requiring these two characteristics is that they are shared by money, as well as shares and bonds. Therefore, the argument goes, consumers will buy such cryptoassets with similar expectations as they have for regulated investments. It also allows the world of “digital collectibles” to remain outside the financial promotions regime, which will presumably be a comfort to those who promote the breeding and trading of digital cats (“CryptoKitties”).
As with any regulatory consultation, it is instructive to note what the proposal does not cover. The regulators have decided that the addition of “qualifying cryptoasset” to the list of “controlled investments” is sufficient action (for now) and that the current list of “controlled activities” is sufficiently comprehensive not to warrant amendment.
Although HM Treasury could amend the RAO to make activities relating to cryptoassets and persons engaging in them regulated, it is not proposing to do so before a more extensive review of the UK’s entire regulatory approach to cryptoassets later this year. Similarly, it has left consumer protection laws untouched. In light of what is not being proposed, it can be seen that the promotion of cryptoassets, particularly stablecoins, to consumers (and especially older consumers) is a significant concern to the Government and needs immediate attention.
The Cryptoassets Consultation should be viewed through the prism of the Promotions Consultation. Currently anyone who is not authorised under FSMA and who wishes to market or advertise “controlled investments” or controlled activities” needs to have their communications approved by an authorised person (or find an exemption). There are no additional criteria imposed on the approving authorised person.
Therefore, not only can any authorised person approve financial promotions by an unauthorised person, but also the FCA has no clarity on which authorised persons under its purview do in fact conduct such approvals.
Consequently, the Promotions Consultation proposes that there be a ‘gateway’ for authorised firms before they can approve financial promotions communications, requiring an authorised firm to have express consent from the FCA before it can approve communications. This would allow the FCA to know which of its flock are giving approval and also ensure that the firm is suitable and competent, with sufficient expertise in the relevant promoted product.
When taken in conjunction with the Cryptoassets Consultation, the implication is that authorised firms will have to demonstrate expertise in cryptoassets in order to obtain the FCA’s consent to approve financial promotions of them.
Perhaps those virtual cat breeders will have a new career open to them.
Claude Brown is a partner at international law firm Reed Smith in London, and co-heads the Firm’s European Fintech practice. With more than 26 years’ experience as lawyer and banker, Claude has been ranked in both Chambers and Legal 500 for the past 15 years. For more information visit www.reedsmith.com.
Howard Womersley Smith, Partner at Reed Smith, started out as a lawyer during the dot.com boom, sparking his interest in technology and data law. He is also an experienced outsourcing lawyer, advises on data compliance and mentors at the Barclay’s Fintech Accelerator.