Developments in Cryptocurrency Regulation: U.K. Edition

At the beginning of 2021, the Financial Conduct Authority (FCA) warned consumers of the risks related to investing in “cryptoassets or [undertaking activities related to] lending or investments linked to cryptoassets, that promise high returns.” Consumers who invest in cryptoasset-related products are not likely to have recourse to the Financial Ombudsman Service or to the Financial Services Compensation Scheme; therefore, they need to understand the nature of the products they are investing in, the risks associated with their investments, and most importantly they need to be prepared for financial loss.  FCA research covering the cryptocurrency consumer market shows that approximately 2.3 million consumers held cryptocurrency in 2021, and that consumers increasingly  view crypto as investment alternatives rather than “gambles.” In addition, the Cryptoassets Taskforce also found that cryptoassets advertisements are frequently targeted at retail consumers and regularly overemphasize benefits without including appropriate warnings of risks and lack of regulation.

This year started off with a bang: Her Majesty’s Treasury (HM Treasury) announced plans for qualifying cryptoasset advertisements to be introduced into the scope of the financial promotions regime. The age of unfettered and misleading advertisements covering various mediums from public transport billboards to social media depicting cryptoassets investments will come to an end. Financial promotions are invitations or inducements to engage in investment activity and can only be communicated by an authorized person, unless the content of the communication is approved by an authorized person or otherwise subject to an exemption. Under the changes, financial promotions of qualifying cryptoassets will be subject to legislative restrictions and FCA rules that are aimed to ensure that the presentation and substance of such promotions contain accurate information and that warnings are prominent. HM Treasury will bring qualifying cryptoassets promotions into the scope of the financial promotions regime by amending the Financial Promotion Order (FPO) to include controlled investments and controlled activities related to and representative of qualifying cryptoassets investments. This will extend the regulatory perimeter of the FCA to include the regulation of qualifying cryptoasset-related financial promotions.

When unpacking the changes to the regulation of cryptoasset financial promotions, it is important to understand which investments and activities will fall within the FPO’s extended scope and what effect will the changes have on the corresponding market. Per the consultation, the proposed qualifying cryptoassets that will be introduced into the scope of the financial promotions regime as controlled investments capture “cryptographically secured digital [representations] of value or contractual rights which [are] fungible and transferable.” The proposed definition includes assets that are “fungible [i.e., Bitcoin] , transferable [i.e., tokens that can be traded between users for speculation], [but it excludes] . . . electronic money [per] Electronic Money Regulations, and . . . currency issued by a central bank.” In addition, controlled activities such as “dealing, . . . arranging deals in investments, managing investments, advising on investments and agreeing to carry on specified kinds of activity” are proposed to be revised to apply to qualifying cryptoassets. It is important to note that extending the scope of the FPO to include investments and activities that pertain to qualifying cryptoassets will have no effect on the regulatory status of the underlying activities.

The FCA’s current proposal is to align the cryptoassets financial promotion rules with the rules for high-risk investment promotions that fall under the ‘Restricted Mass Market Investments’ classification. The proposed ruleswould permit mass marketing of cryptoassets to retail consumers and direct financial promotions subject to further requirements. Cryptoassets financial promotions will also need to be compliant with the existing FCA rules as stated in the Conduct of Business Sourcebook, and be fair, clear, and not misleading. While the introduction of cryptoassets into the scope of the financial promotions regime is a step in the right direction for consumer protection, the proposed rules that cryptoasset firms will need to comply with are technical. Compliance with these rules may require firms to make operational changes to their systems and controls and to review their product and services offerings in light of the upcoming requirements. In addition, because the financial promotions rules apply to all in scope promotions capable of having an effect in the U.K. if directed at persons in the U.K., they have wide applicability that could extend to overseas persons. The financial promotion rules, once in effect, will operate in parallel with the anti-money laundering and counter-terrorist financing FCA registration requirements for cryptoasset firms.

The changes to the regulation of cryptoasset financial promotions are expected to come into effect after a transitional period of approximately six months after the publication of the proposed FPO regime and the corresponding FCA rules. The FCA consultation will close in March 2022 and the Policy Statement and final Handbook rules are expected to be published in the summer. The FCA is estimating that the new rules will affect approximately 300 firms. Once the new rules are in effect, we will be able to evaluate how they will shape the cryptoasset market and their participants.