Clifford Chance

In January 2022, both HM Treasury (HMT) and the FCA published new proposals for the regulation of the promotion of certain cryptoassets. Are the rules tightening?

The Proposals

• On 18 January 2022, HMT published its response to the cryptoassets promotions consultation. In its response, HMT confirmed its intention to bring certain cryptoassets into the scope of the UK financial promotions regime.
• On 19 January 2022, the FCA published its consultation paper (CP22/2) on strengthening the FCA financial promotion rules for high-risk investments, including cryptoassets. The FCA consultation paper builds on the HMT response, and sets out the conduct rules that the FCA intends to apply to in-scope cryptoasset promotions carried out by authorised firms.

Both proposals are still at relatively early stages and firms will be given a suitable transition period (about six months) once the rules are finalised.

Existing financial promotions regime

In the United Kingdom, it is a criminal offence to communicate a financial promotion unless the financial promotion:

• was communicated by a firm authorised under the UK Financial Services and Markets Act (FSMA);
• was approved by such an authorised firm; or
• qualifies for an exemption.  

Importantly, only firms authorised under FSMA (such as banks, investment firms or consumer credit firms) are allowed to communicate or approve financial promotions where no exemption applies.  This does not include firms that are otherwise authorised by, or registered with, the FCA, such as:

• authorised payment institutions (authorised under the UK Payment Services Regulations);
• authorised electronic money institutions (authorised under the UK Electronic Money Regulations);
• registered cryptoasset exchange providers (registered under the UK Money Laundering Regulations); or
• registered custodian wallet providers (registered under the UK Money Laundering Regulations

In practice, this means that most UK cryptoasset providers will be prohibited from communicating financial promotions unless an exemption applies.

A financial promotion is, in summary, any invitation or inducement to engage in an investment activity. An investment activity, in turn, is defined as a controlled activity performed in respect of a controlled investment. This means that the regime not only covers promotions for (the straightforward sale of) a controlled investment, but also promotions in respect of certain activities in respect of such controlled investments. Controlled investments include shares, bonds and derivatives. Controlled activities include dealing, providing portfolio management or providing investment advice.

The UK regime covers all financial promotions which are capable of having an effect in the United Kingdom, including advertisements targeted at UK investors from abroad.

The UK financial promotions regime differs from "solicitation" based regimes in other jurisdictions in two ways:

• a financial promotion may also arise through the passive showing of information, for example if a communication or banner displayed on a website meets the characteristics of a financial promotion; and
• a financial promotion may arise after an initial contact has already arisen, i.e. there is no generic exemption that allows the provision of financial promotions at the request of a potential client or investor.

The impact of this difference for cryptoasset services providers is that, once the new regime is in place, cryptoasset service providers will need to assess the content of their website offering (to the extent it could have an effect in the UK) and consider whether any information displayed could amount to a financial promotion. For some cryptoasset services providers, this may already be familiar as they would have had to conduct a similar assessment in the context of any regulated cryptoasset products, such as crypto derivatives.

HMT proposal – restrictions for unauthorised firms

In its proposal, HMT confirmed its intention to bring certain cryptoassets into the scope of the existing financial promotions regime.

HMT intends to implement this by creating a new controlled investment called 'qualifying cryptoassets'. HMT has proposed to define qualifying cryptoasset widely as: "any cryptographically secured digital representation of value or contractual rights which is fungible and transferable". The definition will exclude other controlled investments, electronic money under the UK Electronic Money Regulations 2011, and central bank money. HMT also intends to exclude cryptoassets that are only transferable to one or more vendors or merchants in payment for goods or services. HMT emphasised that the proposed definition is provisional and may be subject to change.

The definition of 'qualifying cryptoassets' under the proposed financial promotions expansion is different from the current definition of 'cryptoassets' in the UK Money Laundering Regulations. Importantly, 'qualifying cryptoassets' would currently appear to exclude NFTs, because they are not fungible. While this narrower definition is likely going to be welcomed by some market participants, it may represent an additional compliance burden as the United Kingdom would effectively be operating two overlapping regimes.

HMT also proposed to amend certain existing controlled activities in the legislation to ensure that they also capture activities relating to qualifying cryptoassets.

One important point to note is that HMT intends to apply many but not all of the existing exemptions under the current financial promotions regime to qualifying cryptoassets. Specifically, HMT intends to apply the exemption for investment professionals (amongst others), but not the exemptions for high-net-worth individuals and self-certified sophisticated investors.

By way of reminder:

• the investment professional's exemption allows communications to persons reasonably believed to be 'investment professionals', which include banks, investment firms, other persons whose ordinary business involves the activity to which the communication relates, or a government, local authority or international organisation;
• the high-net-worth individuals exemption allows non-real time or solicited real-time communications to persons that have self-certified that they meet the prescribed high-net-worth criteria and provided such communication is accompanied by a warning statement; and
• the self-certified sophisticated investors exemption allows communications to persons that have self-certified that they meet the prescribed investment experience criteria and provided such communication is accompanied by a warning statement.

HMT confirmed it will put in place a suitable transitional period (about six months) from both the finalisation and publication of the proposed financial promotions regime and the complementary FCA rules.

FCA proposal – restrictions for regulated firms

The FCA proposal is only relevant for UK authorised firms, which will still be allowed to communicate and approve financial promotions in respect of qualifying cryptoassets following the expansion of the financial promotions regime under the HMT proposal. However, in its consultation, the FCA sets out similar additional restrictions it intends to apply to authorised firms making such in-scope financial promotions in respect of qualifying cryptoassets. The consultation closes on 23 March 2022.

The FCA confirmed that the general conduct rules for financial promotions, such as the requirement for financial promotions to be clear, fair and not misleading, will also apply to qualifying cryptoasset promotions.

In addition to the general conduct rules, the FCA proposes to classify qualifying cryptoassets as restricted mass market investments (RMMI). RMMI are intended to be the FCA's medium category of high-risk investments and, in addition to qualifying cryptoassets, also include unlisted securities and peer-to-peer agreements.

In practice, this would mean that the mass‑marketing of cryptoassets to retail consumers will only be permitted subject to the special FCA financial promotion rules for RMMI, which include a prescribed-form risk warning and a ban on inducements to invest (e.g. a refer-a-friend bonus). Additional restrictions are proposed to apply to 'direct offer financial promotions', which, broadly, are financial promotions that specify how investors should respond or include a form to respond.

For authorised firms wishing to approve financial promotions of unauthorised firms, the FCA intends to tighten the applicable rules. Specifically, approving authorised firms will be required to ensure they have the appropriate competence and expertise in the relevant product or service, and will need to monitor approved promotions on ongoing basis. Regarding the appropriate competence and expertise, authorised firms will be deemed to be competent in those activities and products to which their authorisation relates. As most cryptoasset activities are currently unregulated and sit outside the financial promotion regime, the FCA acknowledged that there is unlikely to be an existing population of approving authorised firms.

In practice, this means that unregulated cryptoasset service providers will struggle to find authorised firms willing to approve their in-scope financial promotions. Therefore, such providers will likely need to limit their financial promotions to recipients to which exemptions apply.

Conclusion

The expansion of the current financial promotions regime to currently unregulated cryptoassets is a fairly radical step. Taken together with (1) the limited available exemptions in respect of cryptoasset promotions, and (2) the limited available authorised firms willing and able to approve cryptoasset promotions, this will mean that unregulated cryptoasset service providers will only be able to promote in-scope cryptoassets and related in-scope services to a fairly limited group of people and/or in fairly limited ways. Specifically, unless HMT decides to expand some of the available exemptions, the ability of unregulated cryptoasset services providers to target UK clients will be limited to the wholesale and sophisticated markets.  The proposed FCA conduct rules further restrict the promotion of in-scope cryptoassets even by authorised firms.

However, it should be noted that the current proposals do not prohibit unauthorised entities from carrying on investment services or investment activities in relation to in-scope cryptoassets, but merely from marketing such services or activities. HMT is, however, currently conducting a separate consultation about prohibiting unauthorised entities from carrying on investment services or investment activities in respect of stablecoins.