FCA Consultation on Cryptoassets and the Regulatory Perimeter

On 23 January 2019, the FCA published a Guidance on Cryptoassets (CP 19/3)
to provide regulatory clarity for market participants carrying on activities in
this space. The cryptoasset market, and the underlying Distributed Ledger
Technology (DLT), is developing quickly, and participants need to be clear on
where they are conducting activities that fall within the scope of the FCA’s
regulatory remit and for which they require authorisation.

This consultation, which focuses on where cryptoassets interact with the
FCA's regulatory perimeter, is a response to industry request for greater
clarity, as well as a way to support customer protection in understanding what
is regulated and what is not. In October 2018, the UK Cryptoassets Taskforce
(the Taskforce) published a report that set out the UK’s policy and regulatory
approach to cryptoassets and DLT, assessing the risks and potential benefits of
cryptoassets, identifying potential harms, setting out a plan for regulation in
the UK and detailing the different activities that should be assessed for
regulation. Although numbers are still relatively small, more customers are
investing in cryptoassets, and the FCA has already alerted them to be prepared
to lose money, and on the limited regulatory protections for cryptoassets
services that fall outside the FCA’s regulatory remit (e.g. no access to the
Financial Services Compensation Scheme and the Financial Ombudsman
Service for disputes).

Chapter 2 of the Guidance sets out the wider context of the consultation,
explaining the key concepts related to cryptoassets and the cryptoassets
market. Chapter 3 looks at where cryptoassets would be considered ‘Specified
Investments’ under the Regulated Activities Order (RAO), ‘Financial
Instruments’ such as ‘Transferable Securities’ under the Markets in Financial
Instruments Directive II (MiFID II), or captured under the Payment Services
Regulations (PSRs), or the E-Money Regulations (EMRs). Firms carrying on
regulated cryptoasset activities (by way of business in the UK) need to make
sure they are appropriately authorised or exempt. The guidance takes a step-
by-step approach to help firms determine whether certain cryptoassets fall
within the perimeter. It includes case studies and practical examples of how
the guidance works, a Q&A section (e.g. What happens if I carry on regulated

activities without any permissions? or How do I know if my token is a Specified
Investment?, Do I need to publish a prospectus?) to give guidance on more
nuanced, complex, and frequently asked questions, in Chapter 4.

There is no single agreed definition of cryptoassets, and in line with the
Taskforce, the FCA has categorised cryptoassets into three types of tokens:

 Exchange tokens: these are not issued or backed by any central
authority and are intended and designed to be used as a means of
exchange. They are, usually, a decentralised tool for buying and selling
goods and services without traditional intermediaries, and are usually
outside the perimeter;

 Security tokens: these are tokens with specific characteristics which
meet the definition of a Specified Investment like a share or a debt
instrument as set out in the RAO, and are within the perimeter;

 Utility tokens: these tokens grant holders access to a current or
prospective product or service but do not grant holders rights that are
the same as those granted by Specified Investments. Although utility
tokens are not Specified Investments, they might meet the definition of
e-money in certain circumstances (as could other tokens), in which case
activities in relation to them may be within the perimeter.

Exchange tokens (like Bitcoin, Litecoin, etc.) are not issued or backed by any
central authority and can be used directly as a means of exchange, enabling
the buying and selling of goods and services without the need for traditional
intermediaries such as central or commercial banks. However, they are not
currently recognised as legal tender in the UK nor considered to be a currency
or money (less than 600 merchants in the UK accept exchange tokens as a
payment tool).

The FCA is a technology neutral regulator, so the use of new technology alone
does not alter how it makes judgements in relation to the regulatory
perimeter. Firms should consider the application of the financial promotion
rules (including ensuring communications are clear, fair and not misleading), of
the prospectus directive, and of relevant financial crime controls.
The impact of CP19/3 is that currently unregulated crypto-related businesses
will need to seek authorization under such regimes as MiFID II, while some of those that will remain unregulated after the review, such as crypto exchanges,
will still have to comply with 5 th Anti-Money Laundering (AML) Directives once
transposed into UK law by the end of 2019. The new Directive, pending formal
consultation by HMT in 2019, will extend AML regulation to entities carrying
out activities such as exchange between cryptoassets and fiat currencies,
exchange between one or more other forms of cryptoassets, transfer of
cryptoassets; safekeeping or administration of cryptoassets or instruments
enabling control over cryptoassets, participation in and provision of financial
services related to an issuer’s offer and/or sale of a cryptoasset.

While cryptoassets have the potential to bring benefits to markets, they also
pose a range of substantial risks to consumers, which stem from purchasing
unsuitable products without having access to adequate information,
experiencing unexpected or large losses, facing fraudulent activity, as well as
the immaturity or failings of the market infrastructure and services (which
means that existing systems and controls may not be effective and may require
further development to appropriately address the risks). The potential of
misunderstanding the nature of these assets can be compounded by poor
practices in relation to advertising, which often overstate benefits and rarely
warn of volatility risks, the fact consumers can lose their investment, the
absence of a secondary market for many offerings, and the lack of regulation.
Misunderstanding can be even more problematic when firms offer both
regulated and unregulated products at the same time, as it can be harder for
consumers to determine which products provide recourse.

If a firm acts in line with this Guidance, the FCA will consider them to have
complied with regard to the aspects of the requirement to which the Guidance
relates. The Guidance represents the FCA’s views and does not bind the courts,
however, it can be persuasive in any determination by courts. Should the
Guidance and Q&A not provide enough clarity, firms can request support from
the direct support service, which offers a dedicated contact for innovator
businesses that need support when applying for authorisation or variation of
permission.

The consultation should be read by firms trading, exchanging, holding, and
creating cryptoassets such as coins or tokens, and by individual investors, with
comments to be submitted by 5 April 2019. A Policy Statement is expected by
summer this year. The FCA is also planning to consult on banning the sale of
derivatives linked to certain types of cryptoassets to retail investors. The
Government is also planning to consult on whether to expand the regulatory perimeter to include further cryptoassets activities. The FCA has commissioned
qualitative and quantitative research on consumers’ understanding and
attitude towards cryptoassets. This research is still underway, but we expect it
to give us a clearer picture on the ownership of cryptoassets in the UK.