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 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 authorisation 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 the 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.