Cryptoassets – Development of FCA Guidelines
As the cryptoasset market continues to grow significantly, there has become an increasing demand for the Financial Conduct Authority (FCA) to provide regulatory guidance to both service providers and crypto users alike. Known to be high risk, partly due to often falling into a grey area of regulatory law (and a result of uncertainty and volatility in the market) the use of cryptoassets has seen an influx of cybercrime and scams which have aided criminals to launder money.
In January 2019, the FCA sought consultation on cryptoassets from a variety of organisations involved in the market in preparation for greater regulatory intervention in the sector. On 31 July 2019, the results of this consultation were published in a policy statement setting out clearly the FCA's guidance in relation to the UK's regulatory regime. The amendments to such guidance hold particular significance to firms selling, buying and issuing cryptoassets.
However, it is of course worth bearing in mind that a separate regulatory framework has not yet been put in place (and the guidance paper deals with how the FCA will interpret the regulatory position for certain types of tokens – with the specific purpose of identifying whether or not a particular cryptoasset would fall within or outside the FCA's regulatory perimeter).
Cryptoassets can be categorised as either regulated tokens or unregulated tokens. All tokens that are not e-money or security tokens (as defined below) are and remain unregulated including popular cryptocurrencies such as Bitcoin and Litecoin. The consultation highlighted that there was majority support for the FCA's initial guidance, and a need for regulation (particularly for consumer protection, and to stabilise the market). The FCA has taken into account the feedback from the participants, confirming that the final guidance issued will solidify the categories of tokens falling within their scope of regulation.
The report distinguishes between three types of cryptoassets:
1. Exchange tokens (i.e. those used primarily as a means of exchange);
Generally these tokens fall outside of the regulatory regime. However, the guidelines point to the fact that, whilst these tokens are unregulated, the Senior Managers and Certification Regime will apply to relevant individuals within authorised firms (who are dealing with those unregulated crypto assets), as well as the Principles for Business. In addition, if an unregulated exchange token is used to facilitate a regulated payment, it does not automatically follow that it would mean that the cryptoasset itself would fall inside the 'regulated perimeter', rather it is the firm itself which would have to ensure that it complied with the usual FSMA provisions.
2. Utility tokens (i.e. those which have a specific purpose, such as providing a consumer with access to a current or prospective service, or those which are treated as electronic money); and
It is noteworthy that some of the respondents requested further guidance on the distinction between exchange and utility tokens. Whilst utility tokens will generally be unregulated, e-money tokens are treated differently and are subject to the Electronic Money Regulations (which means that relevant firms must ensure that they have correct permissions and follow the appropriate rules and regulations associated). A potential example of an e-money token is a 'stablecoin' which aims to peg its value to a specific currency (for example, by backing the coin with a 'fiat' currency or other assets, or by utilising algorithms which control the supply of tokens and by extension any market 'inflation').
3. Security tokens (i.e. those which construe an ownership type interest on the purchaser in the issuing business).
These tokens fall within the FCA's regulated perimeter (e-money tokens have been removed from this definition and have been given their own category). These tokens provide "rights and obligations akin to specified investments as set out in the RAO, including those that are financial instruments under MiFID II." Of course, one of the key points to note is that there can be occasions on which an issuer of a cryptoasset would need to publish a prospectus (unless an exemption could be relied on).
In addition to the above, the provision under section 21 of FSMA also prevents a person from making a financial promotion (i.e. in the course of business, communicating an invitation or inducement to engage in an investment activity unless the person doing so is an approved person). The guidance from the FCA is that a firm offering access to unregulated activities must not "communicate that their authorisation extends to those unregulated cryptoassets."
We also comment that, as the FCA has rightly pointed out, the Advertising Codes enforced by the Advertising Standards Agency are also relevant (and which is particularly important given the recent announcement of BitMex's criticism in that regard).
Separately, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) published papers in January 2019 explaining the EU's stance on cryptoassets (the FCA places reliance and emphasis on the importance of the Fifth Anti-Money Laundering Directive in that regard, the implementation of which is due before the end of December 2020). Each outlined a set of rules applying to the monitoring of security tokens that qualify as financial instruments in addition to recognising the need for EU policy to outline the position taken to assets that do not qualifying as security tokens.
Overall the involvement of major regulatory authorities, both nationally and internationally, indicates that a level of growth in the cryptoasset sector is expected. Clarity on the regulatory position provides important security to consumers and users of financial technology. It is positive to see the FCA recognising the need for clarity within this growing market which should provide more certainty to a sector in its infancy.
However, big risks still remain in capitalising on the new market, which is often subject to great fluctuations. Prospectively, future developments may involve the FCA devising a set of absolute characteristics for each type of cryptocurrency, leaving little room for uncertainty. However, the challenge is that some cryptoassets could be mistakenly described as one type of token, or could be a 'dual' token. This would allow market users to correctly assess which category their assets fall into, and whether they will be subject to regulation. This will aid consumers in identifying which products best suit their needs, encouraging investment and consequently directly impacting the economy. The reality is that the regulatory position for each cryptoasset will have to be taken on its own merits.
Whilst European authorities provide great insights into an international approach to monitoring the market, it is difficult to assess the strength of the EU's regulatory powers directly within the UK, considering the current Brexit negotiations. It is likely therefore that the FCA guidance in this area will greatly influence the shape and development of the market after 31 October 2019.