Further Steps towards the Regulation of Cryptoassets in the UK

HM Treasury (HMT) recently published its ‘Cryptoasset promotions: Consultation response’ to its July 2020 consultation paper on cryptoasset promotions. The Financial Conduct Authority also published its own consultation paper with special provisions for cryptoassets.

In the response, HMT confirmed its intention to reform the law on the promotion of cryptoassets. HMT plans to make the reform through secondary legislation that expands the scope of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (Financial Promotion Order) to include ‘qualifying cryptoassets’.

The FCA’s consultation complements HMT’s proposals. It seeks to bring qualifying cryptoassets under a more general regulatory umbrella and to list them alongside high-risk investments, but to nevertheless include them in the category of ‘Restricted Mass Market Investments’ accessible to retail consumers. The promotion of qualifying cryptoassets will be subject to the requirements of the FCA’s financial promotion rules, including special requirements for ‘direct offer financial promotions’.

The final drafting for the definition of qualifying cryptoassets is still under development but the response indicates HMT’s thinking in this regard, with HMT looking to define qualifying cryptoassets as ‘any cryptographically secured digital representation of value or contractual rights which is fungible and transferable’.  

Some points on the definition of qualifying cryptoassets and activities connected with qualifying cryptoassets are noteworthy and highlight the fact that HMT is seeking to set down general definitional principles:

• The definition will exclude: other investments governed by the Financial Promotion Order; electronic money under the Electronic Money Regulations 2011; and central bank money. The Financial Promotion Order already applies to controlled investments such as shares, bonds or fund units held on a blockchain.
• The ‘transferability’ requirement will result in the exclusion of tokens such as travel passes, lunch passes, and supermarket loyalty schemes that are cryptographically secure. HMT emphasises that tokens with these characteristics do not typically give rise to consumer protection risks. The transferability requirement will also distinguish between those tokens that are used specifically and only for payment to a vendor (not in scope), and tokens which can also be traded between users for speculation or other purposes (in scope).
• The ‘fungibility requirement’ will result in the exclusion of non-fungible tokens (NFTs) from the regime. HMT note that NFTs may represent a wide array of different assets which might constitute non-financial services products. Further, the NFT market is evolving rapidly and remains at an early stage of development with the result that there is not yet sufficient information on risks and use-cases. The necessary implication is this may change if risks arise.
• The definition does not refer to Distributed Ledger Technology or blockchain with HMT noting that this will future-proof the definition for innovations in the underlying technology that cryptoassets utilise. This technology-agnostic definition is in line with HMT’s consultation on the regulatory treatment of stablecoins.
• The qualifying cryptoassets-related activities do not include cryptoasset lending activities or Decentralised Finance activities HMT suggesting that this would result in unnecessary and disproportionate amendments to the regulatory perimeter; the activities of crypto wallet providers will also not be included as there was no a clear case of consumer harm.

The fact that, under the HMT proposals, an FCA authorised firm can make or approve a financial promotion is a first step in a journey towards bringing otherwise unregulated cryptoassets closer to the general regulation of financial services and regimes for the protection of investors in financial instruments. By seeking to establish more general principles underpinning the definition of qualifying cryptoassets, HMT is seeking to bring coherence to continuing that journey towards a more comprehensive investor protection regime for cryptoassets.

The inclusion of qualifying cryptoassets in the FCA’s new category of ‘Restricted Mass Market Investments’ and not the narrower category of ‘Non-Mass Market Investments’ would mean that, in practice, the public promotion of cryptoassets to retail consumers, albeit subject to the FCA’s financial promotion rules, will be allowed. This suggests that the future regime, although designed for safety, will not prevent the UK public from taking advantage of the opportunities which cryptoassets have the potential to bring.

Andrew Henderson is a Partner at Macfarlanes LLP.