The Financial Conduct Authority (FCA) is consulting on guidance that focuses on the interaction between cryptoassets and the FCA’s regulatory perimeter (the Consultation). This consultation follows on from the House of Commons Treasury Committee’s report published on 19 September 2018 which called for cryptoassets to be brought within the FCA’s regulatory perimeter, a stance which was also supported by the Cryptoassets Taskforce when it considered the issue in October 2018.
The FCA’s regulatory perimeter
The FCA’s regulatory perimeter is the boundary that separates FCA regulated financial services activities from unregulated business. In order to come within the perimeter, one must be carrying on a regulated activity in respect of a “specified investment”, as set out in the Financial Services and Markets Act 2000 and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO).
The consultation is intended to result in guidance clarifying when different types of cryptoassets will be “specified investments” and thus fall within the regulatory perimeter. The Consultation outlines where different categories of cryptoassets are likely to be specified investments under the RAO.
The consultation does not provide a single definition of a cryptoasset. Whether a cryptoasset falls to be classified as a specified investment will depend on how it is structured and will require a case-by-case analysis of the cryptoasset itself.
Even if a cryptoasset is not a specified investment, there are a number of broader financial services rules and regulations that those involved in promoting or dealing in it should be aware of, such as financial promotion rules, conduct of business rules and the FCA’s Principles for Business. Other non-financial rules and regulations may also apply, including the Advertising Codes, Trading Standards, general common law, criminal law and the General Data Protection Regulation.
A firm that carries on regulated activities both relating to cryptoassets that are inside the regulatory perimeter and those that fall outside must make sure there is sufficient and clearly visible separation between the two.
How does the FCA propose to regulate cryptoassets?
The consultation states that exchange tokens which enable the buying and selling of goods without the need for an intermediary (e.g. Bitcoin and Litecoin when used for that purpose) currently fall outside the regulatory perimeter.
Although exchange tokens can also be used to facilitate regulated payment services such as international money remittance, the consultation states that such activity would not be covered by the Payment Services Regulations 2017 (PSRs) since the PSRs regulate each side of the remittance and not the use of cryptoassets in between which act as the vehicle of remittance, in a manner equivalent to cash.
In addition, cryptoassets that establish a new sort of unit of account rather than representing fiat funds are unlikely to amount to e-money and therefore fall within the FCA’s regulatory perimeter under the E-Money Regulations 2011 (EMRs) unless the value of the unit is pegged to a fiat currency, but even then, it will depend on the facts of each case.
Although exchange tokens are unlikely to fall within the FCA’s regulatory perimeter, firms that facilitate transactions in exchange tokens should keep in mind that they will have to meet the requirements of the Fifth Anti-Money Laundering Directive when it is implemented in the UK in 2020.
The consultation states that security tokens that grant holders rights akin to those conferred on shareholders, debt-holders or holders of other “traditional” investments will constitute specified investments and therefore fall within the regulatory perimeter. Exactly how such tokens will be regulated will depend on the type of traditional underlying security the security token most resembles.
The FCA points to several factors relevant to determining whether or not a security token is a specified investment. It will be the substance of the rights attaching to a token that will determine whether that token is a specified investment and not necessarily the descriptive labels used by the issuer. Factors the FCA will consider include, for example, whether the contractual rights and obligations the token-holder has by virtue of holding the token.
The consultation points to shares, debt instruments, warrants, certificates representing certain securities, units in collective investment schemes and rights to and interests in investments as the traditional securities most likely to be synthesised by security tokens. The FCA states that security tokens resembling such traditional securities are likely to constitute specified investments:
- shares – a token that give holders similar rights to shares, like voting rights, or access to a dividend of company profits.
- debt instruments that are debentures – a token that creates or acknowledges indebtedness by representing money owed to the token holder.
- warrants – where a firm issues A tokens that grant token holders the right to subscribe for B tokens in the future, and B tokens are themselves specified investments (for example, shares or debentures), A tokens will likely constitute warrants and are likely to be specified investments.
- certificates representing certain securities – a token that confers rights in relation to tokenised shares or tokenised debentures.
- units in collective investment schemes – a token that acts as a vehicle through which profits or income are shared or pooled, or where the investment itself is managed as a whole by a market participant, for example the issuer of tokens.
- rights to and interests in investments – a token that represent rights to or interests in a share, although the token itself does not represent or have characteristics of a share.
The consultation clarifies that a firm that carries on specific regulated activities (such as involving cryptoassets that are specified investments) will need to make sure it is appropriately authorised or exempt, in the same way as they would need to be if they were carrying out such activities in respect of traditional securities.
It should be further noted that a number of these, for example, tokens that amount to units in a collective investment scheme, will attach regulatory treatment – for example, the Non-Mainstream Pooled Investment Rules.
If a token is a transferable security under MiFID II and will be offered to the public in the UK or admitted to trading on a regulated market, the issuer will need to publish a Prospectus unless an exemption from the requirements of the Prospectus Directive applies. If a Prospectus is required, the specific disclosure requirements will depend on the type of security.
Utility 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. The consultation notes that utility tokens do not typically exhibit features that would make them the same as securities and will not be captured in the regulatory regime unless they meet the definition of e-money and thus fall to be regulated under the EMRs.
Cryptoassets as e-money
According to the FCA, any category of cryptoasset has the potential to be e-money depending on its structure and whether it meets the definition of e-money.
The EMRs define e-money as electronically stored monetary value as represented by a claim on the electronic money issuer which is:
- issued on receipt of funds for the purpose of making payment transactions;
- accepted by a person other than the electronic money issuer; and
- not otherwise excluded under the EMRs.
For example, the consultation notes that tokens that are pegged to a fiat currency and are used for the payment of goods and services on a network could potentially meet the definition of e-money.
The FCA expects to publish final guidance on the existing regulatory perimeter in relation to cryptoassets no later than the summer of 2019. Since the FCA is approaching to take a case-by-case approach in respect of regulating cryptoassets, firms that deal in cryptoassets will have to consider which activities they are conducting fall within the regulatory perimeter. Even firms that are not conducting activities that fall within the regulatory perimeter will have to consider whether there are any other applicable rules or regulations, such as in relation to financial promotions, that may apply.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2019