On 18 January 2022, HM Treasury issued its response to last year's consultation on financial promotions. The resulting legislation will bring certain unregulated cryptoassets within the scope of the UK financial promotion framework, and introduce a more robust regime for authorised firms approving financial promotions. The Treasury response was closely followed, on 19th January 2022, with the FCA's consultation on rules and guidance, necessary for implementing this new regime.
HM Treasury Response
The Government has set out a proposed definition of 'qualifying cryptoasset' which will be included in the list of controlled investments in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the FPO). Corresponding amendments will also be made to several controlled activities, with the intention of limiting consumer harm arising from so-called high-risk investments. Of note is that the proposed definition of 'qualifying cryptoasset' includes requirements as to both transferability and fungibility, thereby seemingly excluding from its scope the marketing of non-fungible tokens (or NFTs). As NFTs and other crypto assets continue to blur the boundaries between financial and non-financial products, this will inevitably be an area of interest as rules, guidance and case law develops. Cryptoasset firms will be concerned that the proposals fail to differentiate between the promotion of cryptoassets for investment purposes and the sale of utility tokens to consumers for the purpose of accessing goods and services. Under the current proposals all sales of transferrable fungible tokens must be treated as if they are investments.
The Government is also making changes to introduce a new regulatory gateway for firms approving financial promotions for unauthorised firms (known as the ‘section 21 gateway’). This proposal involves imposing a new requirement on authorised firms, requiring that they will only be able approve financial promotions for unauthorised persons if they have been assessed by the FCA as suitable to do so. If legislation is passed to create the s21 gateway in the way that Treasury has set out, then authorised firms wanting to approve financial promotions for unauthorised persons will need to first apply for a variation or cancellation of the financial promotion restriction.
The Government will be shortly setting out the next steps relating to the wider regulatory regime for stablecoins. While it remains to be seen how this will further impact those operating in the crypto space, we suspect that further regulation in this area is inevitable.
The FCA has set out its intention to take, broadly, three steps in relation to high-risk investments:
- Categorise high risk investments as either ‘Restricted Mass Market Investments’ or ‘Non-Mass Market Investments. In this respect, the FCA intends to generally apply the same rules to qualifying cryptoassets as currently apply to Non-Readily Realisable Securities and Peer-to-Peer agreements. Together, they will collectively fall under the category of ‘Restricted Mass Market Investments’ going forwards.
- Ensure consumers only access high risk investments knowingly by introducing a package of measures to:
- strengthen risk warnings (including introducing prescribed wording and risk information);
- ban any monetary and non-monetary inducements to invest;
- introduce two positive frictions for first time investors – a personalised risk warning pop-up and a 24-hour cooling off period;
- improve client categorisation by implementing evidentiary criteria and simplifying language. ‘Direct Offer’ financial promotions of qualifying cryptoassets to self-certified sophisticated investors will also be prohibited; and
- strengthen appropriateness tests, including to prevent re-assessment within a 24-hour period and prohibiting encouraging investors to re-apply.
- Develop a robust regime to complement the proposed s21 gateway.
In respect of s21 approvers, the FCA is proposing changes to the following key areas of the financial promotion lifecycle:
- Approving and communicating promotions – ensure that a financial promotion to a retail client includes the name of the firm that approved the promotion and a date stamp confirming the date on which it was approved, and requiring firms to self assess whether they have the necessary competence and expertise regarding an investment product or service before approving or communicating a relevant financial promotion.
- Lifetime of the promotion – including an ongoing monitoring requirement for firms approving promotions to move away from a ‘once and done’ approach. This rule would require s21 approvers to take reasonable steps to monitor the continuing compliance of approved promotions to consider whether:
- There have been any changes to the promotion, which mean it is no longer being lawfully communicated.
- There have been any changes which may affect whether the promotion continues to be clear, fair and not misleading, including consideration of the ongoing commercial viability of the proposition described in the promotion. They should also assess whether the headline rates of return in the promotion continue to be reasonably achievable.
- Funds raised are being used for the purposes described in the promotion.
- The promotion complies with any new requirements the FCA may introduce, e.g. risk disclosures and positive frictions.
- Firms would also be required to collect attestations of ‘no material change’ from clients with approved promotions every 3 months, and for the lifetime of the approved promotion.
- Conflicts of interest - extending existing conflicts of interest obligations to firms (i) approving financial promotions for unauthorised persons, and (ii) confirming compliance of a financial promotion for an authorised firm.
- Consumer journey – to clarify the role of firms approving promotions in the client categorisation and appropriateness test for ‘Restricted Mass Market Investments’ and preliminary assessment of suitability for ‘Non-Mass Market Investments’, including requirements to check the compliance of appropriateness tests periodically, throughout the lifetime of a promotion.
The consultation is open until 23 March 2022 and the FCA intends to publish a Policy Statement and final Handbook rules in summer 2022. The FCA is proposing to then give firms 3 months to comply with the new requirements (save that any requirements relating to cryptoasset promotions will apply from the date qualifying cryptoassets are brought within the financial promotion regime).
A major concern to those unauthorised firms operating in the crypto space will no doubt be the issue of complying with this new regime in practice. As noted above, the availability of typical FPO exemptions will be limited in the case of cryptoassets and so firms will inevitably need to rely on a (we suspect) now far reduced pool of s21 approvers. Even once a s21 approver is on board, any financial promotions will need to comply with FCA rules and, more specifically, new rules relating to restricted mass market investments.
There is quite clearly a tension between evolving technology and the need to prevent consumer harm. The risk is that these new rules, compounded with the existing UK AML/CTF regime (see our previous articles here) further inhibit innovation in the UK and make setting up here commercially unviable.