On 3 July 2019, the United Kingdom Financial Conduct Authority (the “FCA”) published its consultation paper on a proposed ban on the sale, marketing and distribution to retail clients of derivatives that reference certain types of cryptoassets (“CP 19/22”).
The proposal follows on from a number of FCA statements and papers relating to cryptoassets, their regulatory treatment and their effect on markets, including:
- the UK Cryptoasset Taskforce Final Report on cryptoassets published in October 2018 (see our client alert on this here);
- the FCA’s perimeter guidance consultation paper on cryptoassets published in January 2019, consulting on guidance clarifying what types of cryptoassets fall within its regulatory perimeter; and
- the FCA’s policy statement published on 1 July 2019 restricting the sale of contracts for difference (“CFDs”) and CFD-like options to retail clients, which forewarned that a consultation paper on a proposed crypto-based derivatives ban would be published shortly.
Scope of the proposed ban
The method of implementation for the proposed ban is set out at Appendix 1 of CP 19/22. The proposed amendments to the FCA Conduct of Business sourcebook (“COBS”) include a prohibition on firms selling, distributing or marketing “a cryptoasset derivative or cryptoasset exchange traded note to a retail client”.
CP 19/22 makes clear that the ban seeks to capture investment products that reference “unregulated transferable cryptoassets”. The FCA has defined this as:
“a cryptographically secured digital representation of value or contractual rights that uses distributed ledger technology and which:
- is capable of being traded on or transferred through any platform or other forum;
- is not limited to being transferred to its issuer in exchange for a good or service, or to an operator of a network that facilitates its exchange for a good or service;
- is not electronic money; and
- is not a specified investment.”
Rationale of the proposed ban
CP 19/22 makes clear that the FCA believes that some retail clients cannot reliably assess the value and risks of derivatives or exchange traded notes that reference certain cryptoassets. In particular, the FCA cites extreme volatility and difficulty in valuation as features that might cause retail clients to suffer sudden and unexpected losses. To test the lack of reliable valuation models for derivatives linked to cryptoassets, the FCA refers to bitcoin valuations by two different analysts using the same pricing model. One valuation was four-hundred times bigger than the other.
In addition, the FCA argues that cryptoassets are “typically characterised” by information asymmetries which prevent retail clients from making well informed decisions, as well as significant operational risk and widespread misconduct including cyber risk, financial crime and market abuse.
In attempting to quantify the potential harm that the FCA is seeking to address, CP 19/22 includes a cost benefit analysis, which estimates that the proposed ban could reduce retail client losses by £75m – £234.5m.
CP 19/22 is particularly relevant for:
- firms issuing or creating products referencing cryptoassets;
- firms distributing products referencing cryptoassets, including brokers, investment platforms and financial advisers;
- firms marketing products referencing cryptoassets;
- operators of trading venues and platforms; and
- retail clients.
The consultation is now open until 3 October 2019. Should the FCA decide to proceed with the final rules, a final policy statement and the amended COBS is expected to be published in Q1 2020. If you are planning to respond to CP 19/22 and require assistance, please contact the authors of this alert.