The key points – what’s required or good practice now?
- Marketing – Despite imminent plans to bring most cryptoassets within the scope of the UK’s financial promotions regime, NFTs are not set to be affected by this. However, the Advertising Code applies to cryptoassets which are not regulated products including most NFTs. The Advertising Standards Authority (ASA) issued guidance in March 2022 on advertising cryptoassets and includes NFTs in its scope. The guidance requires that advertisements of cryptoassets include a prominent statement that the product is not regulated. For financial services firms which are regulated in the UK, it would be prudent to keep in mind the FCA’s Principles for Businesses (even though most of the Principles do not apply to the unregulated business of the firm) when marketing NFTs and communicating with clients. Marketing of NFTs in the EU will vary between Member States as there is currently no applicable pan-EU regime. The EU’s Markets in Cryptoassets Regulation (MiCA) will introduce a marketing regime for some cryptoassets but is not set to apply to NFTs.
- Licensing – NFTs that do not amount to a traditional security (like a bond or share), a unit in a fund, e-money or a derivative are not regulated in the UK. Current changes to the UK crypto regime to bring stablecoins within the regulatory scope will not impact on NFTs but future changes are possible. The position at pan-EU level is similar but individual Member States may have their own regimes. MICA, the pan-EU regulation on crypto-assets, is due to be introduced in the next couple of years and this will impose authorisation and marketing requirements for firms dealing with certain types of cryptoassets. However, this is not set to apply to NFTs.
- Registration under the Money Laundering Regulations (MLRs) – If issuing or exchanging (in each case for money, other cryptoassets or another form of value) NFTs by way of business from within the UK, you will need to register with the FCA under the MLRs before doing so. If you operate in the EU, individual jurisdictions will have similar requirements. In the UK at least, the registration requirement will not apply if services are offered into the UK on a purely cross-border basis from overseas.
What is an NFT and what are their use cases?
A non-fungible token (NFT) is a unique digital record stored on a blockchain which usually represent rights in other digital or real assets (such as digital art or reward items like alcohol or holidays). An NFT is a method of tracking or certifying the ownership or right to that asset. This proof of ownership is possible as information stored on blockchains is almost impossible to change or destroy.
As NFTs’ metadata will point to different digital or real world assets, that gives them a level of uniqueness between themselves and makes them “non-fungible”. This contrasts with other forms of tokens like Bitcoin and Ether, which among each set of tokens are practically identical in function and metadata, making them directly exchangeable for each other or “fungible” like serialised bank notes.
Why are lawmakers paying attention to NFTs?
NFTs have been one of the hottest sectors of the crypto market in the last 12-18 months, with individual NFTs selling frequently for hundreds of thousands of dollars – up to a record of $69 million – and nominal transaction volumes on NFT marketplaces reported to have neared $25 billion in 2021, up from less than $100 million a year earlier. The apparent size of the opportunity has spurred interest from financial firms and non-financial businesses alike in issuing, marketing and intermediating transactions in NFTs. Diageo-owned Johnnie Walker recently paired with Blockbar to launch an NFT entitling owners to – amongst other things – bottles of 48-year old whiskey, and JP Morgan recently made history, becoming the first bank to open on the “metaverse” where users can buy and sell NFTs and make use of other crypto-services.
While the boom appears to be cooling now – OpenSea, the biggest NFT marketplace, just announced 20% layoffs months after raising $300 million at a $13.3 billion valuation – NFTs remain a hot topic. Even with an apparently sustained drop in prices and volumes, there remains a lot of money and interest in NFTs; that, coupled with NFTs’ close connection with cryptoassets more generally, is likely to keep them squarely in lawmakers’ sights.
UK and EU marketing restrictions on NFTs
The UK financial promotions regime, a regime in the UK which governs marketing of regulated products such as investments, does not currently apply to NFTs which are not regulated (which would be the case unless the NFT contains features which would bring it within the regulated products category e.g. security, e-money, unit in a fund or a derivative). HM Treasury (HMT) is proposing an expansion of the financial promotion regime to capture certain cryptoassets (“qualifying cryptoassets”) even where they are not regulated under the licensing regime in the UK. However, these changes will not apply to NFTs because the proposed definition of “qualifying cryptoassets” will only capture fungible cryptoassets, which NFTs generally would not be.
Notwithstanding that the UK financial promotions regime will not apply, the ASA’s Advertising Code applies to NFTs. The ASA provided guidance in March 2022 on advertisements for cryptoassets of all types in the UK. Advertisers must clearly state that cryptoassets are not regulated by the FCA and are not protected by financial compensation schemes.
For financial services firms which are regulated in the UK, even though NFTs are not regulated products, such firms are subject to the Principles for Businesses, in particular Principle 6 (Customers’ interests) and Principle 7 (Communications with clients). These two Principles do not apply to firms’ unregulated business, but it would be prudent for regulated firms to nevertheless pay regard to these Principles and ensure that their communications and offers of such products are broadly aligned with the Principles, and perhaps even with general financial promotions requirements.
UK and EU licensing regime and NFTs
NFTs that do not fall under the category of regulated products in the UK (such as units in funds, or securities, or derivatives or e-money), are not currently regulated in the UK.
Back in 2019, the FCA published a policy statement which effectively splits the world of cryptoassets into three broad buckets: security tokens, e-money tokens and unregulated tokens. Security tokens have the attributes of securities (shares, bonds, fund units, derivatives, etc.), while e-money tokens have the attributes of electronic money. The FCA regulates these types of tokens as securities or as e-money as appropriate, under the existing regimes for those instruments. Everything else, including NFTs, falls into the bucket of “unregulated tokens”.
The government confirmed in April 2022 that it plans to bring stablecoins used as a means of payment into the UK regulatory perimeter. This will not impact NFTs, at least not for the time being. However, the HMT has indicated that it is considering the case for bringing a broader set of cryptoassets (such as Bitcoin) into the regulatory regime to a longer timetable. It remains to be seen if this will include NFTs – one to monitor.
In the EU, the licensing position will vary between Member States. As for the direction of travel in the EU, the European Parliament and Council reached preliminary political agreement on the MiCA last month. MiCA would provide a pan-EU regulatory regime for most cryptoassets, creating a licensing requirement for cryptoasset service providers and imposing conditions on cryptoasset issuers. Whether NFTs would be captured by MiCA was subject to much debate among the EU co-legislators. The settled position following political agreement appears to be that NFTs that are unique and non-fungible are out of scope – but this remains to be confirmed by the final text in autumn. As the proposal currently stands, fractionalised NFTs will be considered fungible and will therefore be regulated by MiCA; the same will be true for NFTs referencing non-unique or fungible items, which might cause some NFTs to become regulated. For more details on MiCA, please see our post here.
UK and EU anti-money laundering regime and NFTs
Whilst NFTs are not in scope of the UK general licensing regime, they are in scope of the UK anti-money laundering regime under the MLRs. Most prominently, firms in the UK exchanging, or providing custody for, these or any other cryptoassets must be registered with the FCA and comply with anti-money laundering (AML) rules, perform customer due diligence, etc. “Exchanging” is defined broadly and includes issuing tokens, as well as operating an exchange or marketplace for them.
UK (and EU) anti-money laundering rules also extend to “art market participants”, capturing firms that trade or intermediate transactions in works of art above a certain value threshold. HMRC, the UK tax authority, is responsible for overseeing art market participants’ AML compliance. While NFTs are often spoken of as a way of selling digital art, the relevant UK legal definition of a “work of art” comes from tax legislation that excludes digital art from its definition. HMT closed a consultation in October 2021 which proposed bringing digital art within the scope of this definition and therefore of the MLRs. However, for now it does not appear that digital art will be included in the MLRs – though HMT noted in their consultation response that they intend to keep this under consideration as they conduct further work to consider possible future changes to the relevant definitions.
The position in the EU will be similar as the UK MLR requirements on cryptoassets are derived from the Fifth Money Laundering Directive. However, there are likely to be variations in application in the different Member States, and rules will be subject to future developments – with the EU actively considering expanding the scope of its anti-money laundering legislation to capture NFTs.