The Financial Conduct Authority (FCA) has published its Consultation Paper (CP19/3: Guidance on Cryptoassets) which sets out guidance on how cryptoassets can be subject to FCA regulation. Our Financial Services Regulatory experts summarise the FCA's expectations and highlight the key considerations for firms.
The Guidance seeks to clarify where different categories of cryptoasset tokens fall in relation to the FCA's regulatory perimeter, i.e. the boundary that separates regulated and unregulated financial services activities. Activities which fall within the regulatory perimeter are regulated and require authorisation from the FCA, and in limited circumstances the Prudential Regulation Authority, before they can be carried out. Carrying out regulated activities without the relevant authorisations may constitute a criminal offence.
Types of Cryptoassets
The FCA recognises three types of cryptoassets which it has described as follows:
- Exchange Tokens not issued or backed by any central authority and are intended to be designed to be used as a means of exchange. The FCA has confirmed that these types of token generally fall outside of the regulatory perimeter. This is the case even when Exchange Tokens are acquired and held for the purpose of speculation (and in the hope of making a gain) rather than exchange. However, they may be caught by the UK's Anti Money Laundering Regime in future. Her Majesty's Treasury will be consulting separately on the transposition of the EU's 5th Money Laundering Directive, which captures certain activities in relation to cryptoassets, later this year;
- Security Tokens -these include specific characteristics which bring them within the definition of a 'Specified Investment', such as a share or a debt instrument, which mean they fall within the regulatory perimeter; and
- Utility Tokens - these 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. Although these are not Specified Investments, they could still require FCA authorisation if they constitute 'e-money' or are used to facilitate regulated payment services.
The FCA has made clear that the above tokens are not mutually exclusive, nor are they exhaustive of the types of cryptoassets that can exist. Whether a cryptoasset falls within the regulatory perimeter should always be considered on a case-by-case basis with regard to a number of different factors.
Factors to consider when determining if a token is a Security Token
The FCA has highlighted that activities involving tokens which include characteristics of 'Specified Investments' such as shares or debt instruments (types of security), may require FCA authorisation. It has set out a non-exhaustive list of factors that it considers are indicative of a security:
- the contractual rights and obligations the token-holder has by virtue of holding or owning that cryptoasset;
- any contractual entitlement to profit-share (e.g. dividends), revenues, or other payment or benefit of any kind;
- any contractual entitlement to ownership in, or control of, the token issuer or other relevant person (e.g. voting rights);
- the language used in relevant documentation (e.g. Whitepapers). However, the FCA has made clear that if a Whitepaper declares a token to be a utility token, but the characteristics of the token indicate it is a Specified Investment, the FCA would treat it as a Security Token;
- whether the token is transferable and tradeable on cryptoasset exchanges or any other type of exchange or market;
- whether there is a flow of payment from the issuer or other relevant party to token holders; and
- whether any flow of payment is a contractual entitlement - the FCA has made clear that it would consider this to be a strong indication that a token is a security.
What does this mean for you?
If you engage in activity by way of business in the UK, that relates to a Security Token or to a token that constitutes e-money or is involved in payment services, you should consider whether those activities require authorisation.
If a token is a transferable security and will either be offered to the public in the UK or admitted to trading on a regulated market, an issuer will need to publish a prospectus in accordance with the UK's Prospectus Regime unless an exemption applies.
If your activities fall within the FCA's regulatory perimeter, you should consider, in particular:
- the application of financial promotion rules, including ensuring communications are marketed in a way which is clear, fair and not misleading;
- the application of the Propectus Directive;
- the application of relevant financial crime controls; and
- operational resilience and cyber security issues - cryptoassets are now regarded as high-value targets for theft and service providers (e.g. custodians/wallet providers) are increasingly being targeted by cyber-criminals to obtain the private keys which enable consumers to access and transfer their cryptoassets.
Who is this Guidance relevant for?
The FCA's Guidance is relevant to:
- firms issuing or creating cryptoassets;
- firms marketing cryptoasset products and services;
- firms buying or selling cryptoassets;
- firms holding or storing cryptoassets;
- financial advisers;
- professional advisers;
- investment managers;
- recognised investment exchanges; and
- consumer organisations.
What are the next steps for firms?
Firms have until Friday 5 April 2019 to respond to the FCA's consultation. Firms can do so by emailing [email protected]
The FCA will consider feedback received before publishing its final Guidance on the existing regulatory perimeter in relation to cryptoassets this Summer.