The FCA’s Guidance provides clarity in the evolving cryptoassets market. Syedur Rahman of Rahman Ravelli explains its implications.
The Financial Conduct Authority (FCA) released policy statement PS19/22 as its final guidance on cryptoassets. While the Guidance may have been some time coming it certainly clarifies a number of issues that are of importance for those in the virtual currency market.
Most importantly, it provides an explanation of the regulatory treatment of cryptoassets and the obligations facing those that have dealings with them. It has been created to be of value to the firms that issue, create, promote, trade, store or hold and to financial advisers, investment managers and others in related fields.
Those working in the crypto market need to study the Guidance carefully and, if anything appears unclear, they must seek specialist legal advice to ensure they are fully aware of all its implications. For those looking to invest in cryptoassets, the Guidance is an important, up-to-date summary of the regulatory protections that apply.
The overall effectiveness of the Guidance will only become known with the passage of time. It should also be noted that certain aspects of related guidance are still due to be completed:
• On October 3, the FCA’s consultation on the possibility of banning the sale of derivatives relating to certain unregulated cryptoassets to retail customers closed. A policy statement in relation to this is expected early in2020.
• A Treasury consultation on whether there is any further regulation needed of cryptoassets, particularly regarding unregulated cryptoassets.
• Work related to the European Union’s Fifth Anti-Money Laundering Directive (5AMLD), which is to be implemented by 10 January 2020.
The FCA’s Regulatory Perimeter
The FCA Guidance follows January 2019’s consultation paper CP19/3 and the final report of the Cryptoassets Taskforce’s final report of October 2018, which committed the FCA to providing guidance on cryptoassets in relation to its regulatory perimeter - the boundary between regulated and unregulated financial services activities, whereby those conducting activities within the perimeter usually require authorisation from the FCA unless they can rely on an exclusion. To be within the FCA perimeter, a “specified activity” in relation to a “specified investment” must be carried out. The FCA has provided guidance on whether varying types of cryptoassets are a “specified investment” and, therefore, are within its regulatory perimeter.
The FCA outlines:
• Two categories of unregulated tokens - exchange tokens and utility tokens.
• Two categories of regulated tokens - security tokens and electronic money (“emoney”) tokens.
The Guidance sets out that exchange tokens do not grant the holder any rights associated with specified investments. They are decentralised - with no central issuer obliged to honour any contractual rights - and fall outside the regulatory perimeter. Bitcoin and Ether are examples of such tokens. As a result, activities involving them are also outside of the regulatory perimeter.
But the FCA does remind firms to be aware of 5AMLD and the Government’s intention to extend UK anti-money laundering regulation to include the exchange services, transfers and issuing of cryptoassets.
In its Guidance, the FCA makes it clear that utility tokens – which are described as tokens offering access to an existing or future service or product - fall outside the regulatory perimeter.
The FCA outlines situations where a token would be constitutes a utility token and, therefore, unregulated. These include:
- issuing a token that is fully transferable and used to access products and services within a firm’s own network but cannot be used as a means of exchange across other networks.
- using a token as a settlement token (only within a firm’s internal network) to improve the speed of back-office functions through a permissioned distributed ledger technology (“DLT”) system.
- issuing a transferable token that gives the holder storage rights on a particular network.
Security tokens - described in the Guidance as tokens that provide rights and obligations similar to specified investments other than e-money - will fall within the regulatory perimeter.
Examples of rights provided by a token which will make it likely to constitute a security token, include:
- If it represents ownership rights (such as via dividend payments) or control (via voting).
- If a token represents debt owed by the issuer, it is likely to constitute a security token.
- If a token gives its holder the right to subscribe to a future security token. • If it is a means by which profits or income are shared or pooled.
The Guidance states that tokens meeting the definition of e-money under the Electronic Money Regulations 2011 (EMRs, will fall within the regulatory perimeter.
E-money is defined under the EMRs as electronically stored monetary value as represented by a claim on the e-money issuer which is issued on receipt of funds for the purpose of making payments, accepted by someone other than the e-money issuer and does not fall within an exclusion under regulation 3 of the EMRs (which relates to types of prepaid balances).
The Guidance clarifies that stablecoins - described as tokens stabilised through being backed by fiat currency (government-issued currency that is not backed by a physical commodity, such as gold or silver, but by the government that issued it), cryptoassets, other tangible assets, algorithms or a combination of these - may fall within the FCA’s regulatory perimeter, depending on their structure and stabilisation method. The FCA states that any token pegged to a currency such as the US dollar or UK pound or other assets and used for the payment of goods and services on a network could be classed as being within the definition of e-money and, therefore, be within its regulatory perimeter. But it would also have to meet the definition of e-money outlined above.
The FCA’S Guidance outlines clearly the categories of participants in the market (and their activities) that are likely to be subject to regulations or otherwise require authorisation for the provision of services, for example giving investment advice.
The participants and activities include:
• Issuers of tokens – issuing tokens including through initial coin offerings (ICO).
• Advisers and intermediaries – advising consumers and assisting with the buying of tokens.
• Exchanges and trading platforms – enabling transactions to be conducted between participants in the market.
• Wallet providers and custodians – providing token storage.
• Payment providers – enabling customers to pay merchants in fiat currency or transfer fiat currency via a cryptoasset.
If customers are invited to involve themselves in investment activity, such as buying a security token, that activity could fall within the financial promotion regime. The FCA expects market participants to comply with the financial promotions rules outlined in the FCA Handbook in relation to Section 21 of the Financial Services and Markets Act. The FCA also emphasises that firms should make sure that they do everything to ensure customers know which activities the firm is authorised for. Firms should not do anything to indicate that their authorisation extends to unregulated cryptoassets.
Any security token issuer that is to be offered to the public in the UK or traded on a regulated market has to publish a prospectus; although some exemptions do apply.
The Effect of the Guidance
There is little doubt that the Guidance is of value in helping firms know if their cryptoasset activities come under FCA regulation, whether they need to be authorised and how they make sure they are compliant.
The cryptoasset market is in its infancy. Yet it is a complex and developing market that is likely to only increase in size. The clarity the Guidance offers is much-needed and comes after a period in which the FCA has been vocal in urging potential customers to exercise caution.
While it is important to note that the Guidance is not binding on the courts it could play a role when it comes to settling disputes related to cryptoassets. The complications and the volatility of the cryptoassets market mean that we should expect such disputes. But the FCA Guidance does at least indicate an awareness of the issues and represents a considered yet cautious attempt to assist those involved in this rapidly evolving area.