Strengthening the Financial Promotion Rules Reprised - Cryptoassets

The legislation bringing the promotion of "qualifying cryptoassets" into the FCA's remit applies to all firms marketing qualifying cryptoassets to UK retail clients (as defined in COBS), irrespective of the jurisdiction in which they are established, or the technology used to make the promotion. Broadly speaking, any cryptographically secured digital representation of value or contractual rights, that is transferable and fungible (so excluding truly non-fungible tokens or NFTs, such as digital artworks) will be caught, unless it constitutes electronic money under the Electronic Money Regulations 2011 or a controlled investment under the Regulated Activities Order (both of which remain subject to the existing regimes).

There will be 4 ways in which promotions relating to relevant cryptoassets can be made to UK consumers:

1. By a firm which is FCA-regulated (many cryptoasset firms are not currently FCA-regulated).
   
   
2. Under an exemption which permits firms registered with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) to communicate their own cryptoasset financial promotions. Broadly, cryptoasset exchanges and wallet providers (wherever located) acting in the course of business carried on by them in the UK are already obliged to register under the MLRs. The FCA expects that some firms that are not currently registered (due to their interpretation of the territorial scope of the MLRs), but which wish to continue servicing UK consumers, are likely now to seek registration.
   
   
3. By unregulated cryptoasset firms whose promotions have been approved by an authorised firm (note that from a date which is yet to be announced, FCA-regulated firms which approve financial promotions for other entities will need to go through the "gateway" established by the Financial Services and Markets Act 2023 to do so).
   
   
4. Under a different exemption in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005.

The FCA's broad approach is largely unchanged, and is founded on the classification of cryptoassets as Restricted Mass Market Investments (RMMIs). This means that many of the rules examined in our previous briefing will apply. In summary, client categorisation, appropriateness assessments, prescribed risk warnings, "positive" frictions built into customer journeys, and a ban on incentives to invest will be required. However, the FCA has altered the detail of some of its proposals as follows:

1. Risk warnings: The new mandatory risk warning has been shortened, and the FCA has amended the text to specify that consumers cannot expect FSCS or FOS protection. Firms may vary the wording where there is a good reason, but must keep records of such changes and the rationale behind them.
   
   
2. Ban on incentives: The FCA has clarified the scope of the ban on incentives to invest, and will not apply the "shareholder benefits" exemption that was introduced in PS22/10 to assist the crowdfunding sector (under which certain goods and services can be provided by the issuer of the security alongside or as a result of the investment).
   
   
3. Design of the customer journey: Clearer guidance has been provided on the operation of the consumer journey rules, including the application of the Direct Offer Financial Promotion (DOFP) rules. This is intended to maintain consumer protection without limiting firms' opportunity to provide information about the cryptoasset.
   
   
4. Operation of the cooling-off period: The 24 hour cooling-off period (among the proposals that has prompted the most discussion in the market) begins once the consumer has requested to see the DOFP, but the firm can continue to complete processes such as money laundering and verification checks, or the categorisation during this period (rather than needing to wait 24 hours before doing so). Where these processes take longer than 24 hours there is no requirement to introduce an additional freeze of the customer journey.
   
   
5. Sophisticated and high net worth investors: The FCA has narrowed the types of clients to which DFPs can be made by removing the availability of the self-certified sophisticated investor category in COBS. It has also clarified and streamlined what checks firms should make of income declared by consumers in relation to the high net worth investor category.
   
   
6. Appropriateness assessments: Where consumers need to undergo multiple appropriateness assessments, the rules now require that, starting with the second assessment, consumers must wait at least 24 hours before going through the assessment again. The FCA has added more detail on how firms should complete the assessment.
   
   
7. Record-keeping: Record-keeping requirements have been limited to metrics relating to client categorisation and appropriateness assessments.
   
   
8. Implementation date: The initial proposed implementation period was reduced (to 8 October 2023) to reflect the change in legislation, driven by a greater urgency within government.
   
   
9. Date/time stamping of approvals: The original rules require that financial promotions have a date and time stamp recording the point of approval. Where space is limited by a third-party provider, this can now be replaced with the firm's Firm Reference Number and a link to a web page setting out the full details.
   
   
10. Consumer Duty: The FCA has been clearer about the application of the Consumer Duty. The Consumer Duty will not (in line with the existing perimeter) apply to firms registered under the MLRs, but will apply to authorised firms, with the customer understanding outcome being the key element of the Consumer Duty in the context of financial promotions.

The FCA also consulted on draft non-Handbook guidance. The guidance itself is concise (12 pages) and relatively self-explanatory. All firms promoting cryptoassets will need to read read and take account of the guidance, and elements of it (for example, on the due diligence required on any claims made) are likely to be of particular use to authorised firms that intend to approve financial promotions for unauthorised cryptoasset firms.

The consultation also included an interesting set of "discussion questions" on what the FCA refers to as 'complex yield models/arrangements'. While this is somewhat tangential to the topics covered by the guidance, it is indicative of the FCA's perspective on the areas of greater risk. The FCA is clearly in intelligence-gathering mode in this area, especially given that HM Treasury is still in the process of considering exactly how these models should be regulated.

These models include a variety of structures that can be described as 'staking', 'borrowing' and 'lending'. Staking involves (at a high level) the holder of a cryptoasset agreeing to hold or lock the cryptoasset on a blockchain, for either a set period of time or indefinitely. This supports the validation of transactions, and some or all of the holders staking their cryptoassets are then rewarded, generally with new cryptoassets. Staking is of increasing importance to cryptoasset markets as it underpins 'proof of stake' consensus mechanisms, which are becoming increasingly common as they are becoming more widely preferred to the more energy-intensive 'proof of work' consensus mechanisms (such as the mining that creates new bitcoins). In the realm of 'lending' and 'borrowing', there is a significant array of different models, and, as the FCA notes, some of these structures will technically amount to operating a collective investment scheme. Doing so without authorisation is likely to be a breach of the general prohibition – a criminal offence.

Beyond that issue, the FCA is especially concerned about the way these models calculate and support advertised rates of return, and whether the risks (for example, that of loss of the cryptoasset in the event of insolvency of the firm) are properly identified and explained.

The discussion questions invite respondents to supply quite a lot of detail on business models, risks and benefits to consumers, and the ways in which claims in financial promotions are calculated and justified. It is clear that the sector will need to engage with the FCA (and HM Treasury) as the regulation of cryptoassets evolves. However, responding to the FCA's questions in detail will almost certainly place the firm firmly on the FCA's radar, and it will be interesting to discover how many firms respond to the discussion questions and in what way.

The FCA intends to publish finalised Guidance in "autumn 2023".