The FCA’s Guidanceprovides clarity in the evolving cryptoassets market. Syedur Rahman of RahmanRavelli explains its implications.
The Financial Conduct Authority (FCA) released policystatement PS19/22 as its final guidance on cryptoassets. While the Guidance mayhave been some time coming it certainly clarifies a number of issues that areof importance for those in the virtual currency market.
Most importantly, it provides an explanation of theregulatory treatment of cryptoassets and the obligations facing those that havedealings 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, investmentmanagers and others in related fields.
Those working in the crypto market need to study theGuidance carefully and, if anything appears unclear, they must seek specialistlegal advice to ensure they are fully aware of all its implications. For thoselooking to invest in cryptoassets, the Guidance is an important, up-to-datesummary of the regulatory protections that apply.
The overall effectiveness of the Guidance will only becomeknown with the passage of time. It should also be noted that certain aspects ofrelated guidance are still due to be completed:
· On October 3, the FCA’s consultation on thepossibility of banning the sale of derivatives relating to certain unregulatedcryptoassets to retail customers closed. A policy statement in relation to thisis expected early in 2020.
· A Treasury consultation on whether there is anyfurther regulation needed of cryptoassets, particularly regarding unregulatedcryptoassets.
· 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 paperCP19/3 and the final report of the Cryptoassets Taskforce’s final report ofOctober 2018, which committed the FCA to providing guidance on cryptoassets inrelation to its regulatory perimeter – the boundary between regulated andunregulated financial services activities, whereby those conducting activitieswithin the perimeter usually require authorisation from the FCA unless they canrely on an exclusion. To be within theFCA perimeter, a “specified activity” in relation to a “specified investment”must be carried out. The FCA hasprovided guidance on whether varying types of cryptoassets are a “specifiedinvestment” and, therefore, are within its regulatory perimeter.
The FCA outlines:
Two categories of unregulated tokens – exchange tokens andutility tokens.
Two categories of regulated tokens – security tokens andelectronic money (“e-money”) tokens.
The Guidance sets out that exchange tokens do not grant theholder any rights associated with specified investments. They are decentralised- with no central issuer obliged to honour any contractual rights – and falloutside the regulatory perimeter. Bitcoin and Ether are examples of suchtokens. As a result, activities involving them are also outside of theregulatory perimeter.
But the FCA does remind firms to be aware of 5AMLD and theGovernment’s intention to extend UK anti-money laundering regulation to includethe 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 futureservice or product – fall outside the regulatory perimeter.
The FCA outlines situations where a token would be constitutesa utility token and, therefore, unregulated. These include:
· issuing a token that is fully transferable andused to access products and services within a firm’s own network but cannot beused as a means of exchange across other networks.
· using a token as a settlement token (only withina firm’s internal network) to improve the speed of back-office functionsthrough a permissioned distributed ledger technology (“DLT”) system.
· issuing a transferable token that gives theholder storage rights on a particular network.
Security tokens – described in the Guidance as tokens thatprovide rights and obligations similar to specified investments other thane-money – will fall within the regulatory perimeter.
Examples of rights provided by a token which will make itlikely to constitute a security token, include:
· If it represents ownership rights (such as viadividend 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 tosubscribe to a future security token.
· If it is a means by which profits or income areshared or pooled.
The Guidance states that tokens meeting the definition ofe-money under the Electronic Money Regulations 2011 (EMRs, will fall within theregulatory perimeter.
E-money is defined under the EMRs as electronically storedmonetary value as represented by a claim on the e-money issuer which is issuedon receipt of funds for the purpose of making payments, accepted by someoneother than the e-money issuer and does not fall within an exclusion underregulation 3 of the EMRs (which relates to types of prepaid balances).
The Guidance clarifies that stablecoins – described astokens stabilised through being backed by fiat currency (government-issuedcurrency 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 regulatoryperimeter, depending on their structure and stabilisation method. The FCAstates that any token pegged to a currency such as the US dollar or UK pound orother assets and used for the payment of goods and services on a network could beclassed as being within the definition of e-money and, therefore, be within itsregulatory perimeter. But it would also haveto meet the definition of e-money outlined above.
The FCA’S Guidance outlines clearly the categories of participantsin the market (and their activities) that are likely to be subject toregulations 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 initialcoin offerings (ICO).
Advisers and intermediaries – advising consumers and assistingwith the buying of tokens.
Exchanges and trading platforms – enabling transactions tobe conducted between participants in the market.
Wallet providers and custodians – providing token storage.
Payment providers – enabling customers to pay merchants infiat currency or transfer fiat currency via a cryptoasset.
If customers are invited to involve themselves in investmentactivity, such as buying a security token, that activity could fall within thefinancial promotion regime. The FCA expects market participants to comply with thefinancial promotions rules outlined in the FCA Handbook in relation to Section21 of the Financial Services and Markets Act.The FCA also emphasises that firms should make sure that they do everythingto ensure customers know which activities the firm is authorised for. Firmsshould not do anything to indicate that their authorisation extends tounregulated cryptoassets.
Any security token issuer that is to be offered to thepublic 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 inhelping 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 acomplex and developing market that is likely to only increase in size. Theclarity the Guidance offers is much-needed and comes after a period in whichthe FCA has been vocal in urging potential customers to exercise caution.
While it is important to note that the Guidance is notbinding on the courts it could play a role when it comes to settling disputesrelated to cryptoassets. The complications and the volatility of thecryptoassets market mean that we should expect such disputes. But the FCAGuidance does at least indicate an awareness of the issues and represents aconsidered yet cautious attempt to assist those involved in this rapidly evolvingarea.