What the FCA’s CP22/2 proposals could mean for financial promotions of cryptoassets in the UK

HM Treasury’s 2020 consultations and subsequently consultations determines the legislative framework for the introduction of certain types of crypto-assets within the framework of the regulation on financial promotions.

Financial Conduct Authority (FCA) Consultation paper 22/2 sets out its proposed approach to regulating financial promotions for high-risk investments – including crypto-assets. Therefore, the advisory refers to promotions of cryptoassets and other high-risk instruments. It also intends to strengthen the direct offer financial promotion regime and introduce a new framework for FCA authorized firms to approve financial promotions for unregulated companies. This follows HM Treasury consultations on the revised framework for approving such financial promotions.

The FCA’s consultation ends on 23 March 2022 and it hopes to have the rules in place by the summer. As for crypto-assets, these will apply when HM Treasury’s changes to the Financial Promotions Act come into effect. Feedback on the latter’s consultation said it would give the sector a transition period of approximately six months.

This article will look at the changes regarding the crypto-asset and give a brief summary of the proposals. This is based on our interpretation of how it relates to the sector. In some cases, further discussion with the FCA may be helpful to clarify its intent. You should review the proposals and final rules when they are published to ensure compliance with them and, if necessary, seek independent legal advice where appropriate.

What does the FCA propose in relation to financial promotions of crypto-assets?

FCA rules will apply to most crypto asset promotions that exist effect in Great Britain. This will be the case even when it is issued by an overseas entity – such as a cryptocurrency firm that is not registered in the UK.

What “having effect” means in the UK is something to be determined by the FCA. Essentially, anything aimed at or potentially available to UK customers could be considered effective in the UK, although the latter is of course more difficult to assess. HM Treasury’s legislative changes will not apply to firms specifically promoting crypto asset protection services.

In some cases, a firm may benefit from a certain exemption in Account for financial promotions. FCA rules do not generally apply to financial promotions where an exemption applies.

For example, promotion to Certified Professional Investor is exempt. The regulator states:

“Certified sophisticated investors are those who have: i) a certificate signed in the previous three years by an authorized person stating that they are sufficiently educated to understand the risks associated with the relevant type of investment; and ii) have self-signed a certificate within the previous 12 months stating that they qualify for this exemption and understand the implications. In order to use this exemption, the financial promotion must not invite or induce the recipient to engage in investment activity with the person who signed the statement confirming the knowledge of the consumer.”

The exemptions for certified high net worth individuals and self-certified sophisticated investors will not apply to cryptoassets.

The proposed definition of cryptoasset is similar to that found in the UK’s Money Laundering, Terrorist Financing and Transfer of Funds (Payer Information) Regulations 2017. However, the FCA’s definition is only intended to cover those cryptoassets that are fungible and transferable. So, for example, it would rule out non-fungible tokens (NFTs) or cryptoassets in a closed network – such as a supermarket customer loyalty scheme developed on a distributed ledger technology (DLT) system. In addition, the FCA takes into account existing financial promotion regimes for cryptoassets that are also considered financial instruments or e-money.

What are the new FCA categories of financial promotion and where do cryptoassets fit in?

The FCA proposes to classify the financial promotion of investments into three categories:

• Marketable securities (RRS) – “liquid” shares, for example.
• Limited Mass Market Investments (RMMI) – cryptoassets fall under this, as well as other mass market retail products such as regulated collective investment schemes (so regulated funds)
• Non-Mass Market Investments (NMMI) – certain retail prohibited promotions, which include crypto derivatives, binary options and unregulated collective investment schemes.

Of these categories, RMMI will be the main category for crypto asset promotions. In fact, most investment products – excluding liquid stocks – will be treated as RMMI. This simply means that they can be marketed to retail investors, but there will be certain restrictions or obligations. However, it is worth reminding that NMMI promotions to retail investors will continue to be prohibited.

What does this mean in practice for changes to my crypto asset promotions?

Existing FCA financial promotion COBS 4 rules will apply. This will include:

• The most important obligation is that any promotion or communication with investors be “fair, clear and not misleading”.
• “Image advertising” as defined by the FCA – so simply advertising brand awareness – is unlikely to be covered by detailed obligations other than fair, clear and not misleading.
• Where the promotion goes beyond image advertising and relates to retail investors, it will need to provide additional risk warnings with appropriate prominence. However, note that COB 4 rules apply to other matters such as the use of performance information.
• In addition to the existing COB4 rules, the FCA’s current consultation proposes a standardized risk warning for all RMMI promotions: “Do not invest unless you are prepared to lose all the money invested. This is a high risk investment. You could lose all the money you invest and it is unlikely that you will be protected if something goes wrong. Take it [two minutes] to learn more.” This will be a pop-up box with FCA-mandated warnings – but please note that the overall obligation to provide relevant risk warnings for the products and services on offer remains.
• Crypto asset firms may also wish to consider the FCA’s definition of what a retail investor is, and more importantly, what it is not. This definition appears to be broader than what a cryptoasset firm might consider a retail investor and could include, for example, a cryptoasset exchange, brokerage or OTC firm.
• Direct offer financial promotions allow the investor to purchase a product or service directly from the promotion. The FCA intends to ban such advertisements to RMMIs unless the customer is either a limited, high net worth or certified sophisticated investor – but not to self-certified sophisticated investors. Noting that the firm could use the promotion exemption discussed earlier, for certified investors, and if so, would not be subject to the FCA’s financial promotion rules. The firm will also have to conduct a “suitability test” on the customer, and provide a personalized warning and a 24-hour cooling-off period.

According to the regulator: “A limited investor is someone who has signed a declaration that he has not invested in the last 12 months and will not invest in the next 12 months more than 10% of his net assets (excluding certain assets).” HM Treasury still is consulting on other definitions.

Can I continue to offer incentives to attract clients??

No. The FCA is proposing to ban promotions that encourage trading in cryptoassets. For example, offers such as referring a friend to receive a monetary compensation or depositing a certain amount of money into your crypto-asset account in order to receive money to compensate with trading fees will no longer be allowed.

Will I be able to continue to ask my compliance team to approve my financial promotion of cryptoassets?

The FCA is creating a new regime for people who approve financial promotions for unauthorized firms. Cryptocurrency companies registered for money laundering only will in future require an FCA-authorised firm to approve their financial promotions. Failure to do so would be a criminal offence.

The financial promotion should contain the name of the person or company approving it and a stamp with the date of approval.

Whoever approves the financial promotion should have the necessary competence and expertise to approve it. This will be a self-assessment by the company that approves the financial promotion. Although they will need evidence to justify why they believe this is the case in relation to the crypto-asset, if requested by the FCA.

In addition, firms that approve a financial promotion will require systems and controls to ensure compliance is monitored throughout the duration of the promotion. Companies will need to take reasonable steps to monitor the continued compliance of approved promotions, which will include requiring the crypto-asset firm to provide confirmation every three months that matters relating to the promotion have not changed.

What should cryptoasset firms do now?

Companies should wait a while, although they can respond to the FCA’s consultation, which closes on March 23. The regulatory body is only consulting for now, and businesses will have to wait for the final rules before matching your financial promotions.

However, in the coming months you may want to:

• Start reviewing your promotions, including your website, to understand the size of the exercise and should you change your project plan.
• Consider what changes might be needed in your financial promotion approval processes and follow-up throughout the promotion. This is because you will need to certify every three months if you use a third party to approve your financial promotions.
• Assess your new record keeping requirements, as you may need to record the ‘consumer journey’.
• Identify where you are offering incentives to investors that encourage trading activity – such as referrals or cash to offset trading costs – that may need to stop.
• The changes cover third-party promotions that introduce businesses to crypto-asset exchanges, as well as social media promotions targeting UK consumers. You may want to consider what change this may mean for your operational and business risk models – especially if you are accepting new business from these sources.
• It may be worth identifying a firm that will approve your financial promotions in the future.
• Finally, you may wish to review existing FCA guidance to better understand what constitutes fair, clear and not misleading and appropriately prominent: FCA Guidance FY15/4: Social Media and Customer Communications on his own supervisory access to financial promotions on social networks, and FCA promotion case studies.

If you are an Elliptic customer, we can discuss the potential impact of these changes on your business in more detail.