On 23 January 2019, the FCA published a consultation on Guidance on Cryptoassets (CP19/3). The consultation ran for 10 weeks and the FCA intends to publish feedback and the final text of the Guidance in summer 2019.
The FCA consultation follows a recommendation in October 2018 by the UK Cryptoassets Taskforce that the FCA provides extra clarity to firms about where current cryptoasset activities are regulated in the UK.
The Taskforce also recommended that HM Treasury consult on whether cryptoasset activities which are currently unregulated should be captured by regulation in the future. This HMT consultation is due soon and we expect this will be the more ground-breaking of the two consultations.
The proposed FCA Guidance clarifies where different categories of cryptoasset tokens fall to be in relation to the FCA’s regulatory perimeter. It specifically focuses on whether cryptoassets are likely to be:
- specified Investments under the UK’s Regulated Activities Order (RAO);
- financial Instruments under MiFID II;
- e-money under the Electronic Money Regulations 2011 (EMRs);
- captured under the Payment Services Regulations 2017 (PSRs).
As expected, the FCA emphasises that assessing whether a cryptoasset falls within the perimeter can only be done on a case-by-case basis, with reference to a number of different factors, and ultimately it is a firm’s responsibility to make sure it is correctly authorised for its activities.
The FCA considers the regulatory perimeter in the context of three broad categories of cryptoassets: exchange, security and utility tokens (using the term “token” to denote different forms of cryptoassets). We consider each category below.
The FCA’s view is that exchange tokens currently fall outside the regulatory perimeter and that the transferring, buying and selling of these tokens, including the operation of cryptoasset exchanges for exchange tokens, are activities not currently regulated by the FCA.
The one possible exception to this is stablecoin (which the FCA describes as an exchange token which is ‘pegged to’ or ‘backed by’ fiat currency, other cryptoassets or other forms of assets to stabilise its volatility). We consider this further below.
However, whilst exchange tokens currently fall outside the regulatory perimeter, MLD5 will be transposed into UK law by the end of 2019 which will extend AML/CTF obligations to certain cryptoasset activities relating to exchange tokens. HMT published a consultation on the UK transposition of MLD5 on 15 April 2019.
The FCA uses the term “security token” to denote those tokens that meet the definition of a “specified investment” as set out in the RAO, and possibly a “financial instrument” under MiFID II. The FCA identifies the following specified investments as most relevant for tokens (noting that the full list is available in the RAO): shares, debt instruments, warrants, certificates representing securities, units in collective investment schemes, and rights and interests in investments. It goes through each of these instruments in the context of tokens and provides “case studies” setting out examples of what this might look like in practice based on its own market observations.
The FCA is very clear that exposure to exchange tokens through financial instruments derive their value from referencing the cryptoasset, but aren’t cryptoassets themselves (such as CFDs, options, futures, exchange-traded notes, units in collective investment schemes, or alternative investment funds), are very likely to be specified investments and are also capable of being financial instruments under MiFID II.
The FCA notes that utility tokens do not typically exhibit features that would make them the same as securities, and so they will not be captured by the regulatory regime, unless they meet the definition of e-money (please see below).
The FCA confirms that in some instances, depending on how they are structured, cryptoassets can constitute e-money. It notes that exchange tokens like Bitcoin, Ether and other equivalents are unlikely to represent e-money because, amongst other things, they are not usually centrally issued on the receipt of funds, nor do they represent a claim against an issuer. However, the overarching message from the FCA is that any category of cryptoasset has the potential to be e-money, depending on its structure and whether it meets the definition of e-money.
The FCA is clear that the use of cryptoassets is not covered by the scope of the PSRs because the PSRs only cover activities with regards to funds (and cryptoassets are not deemed ‘funds’). The use of exchange tokens to facilitate regulated payment services such as international money remittance would, however, be within scope. This could be, for example, where fiat funds are received from the payer, converted to a cryptoasset, which is converted to the target fiat currency, which is transferred to the payee.
The FCA’s view is that the use of cryptoassets in between as the vehicle for remittance would not be covered by the PSRs, but each side of the remittance is within scope. As part of the consultation, the FCA is seeking examples of other use cases of cryptoassets being used to facilitate payments where further guidance could be beneficial.
The FCA notes that stablecoin, or any token that is pegged to a fiat currency (such as USD or GBP) and is used for the payment of goods or services on a network, could potentially meet the definition of e-money if all other requirements are met. The FCA also notes that tokens are stabilised through other means (not just currency), for example, being backed by certain assets. This may include specified investments, such as a basket of cryptoassets, or potentially through sophisticated algorithms which maintain the supply of the token. The FCA confirms that in certain circumstances, the way the stablecoin is structured may mean that it amounts to a security, such as a fund unit, or a derivative.
The FCA notes that where a firm is engaged 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, it should consider whether those activities require authorisation.
In the context of exchanges/trading platforms, the FCA notes that a firm creating infrastructure for the buying, selling and transferring of securities tokens may need permission to carry out the activities of arranging deals in investments, making arrangements with a view to investments and dealing in investments as agent/principal. If the tokens also constitute Financial Instruments under MiFID II then the firm may also need permission to operate a multilateral trading facility (MTF) or organised trading facility (OTF) depending on how the exchange operates. The provision of custody services in relation to securities may require permissions related to the safeguarding and administration of investments.
Osborne Clarke comment
Novel financial instruments, products or services always create unique challenges for regulation. Cryptoassets are a developing area of regulation across the world right now and it will take time for a co-ordinated approach to emerge. With this proposed Guidance, the FCA has sought to find a way to identify where the regulatory boundaries should be drawn and bring some clarity to a complex area.
Pinpointing when regulatory authorisation is needed is central. Firms carrying on business in the cryptoasset area will need to carefully consider the FCA’s proposed Guidance and decide whether or not they need authorisation if their activities include:
- advising; and/or
- operating trading venues.
If you are a market participant in the cryptoasset space you need to understand whether the cryptoassets you use are within the regulatory perimeter, and you need to understand what rules or regulations will apply to your business.
Although extremely helpful, firms should remember that this proposed Guidance constitutes guidance only. In other words, it is the FCA’s view of what it would likely consider to fall within or outside scope and is not binding. Further clarifications from the FCA and international standard setters should be expected as the cyrptoasset market develops and matures.
Osborne Clarke can assist you in identifying whether your activities or proposed activities may cross over the line into the regulatory perimeter that catches cryptoassets. This regulatory perimeter is also likely to undergo further modifications as HM Treasury and ESMA are working on a new regulatory framework for cryptoasets. HM Treasury is likely to expand the scope of the perimeter in order to bring in further types of cryptoassets.