UK Cryptoassets: FCA finalises guidance for cryptoasset financial promotions

Background

On 8 June 2023, the FCA published its policy statement (PS23/6) setting out the financial promotion rules for cryptoassets (“Policy Statement”), which brought cryptoasset promotions within the FCA’s remit for the first time. The rules took effect from 8 October 2023—since then, firms wishing to promote cryptoassets in the UK to retail consumers’ must be authorised or registered by the FCA, or have their marketing approved by an authorised firm. Additionally, marketing of cryptoassets must be subject to certain restrictions including the banning incentives to invest, ‘positive frictions’ (personalised risk warning and 24- hour cooling-off period) for first-time investors, client categorisation requirements and appropriateness assessments. For further details, take a look at our previous Engage Article.

Alongside the Policy Statement, the FCA also published a consultation on its proposed guidance to ensure firms are able to clearly understand the implications of the new regime. The consultation closed on 10 August 2023 and, on 2 November 2023, the FCA published the finalised Guidance.

The Guidance is designed to help firms comply with the FCA’s cryptoasset financial promotion rules, in particular, the core requirement that promotions are fair, clear and not misleading. While the Guidance does not create new regulatory obligations and, strictly speaking, firms do not need to follow the Guidance to achieve regulatory compliance, the Guidance clarifies the FCA’s expectations for how firms should approach the financial promotions rules relating to qualifying cryptoassets.

Views from Hogan Lovells Global Digital Assets and Blockchain Practice

While this non-handbook goes some way in providing additional guidance on matters such as complex yield products, it does not answer all of the questions that industry will have.

For example, from the 7 February 2024 onwards, firms will need to obtain the relevant permission from the FCA in order to be able to approve financial promotions of an unauthorised person or firm (and the FCA will update the Financial Services Register accordingly to show firms’ ability to approve financial promotions )—until then, there is some uncertainty in the market as to which firms are currently able to approve cryptoasset promotions by unauthorised persons. 

Additionally, the industry is awaiting further guidance following the Guidance Consultation on financial promotions and social media, which was published earlier this year in July 2023. This new guidance is expected to provide urgently needed clarity in the context of using social media in communicating financial promotions, particularly in light of the fact that the social media landscape has evolved significantly since the existing guidance was issued by the FCA in 2015.

More broadly, it is worth noting that the FCA has stated its intention to take robust action where it identifies firms that are communicating cryptoasset promotions in breach of the regime—within the first two weeks of the cryptoasset financial promotions regime going live, the FCA issued 221 alerts in relation to non-compliant firms. It would therefore be prudent for firms seeking to communicate or approve cryptoasset promotions to consult the Guidance, as it will likely serve as an important tool to assist firms in achieving regulatory compliance. Firms looking for further practical advice to ensure they are operating under the correct permissions should get in touch to find out more about our Financial Promotions Tool developed by our experienced Digital Assets and Blockchain practice which helps guide clients through the new cryptoasset promotions regime.

The finalised Guidance

The substance of the Guidance has remained largely unchanged from the version that was consulted upon. However, in response to consultation feedback, the FCA has clarified a number of issues such as in relation to promotions of complex yield models, due diligence requirements, and the application of the Consumer Duty. Some key elements of the Guidance are set out below.

Scope of ‘qualifying cryptoasset’

The Guidance acknowledges the broad definition of the term ‘qualifying cryptoassets’, which will cover a wide range of different types of cryptoassets (but not those that meet the definition of electronic money or an existing controlled investment).

The FCA also emphasises in a number of places throughout the Guidance the importance of understanding the regulatory characterisation of the investment or business in which a firm is engaged, as this will have serious implications in terms of the financial promotions restrictions that may apply to a particular type of investment, and, more broadly, in terms of whether the firm has the requisite authorisations to carry out the relevant activities. For example, in relation to cryptoassets backed by commodities or assets, such cryptoasset may constitute a derivative. In relation to staking, firms should consider whether the particular cryptoassets and associated models may constitute or involve a unit in a collective investment scheme (CIS).

Exemption for MLR-registered cryptoasset businesses

MLR registered persons, which are not otherwise authorised persons for the purposes of FSMA, may i) communicate their own cryptoasset financial promotions; and ii) have cryptoasset financial promotions communicated on their behalf (only where the MLR registered person has prepared the contents of such communications). MLR registered persons cannot approve cryptoasset promotions, or communicate financial promotions involving other controlled investments based on this exemption. For further details on this exemption, take a look at our previous Engage article.

Fair, clear and not misleading

The FCA continues to view cryptoassets as high risk investments—accordingly, the Guidance highlights the FCA’s expectations on firms to take particular care to ensure that those receiving promotions are well equipped to take clear, considered and informed decisions as to whether investing in cryptoassets is right for them. To that end, a firm should consider both the relevant promotion’s substance and presentation, taking into account factors such as:

• Whether the promotional materials are presented in a way that is easy to understand;
• Whether the promotion enables consumers to take an informed view of the relevant risks (i.e. firms should not trivialise the risks and should avoid making exaggerated claims about the potential benefits of cryptoassets);
• Firms should not omit relevant information and should clearly outline any costs, fees and charges for the products or services promoted;
• All supporting information in the financial promotion (e.g. facts and figures) should be accurate, up-to-date and substantiated;
• Where a promotion refers to past performance, it must include adequate risk warnings that past performance is not a reliable indicator of future results, and references to future performance should be based on reasonable assumptions supported by up-to-date data; and
• Firms should have effective systems and controls to monitor the compliance of their promotions or promotions they approve, and be able to amend or withdraw promotions as needed.

The FCA generally expects each stage of a financial promotion to be ‘stand-alone compliant’—however, the FCA recognises that promotions of complex investments might require a high volume of supporting information to ensure consumers have all the information they need to make  informed decisions. Firms may therefore include supporting hyperlinks or separate pathways, and such links to additional information should be prominently presented at a sufficiently early stage of the consumer journey.

The Guidance also highlights the need for firms to clearly and prominently disclose in their financial promotions ‘who’ owns the legal or beneficial rights to the relevant cryptoasset prior to a consumer entering into a relevant agreement. Additionally as part of the appropriateness assessment referred to in the consumer journey rules set out in the Policy Statement, firms should assess whether consumers understand their legal and beneficial rights.

Firms should also ensure that financial promotions give an accurate portrayal of the regulated status of the firm and the cryptoasset to which the promotion relates (e.g. MLR registered persons should not imply that their status is equivalent to being authorised by the FCA). Additionally, firms should not use their regulated status in a promotional way, such as by implying that it has a competitive advantage over other firms, or that their regulated status represents an endorsement by the FCA of their services.

Consumer Duty

Authorised persons communicating or approving financial promotions will need to consider their responsibilities under the Consumer Duty, particularly the cross-cutting rules and the consumer understanding outcome—for further details on these requirements and on the Consumer Duty in general, visit our Consumer Duty Hub.

In this context, an authorised person communicating or approving a cryptoasset financial promotion should not take advantage of retail customers’ vulnerabilities and should avoid causing foreseeable harm (e.g. by presenting the benefits and costs of an investment in an unbalanced way).

Authorised firms should consider whether customers are likely to be able to understand the information on risks and complexity of the relevant cryptoasset—for example, where a product or service is particularly complex, and where firms use social media as the method of promotion, firms may want to use social media to signpost customers towards other channels where additional information is provided.

However, the Consumer Duty does not extend to requiring firms to ensure customers always receive good investment returns.

Stablecoin promotions

Where cryptoassets are promoted on the basis that they offer a form of stability or that their value is linked to fiat currency, firms should be able to demonstrate that such claims of stability are bona fide (for example, by providing details of how the stability is maintained), are genuine and can be substantiated. Where a cryptoasset primarily relies on an algorithm or holdings of other cryptoassets to make such claims, a financial promotion making claims of stability or that such cryptoassets can be a ‘store of value’ would likely be in breach of the rules.

Firms are also expected to disclose to consumers the risks specific to cryptoassets that claim a form of stability.

Cryptoassets backed by a commodity or asset

Where a financial promotion claims that a cryptoasset is backed by a commodity or an asset, firms are expected to clearly set out what particular model or arrangement the cryptoasset uses (e.g. whether the cryptoasset references the value of the underlying asset, or whether it acts as a digital representation of ownership of the underlying asset).

Additionally, a financial promotion in relation to such cryptoassets should set out:

• Proof of ownership of the underlying commodity or asset, such as through disclosures, independent audits or proof of deposits, prior to consumers making an investment;
• Details in relation to (and evidence of) any custodian responsible for the underlying asset, including where the commodity or asset is held;
• Clear terms of redemption, including timescales, fees and proof of ownership requirements of the cryptoasset redeemed, and the asset to be returned to the consumer;
• The risk that the consumer will lose some or all of their money if the issuer or custodian(s) becomes insolvent; and
• Any other reasonably foreseeable factors that may significantly affect the value of the underlying asset.

Complex yield cryptoasset models or arrangements

A complex yield cryptoasset model or arrangement (e.g. staking, borrowing or lending models or arrangements) refers to where a person may transfer or make available (e.g. give control of) their cryptoassets to another person to use—the person giving control of their cryptoasset to another will receive a rate of return. The Guidance notes that specific risks relating to lending and borrowing models to be disclosed may include counterparty risk, credit risk, investment risk, and transparency of onward arrangements.

Additionally, a financial promotion of a complex yield model or arrangement is unlikely to achieve the standard of fair, clear and not misleading unless it sets out:

• Clear evidence of how the advertised rates of return could be achieved—and advertised rates should not be promoted as ‘guaranteed’;
• Clear disclosure of the legal and beneficial ownership of a consumer’s cryptoassets before they enter into an arrangement, and the consequences if something goes wrong (for example, failure of the issuer or custodian);
• Clear disclosure of fees or charges that could materially affect the provider’s ability to deliver advertised or targeted rates of return; and
• All relevant risks associated with the complex yield cryptoasset model or arrangement (such as risks of additional onward transactions, of potential depreciation of the value of tokens etc.)

Firms communicating a financial promotion which states a target rate of return should be able to demonstrate they have appropriate access to data and systems and controls in place to ensure they keep all targeted rates of return up to date; and approvers should take reasonable steps to monitor the continuing compliance of any approved promotion for the lifetime of the promotion. An approver must withdraw approval, for example, if it becomes aware that the promoted rate of return is no longer deemed achievable.

Due Diligence

Firms are expected to conduct due diligence on the cryptoasset and the cryptoasset service being promoted, as well as any claims made in the promotion. The extent of the due diligence required will vary from case-to-case, and firms may be able to rely on information and analysis prepared by independent professional advisers. However, a firm should consider at least:

• The authenticity and accuracy of the promotion (e.g. undertaking background checks on the individuals associated with the cryptoasset, reviewing the whitepaper or other relevant documentation);
• Taking steps to ensure the cryptoasset is not linked to fraudulent activity, scams, money laundering or other financial crime;
• Taking reasonable steps to check the technological and operational risks associated with the cryptoasset (e.g. to understand the underlying blockchain and its vulnerability to hacks);
• Understanding the environmental, social and governance risks associated with the cryptoasset; and
• Conducting relevant legal and compliance checks (e.g. to satisfy itself that the cryptoasset does not constitute a ‘specified investment’).

Next Steps

The new Guidance comes close on the heels of HM Treasury’s publication of a set of policy documents on 30 October 2023 which aim to clarify the intended legislative approach to the financial services regulatory regime in relation to cryptoassets—take a look at our Engage articles on the government’s plans on regulating fiat-backed stablecoins and managing the failure of systemic digital settlement asset firms, as well as regulating activities relating to cryptoassets beyond fiat-backed stablecoins. 

For more digital content or to contact a team member, visit the Hogan Lovells Digital Assets and Blockchain Hub. Whether it's to find out the latest regulatory developments, or learn about new applications of the technology, we have you covered.

Authored by John Salmon, Christina Wu, Lavan Thasarathakumar and Melanie Johnson.