At a glance
Important – this is a generic summary of recent changes in aspects of UK law and financial regulation and how we consider that they may be generally applicable. It is not intended as formal advice to any person. The circumstances of persons to whom this may be relevant will vary considerably, and you should always seek direct formal legal advice as to your particular circumstances, rather than placing reliance on what is set out below.
1. Background
1.1. In general terms, the UK still does not regulate the provision of services by so-called "crypto-asset exchanges" (or their associated providers of wallet custodian services).
1.2. For these purposes:
(a) A "crypto-asset exchange" is an entity that operates an exchange or market for the purposes of allowing persons to transact with each other:
- Acquiring cryptocurrencies for fiat currencies;
- Realising cryptocurrencies for receipt in fiat currencies; or
- Trading positions between two or more cryptocurrencies.
(b) A "wallet custodian" is a business that provides participants in such a crypto-asset exchange with a custody service in relation to encryption keys that allow them access to the cryptocurrencies that they have acquired.
1.3. Cryptocurrencies for these purposes refers to those crypto-assets such as BTC and ETH which are presented as having a quasi-currency function. This distinguishes them from other types of asset that are rendered into digital form (for trading and transfer on a blockchain). This distinction is important, since UK law and regulation generally treats a "crypto-share" or a "crypto-bond" as subject to the same broad financial regulatory controls as apply to old-world shares and debt instruments (so that persons who deal in them or advise on them are required to be regulated in the same manner as would apply to dealing in or advising on shares in a traditional finance sense).
1.4. This crypto-asset is therefore restricted for present purposes to the activities of crypto-asset exchanges and wallet custodians in relation to transactions in cryptocurrencies. (Also outside its purview is the application, if relevant, of any current UK regulations to trading and dealing in non-fungible tokens.)
2. Overview of regulatory position
Registration with the UK Financial Conduct Authority ("FCA")
2.1. Under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the "MLRs") the FCA is responsible for the supervision of certain UK crypto-asset businesses. There is a requirement set out in Regulations 8 and 9 of the MLRs which requires UK crypto-asset exchanges and wallet custodian providers to be registered with the FCA in order to carry on their business. Note as follows:
(a) This registration is not a form of authorisation for carrying on business;
(b) It only applies in relation to crypto-asset exchanges and wallet custodians that carry on operations from a place of business in the UK;
(c) It is a jurisdiction that is simply expressed in the MLRs, but which FCA has taken to allow it to assess the merits of the prospective applicant. As a result, numerous applications have been turned away, while others are caught up in a protracted process of consideration, as the MLRs do not impose a statutory time limit for resolution of the application.
2.2. To bring all crypto-assets into a formal regulatory environment will require significant changes to UK primary legislation (this being too complex for FCA Rules or government delegated legislation alone). For the time being, the measures which were introduced (as explained below) in October 2023 have the relatively limited purpose and effect of considerably restricting access for individuals to the capacity to transact in cryptocurrencies.
2.3. The relevant provisions were implemented through making certain amendments to the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 ("FPO") which is the instrument that offsets out a range of exceptions to the scope of the UK's financial promotion restriction under s 21 Financial Services and Markets Act 2000 ("FSMA"). Broadly speaking, the amendments made apply to the premises for promotion of certain types of crypto-assets which we will identify further below.
3. Outline regulatory analysis
Financial promotion restriction
3.1. In accordance with s 21 FSMA, a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity, unless:
(a) that person is an authorised person (i.e. the holder of a licence from the FCA to carry on one or more regulated activities under FSMA); or
(b) the content of the communication is approved by such an authorised person; or
(c) the communication is covered by an exemption (which references the FPO).
This is the so-called "financial promotion restriction" referred to above.
3.2. Financial promotion media can take many forms including: printed advertisements in papers/magazines; broadcast or online media; marketing brochures and materials; routine communications via email, phone etc.; websites; apps and social media posts.
3.3. The FPO sets out a range of exemptions from the restriction. The premise of the FPO as a whole is to afford a basis for exemptions for specific special circumstances. It is not intended to provide for exemptions of use to the general public. Some of the exemptions relevant to the purpose of note will be considered in outline below.
3.4. One other important clarification: the financial promotion restriction under s 21 FSMA is of general application, i.e. not merely to or in relation to FCA-authorised investment firms. So, too, are the exemptions in the FPO of general application. FCA-authorised firms are subject to complex additional controls set out in the FCA Handbook (see COBS 4). In the interests of keeping this client note as concise as we can, we will not be looking at this aspect here.
Qualifying crypto-assets
3.5. The regulatory changes which bring the promotion of "qualifying crypto-assets" within the scope of the financial promotion restriction have been introduced into the FPO and adjust a number of the exemptions already found there.
3.6. A "qualifying crypto-asset" is defined as any cryptographically secured digital representation of value or contractual rights that:
(a)
- can be transferred, stored or traded electronically; and
- uses technology supporting the recording or storage of data (which may include distributed ledger technology);
(b) is fungible (i.e. mutually exchangeable with crypto-assets of the same kind); and
(c) is transferable.
3.7. However, the definition goes on to explicitly exclude the following:
(a) crypto-assets representing what one may call conventional investments (for example shares, bonds, options, futures etc.);
(b) e-money;
(c) fiat currency;
(d) fiat currency issued in digital form; and
(e) non-transferable crypto-assets issued by a goods or services provider in return for the provision of goods or services, which can only be used in a limited way (these have become more commonly known as utility tokens)
Items (a)-(b) are excluded from this definition because they are investments which are already included within the scope of the financial promotion restriction.
3.8. Thus "qualifying crypto-assets" are de facto restricted to what have become known and understood as cryptocurrencies (BTC, ETH etc.)
Application of the Financial Promotion Restriction to qualifying crypto-assets
3.9. Financial promotion of a qualifying crypto-asset can only be communicated where:
(a) It is communicated by an FCA-authorised person;
(b) It is communicated by an FCA-registered person (under the MLRs);
(c) The content of the communication has been approved by an FCA-authorised person who has the requisite permission to approve such promotions (note that in a separate regulatory initiative that has come into operation at roughly the same time, FCA now restricts the scope of authorised persons to approve third-party financial promotions, and in practice there are now relatively few such firms with the requisite permission); or
(d) The communication can rely on an exemption under the FPO.
3.10. With reference to para. 3.9(d) there are exemptions available to crypto exchanges, and these include where the promotion is to:
(a) Investment professionals (FCA-authorised persons, governmental entities and persons who invest on a professional basis) by virtue of art. 19 FPO;
(b) High value entities meeting certain criteria set out in art. 49 FPO; and
(c) overseas persons (art. 12 FPO).
3.11. Important – exemptions that apply to promotion of private capital debt and shares to high-net-worth individuals and sophisticated investors cannot apply to the promotion of qualifying crypto-assets. Meaning that there are de facto no tailor-made exemptions under FPO for promotion of cryptocurrencies to individuals in the UK (regardless of who is promoting them).
3.12. Although registration under the MLRs applies to UK-based crypto-exchanges only, the financial promotion restriction in its application to crypto-assets has deliberately been made extraterritorial and therefore applies to those firms outside the UK seeking to promote to UK investors.
4. Summary of the position for non-UK crypto exchanges
4.1. The first question we are often asked is what the position is of an overseas exchange which has developed clientele in the UK prior to the FPO amendments taking effect? Can it still communicate with these customers? On the premise that exchange of communications is in relation to transactions that investors intend to undertake without the requirement for promotion of anything to them, the cautious view is that these investors can still be accepted and processed by the overseas exchange (as de facto nothing that needs to be promoted). This might need to be considered in more detail in specific circumstances e.g.:
(a) If the exchange were proposing to considerably broaden its activities and needed to be able to tell its existing clients about this; or
(b) If there were a change in control of the exchange and the new owners needed to promote something material to the existing clientele related to this.
4.2. What is the position of an exchange which posts a website with no express purpose to target the UK? There is an awkward-looking provision in s 21(3) FSMA which indicates that a promotion is deemed made in the UK if it is "capable of having effect" in the UK.
(a) That appears to doom any overseas website, due to the Web being open-access.
(b) FCA's view here, though, has been that there must be something characteristic about the website that makes it clear that it is targeting the UK. By the way, merely being in English is not sufficient for this, given how English is the first language of international financial services.
4.3. What happens if a UK person finds the overseas exchange (perhaps via Google or through the Appstore)? Can the exchange take that person on as a customer? This calls into question the capacity to rely on what is referred to as "passive marketing" or "revere marketing". As a general principle, UK law and regulation recognises the practical distinction between the exchange approaching and the exchange being approached.
4.4. Important – the points identified at 4.1 – 4.3 above are the merest of summaries only; companies thinking of relying on any of these premises to avoid the financial promotion restriction need specialist advice that is pertinent to their circumstances, and should not rely on these outline observations alone.
4.5. Subject to all of the above, reliance must be had on relevant FPO exemptions, such as:
(a) Investment professionals under art. 19 (which includes persons authorised and regulated by FCA, national, local and supranational governmental entities; and persons who invest on a professional basis.
(b) The four categories of high value entity under art. 49 are:
- Any body corporate with (or in a group with another that has) paid-up share capital or net assets of at least £5m;
- A body corporate with (or in a group with another that has) paid-up share capital or net assets of at least £500,000, provided that it or another in its group has at least 20 members;
- An unincorporated entity or partnership with net assets of at least £5m; and
- The trustee of any trust that at some point in the 12 preceding months had gross cash and securities of at least £10m.
(c) Where relying on art. 19 or art. 49, the exemption extends to individuals who are directors, officers or employees of the person concerned that are responsible for its investments and are approached in such capacity.
(d) It bears noting that to rely on arts. 19 or 49, the person making the promotion has to undertake some due diligence to ensure that the persons being promoted to do indeed fall within the scope of the exemptions concerned.
4.6. Are there any other workarounds? The following might in theory offer assistance:
(a) What if a UK person controls an offshore entity and the latter is the entity that is expected to trade on the exchange? If the offshore entity is run by persons vested with investment discretion, then promotion to the offshore entity will be the correct way to solicit a new investor, and it will not matter that there is a connection with a person in the UK. Care should be taken that the offshore entity does indeed operate with its own investment discretion and is not simply seeking advice from the UK person all along.
(b) Article 50 is worth a passing mention. This sets up a regime under which an FCA-authorised person may certify an individual as sophisticated in relation to specific investments, or investing in general. There are complex reasons why in practice this is little relied upon, so an exchange considering relying on this should seek advice.
5. Closing observations
5.1. This area of the law is very likely to change or develop. The provisions considered in this client note make it de facto impossible for private individuals in the UK to be brought into the regime of trading cryptocurrencies; yet it is likely sooner rather than later that there will be central bank digital currencies for routine use, so that this is clearly an area that needs to be reviewed on a frequency of 6-9 months at a minimum.
5.2. Should the overseas exchange ask for UK legal advice on its website? In principle, yes. It would need to take a policy decision on how far its website is a tool aimed at the UK market, and what it should say (or avoid saying) in order that this should not be the conclusion.
5.3. Should UK counsel be retained to advise on the exchange's customer agreements? Not necessarily, especially as these will not be subject to English law. If there are provisions there which expressly disclaim application to UK-resident individuals, it may be worth having these reviewed by UK counsel.
5.4. What happens if the FCA becomes concerned that the exchange is targeting the UK? This is a clear case for the instruction of UK counsel to advise on how to fend off FCA and demonstrate that there is no concern. This sort of thing can arise unexpectedly as, for example, because a UK investor complains to the FCA without informing the exchange he has done so, and the FCA starts to show an interest. Since the FCA cannot enforce the FPO provisions outside the UK, it would be likely to work in conjunction with the relevant local regulator in any case.
5.5. We always recommend that the exchange should employ proper systems and procedures to regulate its promotion and its approach to UK clientele.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.