While it has only been a week since the last Crypto View but we have an update on the Financial Promotion regime in the UK as it applies to cryptoassets. We understand that the FCA is today publishing PS23/6, "Financial promotion rules for cryptoassets". This follows CP22/2 from January 2022, "Strengthening our financial promotion rules for high risk investments, including cryptoassets", with additional rules on other asset classes (P2P Lending and Non-readily Realisable Securities) being announced in August 2022 in PS22/10.
Financial Promotion Order
The publication of these rules coincides with the implementation of the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (FPAO), which amends the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO), and bringing 'qualifying cryptoassets' within scope of the UK's financial promotion regime. This will be effective as of 08 October 2023, and the FCA has confirmed its rules will take effect from the same point.
To recap, a 'qualifying cryptoasset' is any cryptographically secured digital representation of value or contractual rights that is transferable and fungible, but does not include cryptoassets which meet the definition of electronic money or an existing controlled investment. Other cryptoassets which meet the definition of an investment specified under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) are already subject to the financial promotion regime.
In summary, from 08 October, there will be four routes to legally promote cryptoassets to customers in the UK:
The promotion is communicated by an authorised person.
The promotion is made by an unauthorised person but approved by an authorised person. Legislation is currently making its way through the UK Parliament which, if made, would introduce a regulatory gateway that authorised firms will need to pass through to approve financial promotions for unauthorised persons.
The promotion is communicated by (or on behalf of) a cryptoasset business registered with the FCA under the MLRs.
The promotion is otherwise communicated in compliance with the conditions of an exemption in the Financial Promotion Order.
Existing exemptions in the FPO will generally apply to promotions of cryptoassets in line with their existing scopes. However, note that the High Net Worth Individual (art. 48), and the self-certified sophisticated investor (art. 50A) exemptions will not apply to cryptoasset promotions. Further, the Government has expressly legislated to disapply the associations of high net worth or sophisticated investors (Art. 51) and sale of goods and supply of services (art. 61) exemptions to cryptoassets.
Promotions that are not made using one of these 4 routes will be in breach of section 21 of the Financial Services and Markets Act 2000 (FSMA), which is a criminal offence punishable by up to 2 years imprisonment, the imposition of a fine, or both.
To be clear, this applies extraterritorially, and so any marketing that is capable of having effect in the UK, regardless of where the marketing firm is based, is caught by this new regime.
Guidance on Financial Promotions
While only a consultation, GC23/1 gives a very strong indication of the FCA's focus ahead of cryptoassets coming into scope of the financial promotions regime. GC23/1 includes guidance on the following areas:
- Ensuring that cryptoasset financial promotions are fair, clear and not misleading
The guidance here is broad, with itself split into guidance applicable to all cryptoasset financial promotions, to cryptoassets that claim a form of stability or which claim their value is linked to a fiat currency, to cryptoassets that claim to be backed by a commodity or an asset, and complex yield cryptoasset models or arrangements e.g. borrowing, lending and staking.
The FCA's focus is on ensuring that firms avoid using unnecessary jargon or complex language that may confuse or mislead consumers, and that customers are fully aware of the risks involved in a given activity. Where claims are made about returns, or stability these must be backed by evidence. The guidance takes particular aim at the use of the word "stable" in relation to algorithmic stablecoins.
- Financial promotions on social media
The FCA does not provide much guidance here, but cross-refers to previous more general guidance on financial promotions on social media that they published in 2015. They also remind firms that the financial promotion regime is technology neutral and applies to financial promotions made on social media platforms (including, for example, Reddit, Discord and Telegram) in the same way as any other medium.
- Due diligence before a financial promotion is communicated
The FCA expects firms that communicate a financial promotion for a cryptoasset to have sufficient evidence, and carry out due diligence, on the substance of a promotion and underlying cryptoasset before communicating it. This due diligence could include undertaking background checks on the issuer, developers or other key individuals associated with a cryptoasset, reviewing any white papers, confirming the asset is not linked to fraudulent activity, scams, money laundering or other financial crime, and understanding the relevant risks.
- Disclosing legal and beneficial ownership of cryptoassets
If ownership of a cryptoasset changes, for example, in a staking relationship, firms should clearly and prominently disclose the changes to legal and beneficial ownership of the cryptoasset before a consumer proceeds to enter into an agreement with a firm.
- Disclosing a firm's regulated status
Firms should clearly and prominently disclose their regulated status to consumers. In particular, firms registered under the MLRs should not suggest or imply that they are authorised by the FCA or that their MLR status is equivalent to being authorised.
FCA Rules
In addition, there are FCA rules that will apply to cryptoasset promotions. These proposals were outlined in CP22/2, and there have been minimal changes to the FCA's proposed approach from CP22/2, despite them acknowledging that a number of their proposals met with net-negative responses in the consultation. The key rules are:
- Risk warnings and associated risk summaries
The FCA requires a risk warning to be included in all cryptoasset promotions. It must say:
"Don't invest unless you're prepared to lose all the money you invest. This is a high-risk investment and you are unlikely to be protected if something goes wrong. Take 2 mins to learn more."
This risk warning is slightly shorter than was originally proposed. The "Take 2 mins to learn more" should hyperlink to a risk summary specific to the product being offered. The FCA will publish a risk summary template for crypto, which will set out that consumers should not expect to be protected by the FSCS or the ombudsman service if something goes wrong. Firms will be able to vary the prescribed risk summary where they have a good reason, though they must make an adequate record of any divergence from the template and the rationale behind any change.
- Ban on incentives to invest
Firms are to be prohibited from carrying out cryptoasset promotions that include any monetary or non-monetary benefits that incentivise investment. This includes things such as 'refer a friend' or new joiner bonuses. In a departure from the CP, the FCA confirmed that the 'shareholder benefits' exemption set out in PS22/10 will not apply to cryptoasset promotions -- as the FCA believes that it would create an unacceptably high risk of firms arbitraging this rule and using the exemption to promote benefits that distort consumers investment decisions.
- Frictions
The key part to the rules is the introduction of four "frictions" before a firm can show a retail customer a Direct Offer Financial Promotion (DOFP). A DOFP is defined as:
a. an offer by the firm or another person to enter into a controlled agreement with any person who responds to the communication; or
b. an invitation to any person who responds to the communication to make an offer to the firm or another person to enter into a controlled agreement
and which specifies the manner of response or includes a form by which any response may be made.
The FCA has said that the PS clarifies exactly when a DOFP arises: where the financial promotion specifies the manner of response or includes a form by which any response may be made. A manner of response can take many forms, with the FCA giving the examples of a promotion containing a 'buy now' button which enables the consumer to invest. However, elsewhere in the PS, it also gives the example of "requests to be able to invest" as an instance of where a "Consumer requests to view the Direct Offer Financial Promotion". To us, "requesting to invest" and "requesting to see a financial promotion that includes the manner by which a means of investing" are not the same things. We hope the FCA is more explicit in its guidance soon, or at least stops using imprecise language in its policy statements.
We outline the four frictions below:
Cooling-off period
A firm cannot show a retail client a DOFP (or let them invest in cryptoassets, depending on which bit of the policy statement you read), until a 24-hour cooling off period has passed. This starts from the moment the retail customer requests to view the DOFP. Firms may proceed with other parts of the client on-boarding process while the cooling-off period is in effect -- including performing KYC/AML checks, and showing the personalised risk warning. At the end of the 24-hour period, the retail customer will need to give their active consent that they wish to proceed with the investment.
Personalised Risk Warning
Before communicating the DOFP, firms must obtain the retail client's full name, and present them with a personalised risk warning, in the following form:
[Client name], this is a high-risk investment. How would you feel if you lost the money you're about to invest? Take 2 mins to learn more.
This must be prominent, and by way a pop-up box (or equivalent).
Client categorisation
The third friction is that the customer must be categorised into one of four categories:
Certified as a 'high net worth investor' (an investor that earns more than £100,000 or has net assets of more than £250,000);
Certified as a 'sophisticated investor' (an investor that has been certified by an authorised person as sophisticated);
Certified as a 'restricted investor' (an investor that confirms that they have not, in the last 12 months, nor will in the forthcoming 12 months, invest more than 10% of their net assets into restricted mass market investments), or
None of the above
The PS confirms that where consumers must state their income/net assets to confirm they are high net worth they can provide these figures to the nearest £10,000/£100,000 respectively. The categorisation must be carried out every 12 months.
Appropriateness assessment
The final friction is that the products must be assessed as appropriate for the retail customer. To do this, the customer must take an 'appropriateness assessment' set by the firm. There are guidelines published by the FCA as to how these should be carried out. For example, firms are discouraged from having binary yes/no answers, and customers should have different questions if they retake. The PS confirms that retail customers must wait at least 24 hours before undertaking the appropriateness assessment again from their second assessment onward.
Third Party Approvers
CP22/2 set out a number of proposals aiming to strengthen the role of authorised firms that were approving financial promotions on behalf of unauthorised firms. PS23/6 confirms that these are all applicable to cryptoasset promotions:
All approved promotions must include the name of the authorised firm approving the promotion, as well as the date of approval.
The approving firm must have the relevant competence and expertise (C&E) in the type of investment being promoted. The FCA clarified in PS22/10 that firms must self-assess that it has the necessary C&E for the investment product itself, but not necessarily C&E for the specific commercial sector/s to which the underlying investments relate.
Approvers need to take reasonable steps to monitor the continuing compliance of approved promotions throughout the lifetime of the promotion. This includes considering whether, among other factors, there had been any changes which may affect whether the promotion continued to be fair, clear and not misleading.
Approver firms will need to get attestations of 'no material change' from clients with approved promotions every 3 months, for the lifetime of the approved promotion.
The Approver will have responsibility for ensuring compliance with the frictions as well, in particular ensuring that the relevant processes for appropriateness tests comply with the FCA rules.
The FCA has extended existing 'conflicts of interest' obligations to firms approving financial promotions for unauthorised firms. For example, it may be that an Approver may be asked to approve financial promotions by competitors. The FCA says that it is not appropriate for firms to use their position as an Approver to gain a competitive advantage over their rivals. We'll see how this one plays out in practice.
Consumer Duty
In July 2022, the FCA published PS22/9, detailing the final rules, and FG22/5, with guidance, for the Consumer Duty. Coming into force in July 2023, the Consumer Duty looks to set a higher and clearer standard of retail consumer protection across financial services and requires firms to put their customers' needs first.
Subsequently, the FCA has published a further consultation with proposed amendments that made clear that the Consumer Duty will apply to authorised firms approving financial promotions, as well as firms conducting regulated activities or ancillary activities, payment services or issuing e-money.
Cryptoassets currently fall outside the FCA's regulatory perimeter, which means that promotions issued by firms registered under the MLRs will not be caught by the Consumer Duty. However, the PS suggests that it will apply to authorised firms approving financial promotions for cryptoassets, where they are targeted at retail clients, to the extent they can determine or materially influence retail customer outcomes.
The FCA says that they would expect Third Party Approvers to have due regard to their obligations to act in good faith, avoid causing foreseeable harm, and enable and support retail consumers to pursue their financial objectives. This includes taking into account customers' interests when presenting information, ensuring that the promotions support retail customers' understanding, and that they meet the information needs of customers, are likely to be understood by customers intended to receive them, and equip them to make decisions that are effective, timely and properly informed. They should also ensure that the financial promotions are tailored to the characteristics of the customers intended to receive the financial promotion. This is a potentially significant extra burden on Third Party Approvers, a subset of authorised firms that already appeared to be limited. It remains to be seen how many will want to take on this responsibility.
As you can see, these amount to very substantial changes to the UK's financial promotion regime, and apply to firms globally. We strongly recommend reviewing marketing policies and procedures well ahead of 08 October.
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