In January 2019, the UK’s Financial Conduct Authority (FCA) released a consultation on potential guidance on cryptoassets that provides useful direction on how cryptoassets will fall within the regulatory regime, guided from the Cryptoasset Taskforce’s October 2018 final report and with refernece to Her Majesty’s Treasury (HMT). HMT and FCA are exploring legislative changes to potentially broaden the FCA’s regulatory remit on cryptoassets and to bring every firm handling cryptoassets under FCA regulation.
The FCA consultation close in April 2019 promising final guidance “summer 2019”. The FCA has confirmed that exchange tokens, such as Bitcoin, Litecoin or Ether, do not currently fall within the regulatory perimeter with the exception of certain areas such as CFD, cryptofutures, etc; however, exchange tokens will be caught (along with other cryptoassets) by the 5th Anti-Money Laundering Directive (AMLD5), which will be transposed into UK law by the end of 2019. AMLD5 will catch exchange between cryptoassets and fiat currencies or other cryptoassets, transfer of cryptoassets, safekeeping or administration of cryptoassets and provision of financial services related to an issuer’s offer and/or sale of cryptoassets, although being caught by the 5AMLD does not, by itself, mean the cryptoasset will be subject to FCA regulation.
The FCA’s discussion on the classification of security tokens is arguably the most valuable part of its guidance on cryptoassets, as it makes clear that cryptoassets that fall within the definition of a security will be treated as securities and regulated but that because cryptoassets can provide a range of rights and other characteristics, it can be difficult to determine whether they do fall within such definition. The guidance also notes that products that derive their value from or reference cryptoassets, such as options, futures, contracts for difference and exchange-traded notes, are likely to fall within the regulatory perimeter, even if the underlying cryptoasset does not. The FCA also states in its guidance that tokens that are issued in exchange for other cryptoassets, and not for fiat currency, will not necessarily be exempt from the regulatory regime if they are considered security tokens and that issuing of one’s own security tokens does not require the issuing company to have a regulatory licence, (in the same way that issuing one’s own shares does not require a licence) but that authorisation must be obtained by any exchanges in which the tokens are traded, and that the regulatory permeter rules for advisers and brokers and the financial promotions regime will need to be complied with.
The Guidance also make it clear that if a cryptoasset has the features of a share then it will be considered a specified investment and certain activities involving it will require authorization or exemption. In determining whether a cryptoasset is classed as a share, the FCA has noted that a separate legal personality, and a body which survives a change of member, are significant but not determinative factors in classifying the cryptoasset. (Other factors include whether the cryptoasset provides voting rights, control, ownership, access to a dividend based on the performance of the company or rights to distribution of capital on liquidation).
[Interestingly, the FCA has noted that the definition is dependent on the UK’s notoriously complex company and corporate law.]
“Security token offerings” promoted in accordance with security requirements are noted not to give equity rights and are popular as ICOs are no longer attractive to investors and the guidance noted that calling a token a “security token” will not change the nature of the token itself and that a security token that does not meet the company law and corporate law share definitions can be treated as a utility token and does not currently not require the trading platform, broker or advisers to be licensed; however a cryptoasset that represents money owed to the token holder will be considered a debt instrument, and therefore will be considered a security token and coins such as stablecoin linked to a fiat currency may be regulated. The guidance also notes that if the cryptoasset is considered a share or debt instrument, and is capable of being traded on the capital market, it will be considered a transferable security under the Markets in Financial Instruments Directive (MiFID), and the MiFID regime will apply. (As with traditional securities, this does not require the security to be listed.). If the cryptoasset is able to be transferred from one person to another in such a way that the transferee will acquire good legal title, it is likely a transferable security. It is important to note that a cryptoasset may be considered a share under the UK law, but not a transferable security under MiFID.
Cryptoassets may also be warrants – for example, where an issuing entity issues A tokens, which will provide the token holder the right to subscribe for B tokens at a later date. If the B tokens represent shares or debentures (or other specified investments), then the A tokens will be considered warrants and therefore specified investments and therefore regulated. (It is important to note that for the A tokens to be warrants, the B tokens will need to be new cryptoassets issued by the issuing entity. If the A tokens provide a right to purchase B tokens from a secondary market, the A tokens will not be considered warrants). Similarly, A tokens that provide the token holder with a contractual or property right over other investments (either in cryptoasset or traditional form) will be considered certificates representing certain securities. Cryptoassets which represent a right to or interests in other specified investments are also classified as securities.
Certain cryptoassets may be considered units in a collective investment scheme, notably tokens that allow investors to invest in assets such as art or property. Provided the investments in the cryptoassets are pooled, and the income or profits that the cryptoasset holders receive are also pooled, it will likely be considered a unit in a collective investment scheme. Importantly, if the token holders have day-to-day control of the management of the investment, it will fall outside this definition.
Tokens that represent rewards, such as reward-based crowdfunding, or the access to certain services, will be considered utility tokens. Utility tokens do not have the features of securities, and therefore fall outside the regulatory perimeter. The FCA has noted that the ability to trade utility tokens on the secondary market will not affect the classification of the token – even though this may mean individuals purchase these as investments.
The guidance confirms that the use of cryptoassets is not covered by the payment services, unless the cryptoasset is considered electronic money. However, where cryptoassets act as a vehicle for money remittance (i.e. the transfer of money from one account to another, perhaps with a currency exchange) then the fiat sides of the exchange will be caught by the payment services regulations.While cryptoassets do not fall within the payment services regime, they may fall within the e-money one. To the extent that the cryptoasset is issued on receipt of funds (i.e. fiat currency, not other cryptoassets) and the cryptoasset is accepted by a person other than the electronic money issuer, it may be considered electronic money (unless it is excluded). This would include cryptoassets that are issued on receipt of GBP and are pegged to that currency, as long as the cryptoasset is accepted by a third party. Therefore, stablecoins that meet the definitions set out above may fall within the definition of electronic money.
The guidance seems to indicate that utility or payment tokens wrapped in a security token wrapper but not containing traditional security/equity rights will not be a regulated security instrument although each token really needs assessment in its own right.