UK Regulatory Compliance – FCA Guidance on Cryptoassets
The Financial Conduct Authority (FCA) in the UK has now finalised their guidance on cryptoassets.
The document is available at: https://www.fca.org.uk/publication/policy/ps19-22.pdf
In this post we are going to look at some of the details from their consultations and final documentation to see how they affect the JSE project.
|1.4 This guidance is relevant to:firms issuing or creating cryptoassetsfirms marketing cryptoasset products and servicesfirms buying or selling cryptoassetsfirms holding or storing cryptoassetsprofessional advisersinvestment managersrecognised investment exchanges, multi-lateral trading facilities and organised trading facilitiesconsumers and consumer organisations|
It’s unclear whether the regulations are relevant to companies that issued cryptoassets years before the guidance was released however we would still be included due to the firms holding/storing cryptoassets.
|1.9 In CP 19/3, we consulted on Guidance based on the different categories of cryptoassets initially defined in the UK Cryptoasset Taskforce Report (CATF), and set out whether or not they fall within the regulatory perimeter. These categories were:|
Exchange tokens: These are not issued or backed by any central authority andare intended and designed to be used as a means of exchange. They tend to be a decentralised tool for buying and selling goods and services without traditional intermediaries. These tokens are usually outside the perimeter.
Utility tokens: These tokens grant holders access to a current or prospective productor service but do not grant holders rights that are the same as those granted by specified investments. Although utility tokens are not specified investments, they might meet the definition of e-money in some circumstances (as could other tokens). In this case, activities involving them may be regulated.
Security tokens: These are tokens with specific characteristics that mean they provide rights and obligations akin to specified investments, like a share or a debt instrument(described in more detail in Chapter 3) as set out in the Regulated Activities Order(RAO). These tokens are within the perimeter.
The JSE token is a utility token which may or may not be regulated. Not particularly helpful but one can only assume this is intentionally vague to make assessments on a case by case basis.
|1.16 A combination of market immaturity, volatility, and a lack of credible information or oversight raises concerns about market integrity, manipulation and insider dealing within cryptoasset markets. This may prevent the market from functioning effectively and damage its reputation.|
They’ve touched on something really important here. It would be very easy for the JSE team or anyone else working in crypto to trade on insider information. Coinbase got caught out not long ago and this has become so prevalent that it’s an accepted evil within the industry. Developers, advisors and founders are really only bound by their own moral guidance and there will always be temptation to generate large financial gains on positive newsflow. This however hurts other stakeholders, traders and market makers who support the project. Ultimately crypto trading is a zero-sum game and one person’s gain is another’s loss.
This is an area where the FCA could and I believe eventually will provide further regulation to help legitimize the industry.
|1.21 If a firm acts in line with the Guidance, we will treat them as having complied with the relevant rule or requirement. This Guidance represents our views. It does not bind the courts, but it can be a persuasive factor in the courts’ determinations, for example enforcing contracts.|
Sceptics might conclude this is legally irrelevant but perhaps they are just covering themselves as you’d expect.
|2.23 Three-quarters of respondents agreed that most utility tokens are outside the regulatory perimeter and that only those utility tokens that reach the definition of e-money fall within it.|
Feedback from the original consultation is inline with our expectations here. Utility tokens should not be regulated and treated as securities. Doing so would cause a significant slowdown and outflow from the blockchain sector in the UK.
|3.7 E-money tokens are tokens that meet the definition of electronic money in the EMRs. That is:electronically stored monetary value that represents a claim on the issuerissued on receipt of funds for the purpose of making payment transactionsaccepted by a person other than the issuernot excluded by regulation 3 of the EMRs|
3.8 In CP 19/3, we set out where cryptoassets may meet the definition of electronic money and fall within the scope of EMRs. We described that they are likely to be certain types of utility tokens, including those referred to as ‘stablecoins’. Our draft Guidance identified where tokens may be considered e-money, and the permutations for firms.
However, as the cryptoasset market evolves, we need a flexible approach to ensure our regulation remains accurate and appropriate. We have decided to make drafting changes to the Guidance to create a category of cryptoasset in the taxonomy that reflects those tokens that reach the definition of e-money.
A new e-money token category will better illustrate where tokens fall under regulation. Any token that is not a security token, or an e-money token is unregulated. However, market participants should note certain activities that use tokens may nevertheless be regulated, for example, when used to facilitate regulated payments.
This is really critical where we need to make an assessment of whether JSE is a utility token or a e-money token. It does not store monetary value or represent a claim to an issuer like USDT and other stablecoins do. Issued on the receipt of funds, it could be argued that ICO’s fall in to this category but it seems that again this is directed at stablecoins. Accepted by a person other than the issuer. This would include any token that is listed on a 3rd party exchange which isn’t their intention. Potentially the JSE merchant tools and internal wallet transactions could fall in to this category as well. However just about every crypto asset is transferable by nature between two users. The criteria is written, as they conclude, to provide a flexible approach but this leaves uncertainty and ambiguity to where individual assets fall.
|8 There are several different elements that firms need to take into account when considering the regulatory perimeter. Figure 1 shows some of these considerations with respect to the FSMA perimeter; however, the focus of this Guidance is predominantly on the second step, understanding specified investments. This is the area market participants have told us they struggle the most to understand and we agree that it warrants further regulatory clarity. However, references and signposting has also been provided in relation to payments services for additional clarity.|
|24 If you carry on a specified activity, by way of business in the UK, involving a cryptoasset which is a specified investment (i.e. security tokens or e-money tokens) you may require authorisation and the relevant permission. If you are a credit institution, credit union, or municipal bank then issuing e-money tokens will be a regulated activity. In other cases issuing e-money is regulated under the EMRs and market participants will need to make sure they are appropriately authorised, registered or exempt. This requirement is not influenced by the choice of technology – if you are carrying on a regulated activity, it is likely you will need to be authorised. You will also need to ensure you have appropriate authorisation if your token is used to facilitate regulated payments services.|
|30 How do I know if my token is a specified investment?|
Given the complexity of many tokens, it is not always easy to determine whether a token is a specified investment, specifically those types of specified investment that are securities, like shares or debt instruments. There are a few factors that are indicative of a security. These factors may include, but are not limited to:
the contractual rights and obligations the token-holder has by virtue of holding or owning that cryptoassetany contractual entitlement to profit-share (like dividends), revenues, or other payment or benefit of any kindany contractual entitlement to ownership in, or control of, the token issuer or other relevant person (like voting rights)the language used in relevant documentation, like token ‘whitepapers’, that suggests the tokens are intended to function as an investment, although it should be noted that the substance of the token (and not the label used) will determine whether an instrument is a specified investmentFor example, if a whitepaper declares a token to be a utility token, but the contractual rights that it confers would make it a share or a unit in a collective investment scheme, we would consider it to be a security token.whether the token is transferable and tradeable on cryptoasset exchanges or any other type of exchange or marketa direct flow of payment from the issuer or other relevant party to token holders may be one of the indicators that the token is a security, although an indirect flow of payment(for instance through profits or payments derived exclusively from the secondary market) would not necessarily indicate the contrary.If the flow of payment were a contractual entitlement we would consider this to be a strong indication that the token is a security, irrespective of whether the flow of payment is direct or indirect (or whether other ownership rights are present).
Making an assessment on this information is by design ambiguous. The documentation provides little certainty, which is not a criticism of the document itself, but this does not provide clarification and legal protectioon for UK blockchain companies such as ourselves.
The FCA have produced guidelines which are flexible and will not cause conflict with future regulations and legislation, which is understandable.
The following goes on to describe unregulated tokens.
|What are unregulated tokens|
34 Unregulated tokens are those tokens that do not provide rights or obligations akin to specified investments (like shares, debt securities and e-money).
35 These tokens can be centrally issued, decentralised, primarily used as a means of exchange,or grant access to a current or prospective product or service. They might be used in one or many networks or ecosystems. They can be ‘privacy tokens’, ‘fungible utility tokens’,‘non-fungible tokens’, ‘access tokens’ etc. They can be fully transferable or have restricted transferability.
36 The key thing to note is that any token that is not a security token, or an e-money token is an unregulated token.
37 Below we provide further details based on the two broad categories of unregulated tokens identified in the UK Cryptoasset Taskforce report, and a further category specific to this Guidance; exchange tokens, utility tokens, and tokens referred to as ‘stablecoins’. Each of these categories can be further subdivided based on characteristics, such as transferability,fungibility, function, degree of centralisation etc
The question of transferability between two parties is also clarified in one of the case studies.
|Case study 8: transferability: Firm AY is issuing a transferable token that allows the token holder storage rights on their network. No other financial rights are offered.|
This token may be described as a non-fungible utility token that is fully transferable. However, the key distinction is that it does not offer the same rights as a specified investment and is unlikely to be considered a security token. While transferability is one factor that we will consider when deciding whether a token is a security token, transferability alone does not make the token a security token.
The JSE token should be considered as an unregulated utility token given this criteria.
|79 For example, a firm wanting to create infrastructure for the buying, selling and transferring of security tokens (commonly known as exchanges or trading platforms) must ensure it has the appropriate permissions for the activities it wants to carry on.|
It’s noteworthy that if we were ever going to open up an internal exchange then we may need to seek regulatory approval.
|Q&A 8. I am still not sure whether my token is a security token, what should I do?|
The Perimeter Guidance chapter clarifies how we determine a token to be a securitytoken, however definitive judgements can only be made on a case-by-case basis.
This really sums up the documentation. If a legal issue arises then an assessment will be made on a case-by-case basis. This provides the FCA with the flexibility to hopefully weed out bad players in the sector while not disrupting the growth of blockchain within the UK fintech industry.
For JSE, we have a strong case for being categorised as a non-regulated utility token. The tokens are issued to be used within the JSE ecosystem. This includes:
- The JSE ad-exchange where tokens can be used to purchase digital advertising space on publisher websites.
- The merchant tools where 3rd parties can accept JSE tokens (and soon BTC/ETH) for products and services they provide.
- The enterprise tools where tokens are used to purchase API queries.
There is an opportunity for the JSE project to self-regulate to some extent. We are conducting our business to the highest of standards which should set us apart from other projects. This is something we could do more to clarify and publish in future documentation.
The team will continue to operate in ways we see as ethical and inline with the government’s guidance.
Finally we’d like to thank the team who worked on this at the FCA. They’ve done a good job of researching and assessing the current state of cryptoassets. We will end with this image from the documentation which describes their assessment of the market participants.