The UK Financial Conduct Authority (FCA) has unveiled new and near-final rules in Policy Statement 23/6 (PS23/6)1 that will apply to:
- 'authorised persons', which includes firms authorised under Part 4A of the Financial Services and Markets Act 2000 (FSMA) but does not include firms authorised under the Electronic Money Regulations 2011 or the Payment Services Regulations 2017, and
- 'MLR-registered firms', which means cryptoasset businesses2 registered under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR).
For further information relating to the application of the general restriction on financial promotions to qualifying cryptoassets, and how different firms will be affected, please click here.
Under new rules, the FCA will treat cryptoassets as 'Restricted Mass Market Investments' (RMMIs). RMMIs are a grouping of investment types considered to pose a range of risks to consumers and accordingly are subject to general promotional conditions regarding investment exposure levels and an appropriateness test, with additional differentiation for specific assets; for example, different risk warnings.
Financial promotions relating to 'qualifying cryptoassets' will need to comply with a range of new measures including:
- general rules for all financial promotions:
- a ban on providing incentives to invest; and
- the display of a mandatory risk warning and associated risk summaries.
- additional requirements for Direct Offer Financial Promotions (DOFP):
- a 24-hour 'cooling-off' period for first time investors;
- a client categorisation process;
- an appropriateness assessment; and
- record keeping requirements.
Authorised persons and MLR-registered firms issuing cryptoasset promotions will also have to follow the FCA's overarching requirements on clearness, fairness and accuracy. Furthermore, the FCA confirmed that the Consumer Duty (which comes into force on 31 July 2023) will apply to authorised persons communicating or approving financial promotions in relation to qualifying cryptoassets when targeted at retail clients. In contrast to authorised persons, however, the FCA is not, at this stage, proposing to apply the Consumer Duty to unauthorised MLR-registered firms communicating their own promotions.
What is a ‘qualifying cryptoasset'?
Any cryptographically-secured digital representation of value or contractual rights that is transferable and fungible will fall within the definition of 'qualifying cryptoasset". Cryptoassets that meet the definition of electronic money or an existing controlled investment (such as a share, or unit in a collective investment scheme) are excluded from this definition, as are certain 'limited use' cryptoassets that meet specified conditions and cryptoassets that cannot be transferred or sold other than through redemption with the issuer.
How will the rules apply to an MLR-registered firm?
The Government has introduced a new exemption to the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO) for MLR-registered firms. Where they are not also FCA authorised persons, the new rules mandate that the FCA's conduct rules and associated guidance applies to MLR-registered firms as if they were authorised persons. Furthermore, Principle 7 (Communications with clients) and certain rules on status disclosure, use of the FCA logo and establishment of adequate policies and procedures sufficient to ensure compliance will also apply.
What are the rules?
General rules
Ban on incentives to invest
PS23/6 rules extend the ban on financial promotions that offer monetary or non-monetary benefits that incentivise investment activity to qualifying cryptoassets, thus prohibiting firms from offering 'refer a friend' or new joiner bonuses. The ban extends to 'shareholder benefits', for example discounts or offers on products or services based on cryptoassets held by an investor.
Benefits intrinsic to a cryptoasset or exclusively bound up with its function and/or business model, however, are not considered an 'incentive'. By way of example, cryptoassets that serve to provide the owner with voting rights, and which are for the purpose of establishing governance arrangements for a particular platform or project would not be considered an incentive. On the other hand, offering 'free' cryptoassets upon investment, or making a feature or benefit available only for a limited period of time, would likely be considered an incentive.
Risk warnings and associated risk summaries
Firms will be required to include standard risk warnings on all financial promotions for cryptoassets, alongside a standard summary of risk information for the particular investment type ('a risk summary'). The FCA prescribes the following standard wording: "Don't invest unless you're prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be protected if something goes wrong. Take 2 mins to learn more", whilst also introducing different risk warnings for different types of products.
The rules do allow firms to vary the prescribed risk summary if they have a good reason to do so, for example if the wording would be misleading or irrelevant. Similarly, firms can include key investment risks not covered by the template, provided they make an adequate record of any divergence from the template, and the rationale behind the change.
The FCA has provided guidance on the expected content of the risk warnings and summaries, as well as prominence and display requirements for digital and non-digital mediums of communication.
What is a DOFP?
A DOFP is a financial promotion containing:
- an offer by the firm or another person to enter into a controlled agreement3 with any person who responds to the communication; or
- 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 can be made.
An example of a DOFP would be a promotion containing a 'buy now' button enabling an investor to invest, or a form asking the investor to provide their bank account details. The FCA has specified that the assessment of whether a particular financial promotion constitutes a DOFP will be made on a case-by-case basis and will depend on the specific circumstances; however anything that promotes a qualifying cryptoasset and contains a mechanism which enables consumers to place their money in that qualifying cryptoasset is likely to constitute a DOFP.
How do the rules apply to new and existing customers?
Certain measures will apply to first time investors, others to both first time and existing investors:
- Rules related to certain 'positive frictions' (personalised risk warning and a 24 hour cooling-off period) will only apply when making a DOFP to first time investors with the firm (and not existing clients).
-
Other investor journey rules related to DOFPs (client categorisation and appropriateness assessment) will apply where a firm wishes to make a DOFP to new and existing investors. This includes existing investors that have previously invested in a qualifying cryptoasset i.e. certain rules apply before an investor can engage in further investment activity.
Firms will need to be cautious with investor declarations. Firms will also need to categorise investors annually if they wish to make further direct DOFPs. The FCA's Policy Statement includes a useful flowchart to help firms determine if, and when, they need to comply with the investor journey rules.
Making DOFPs to first time investors
Personalised risk warning pop-up
Alongside general risk warning requirements (see above), the FCA mandates that a personalised risk warning pop-up (or equivalent) appears before a DOFP can be communicated, in the form of "[Client name], this is a high-risk investment. How would you feel if you lost the money you're about to invest? Take 2 min to learn more." The 'Take 2 min to learn more' text must link to an accompanying risk summary that, within parameters, can be tailored to the specifics of the investment being promoted.
A 'cooling-off' period
The rules require firms to institute a 24-hour cooling-off period for first time investors. This means that at least 24 hours must elapse between the moment a new investor requests to view a DOFP, and when the firm presents the DOFP to the investor and the consumer is able to place their money. The rules do, however, allow firms to proceed with other parts of the investor journey during the cooling-off period (e.g. KYC checks, client categorisation, appropriateness assessment).
The FCA makes it clear that the cooling-off period does not apply to each individual transaction in a cryptoasset, but is only applicable to first-time investors with a specific firm (i.e. where an investor has not previously received a DOFP from the firm).
Making DOFPs to first time investors and existing investors
Before making a DOFP, firms must apply the following additional investor journey protections further detailed below; these apply irrespective of whether there is a first time or existing investor.
Client categorisation
Before a DOFP can be made, the investor must be categorised as:
- 'Restricted';
- 'High Net Worth'; or
- 'Certified Sophisticated'.
These categorisations require the investor to sign a declaration stating that they meet the relevant criteria to fall within the relevant category. Such declarations are only valid for a 12-month period. This means firms will need to re-categorise investors again after the 12-month period has expired if they wish to make further direct DOFPs.
Appropriateness assessment
Before an application or order for a cryptoasset can be processed in response to a DOFP, firms must assess the specific cryptoasset as appropriate for the investor. In essence, this means assessing that the investor has the necessary experience and knowledge to understand the risks involved in relation to a specific product or service offered or demanded. In practice, this requirement can be, and is often, met through an interactive set of questions put to the investor online. The FCA specifies that firms are allowed to gather the information necessary to conduct the assessment, and complete the assessment, before the DOFP is shown. This time taken for the assessment can be undertaken during the 24-hour cooling-off period.
From the second time a determination is made that an investment would not be appropriate for the investor, the firm cannot reassess the appropriateness of that investment for the same client more frequently than once every 24 hour period.
The questions asked must also differ each time an investor is subject to the assessment. Guidance is given on the types of questions to be covered by an appropriateness assessment; however, the FCA has announced it will introduce targeted amendments to this guidance as part of the assessments to reflect recent market developments.
Finally, the FCA states that firms should not, in their communications with investors, encourage them to retake the test after the investment has been assessed as inappropriate for them if the investors have not attempted to do so on their own initiative. Although firms are free to inform investors of the facts – such as the option to retake the assessment, or that a 24-hour lock-out period has ended – they cannot do so in a persistent or persuasive way. For example, placing any form of pressure on the investor such as imposing a time limit in which to invest would be prohibited.
Record keeping requirements
To assist the FCA with its objective of assessing the effectiveness of the proposals, authorised persons, including firms approving communications, and MLR-registered firms, must record metrics relating to:
- Client categorisation; and:
- the outcome of client categorisation (i.e. number of investors categorised as high net worth, sophisticated and restricted and the reason why they believe they meet those criteria);
- the number of investors who do not proceed with the investor journey at client categorisation (i.e. do not get categorised); and
- Appropriateness assessment (the final outcome of the appropriateness assessment for each investor and the number of times they were subject to the assessment for the same investment, etc.).
Although other metrics can be recorded (e.g. the number of investors subject to the 24-hour cooling-off period; the number of investors presented with, and clicking on, personalised risk warning etc.) this will not be mandatory.
1 PS23/6 Financial promotion rules for cryptoassets
2 Cryptoasset exchange providers and custodial wallet providers.
3 A controlled agreement is defined in PS23/6 by reference to s.30 FSMA as "an agreement the making or performance of which by either party constitutes a controlled activity."
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