The FCA have issued their final guidance on the types of cryptoassets that fall within the FCA’s current regulatory framework (“PS19/22” or “Final Guidance”) based on feedback received to the FCA’s Guidance on Cryptoassets Consultation Paper published in January 2019 (“CP19/3” or “Original Guidance”) which sets out the regulatory parameter for cryptoassets.

The Final Guidance consulted a broad range of respondents including large banks, token issuers, academics and fintechs (the “Respondents”). Respondents broadly agreed with the FCA’s categorisations of unregulated and regulated tokens in the Original Guidance but highlighted that there was ambiguity in certain areas. The FCA’s general approach has been to stick to the Original Guidance but these ambiguities have been acknowledged and addressed through additional clarificatory drafting.

Concerns were raised around the unregulated nature of certain cryptoassets and the risk to consumers, which is beyond the FCA’s remit as the Final Guidance only focuses on the existing perimeter. However, the feedback will be considered and help inform the Treasury’s ongoing work on unregulated cryptoassets and its consideration of whether additional legislation is required.

The Original Guidance set out three types of cryptoassets (defined by the UK Cryptoasset Taskforce Report (“CATF”)) and detailed how they may fall within the regulatory perimeter. These cryptoassets are:

• Exchange tokens: such tokens have no central authority and there is therefore not (usually) a single issuer to enforce rights against. They tend to be a decentralised tool for buying and selling goods and services without traditional intermediaries.
• Utility tokens: these provide consumers with access to a current or prospective product or service and often grant rights similar to pre-payment vouchers.
• Security tokens: these provide rights and obligations akin to specified investments as set out in the Regulated Activities Order (“RAO”) including those that are financial instruments under MIFID2. Essentially, they share characteristics which mean they are the same as or similar to traditional instruments like shares, debentures or units in a collective investment scheme.

The Final Guidance also provides further clarity around:

• E-money tokens: these are tokens that meet the definition of electronic money under the E-Money Regulations 2011 (“EMRs”).
• Stablecoins: these attempt to stabilise the volatility that can be found in cryptoassets through various mechanisms (for example, by backing the token with fiat funds, a basket of cryptoassets, other types of assets or algorithms). However, they vary greatly in their structure and purpose, making them inappropriate for separate categorisation.

It is important to note that although the Final Guidance is not binding it is persuasive. Therefore, any firms dealing with cryptoassets would do well to familiarise themselves with the Final Guidance and ensure compliance.

Exchange Tokens

The Original Guidance stated that these coins are outside the regulatory parameter, therefore market participants like crypto exchanges which only provide a platform for the trading of such tokens fall outside the FCA’s remit. The approach hasn’t changed in the Final Guidance, however drafting has now been added to clarify when these tokens are regulated.

Although unregulated, the Original Guidance sets out that exchange tokens can be used to facilitate regulated payment services, such as international money remittance. The use of exchange tokens as a vehicle for remittance does not mean the tokens themselves fall within the regulatory perimeter, but rather that the Payment Service Regulations 2017 (“PSRs”) would instead apply to each side of the remittance.

Interestingly, whilst some Respondents highlighted that using exchange tokens in such a manner was a key growth area, others highlighted that the volatility of cryptoassets inhibited their effective use as a vehicle for remittance.

It is also important to bear in mind that the Fifth Anti-Money Laundering Directive (“5AMLD”) will be transposed into UK law by 10^th January 2020 and will bring in an AML regime for certain cryptoasset activities (but not the holding of cryptoassets generally) including exchange tokens.

Utility Tokens

The Original Guidance stated that these are generally outside the regulatory perimeter.

The exemption is if they fall under the definition of e-money, in which case they would be regulated under the EMRs. Whilst most Respondents agreed with this interpretation, a number thought that utility tokens should be brought under FCA regulation, particularly any utility tokens used as a form of speculative investment. Respondents also felt that further guidance was needed around the distinction between exchange and utility tokens.

In response, the FCA have now separated e-money tokens from the utility tokens and security tokens category, by creating a specific regulated e-money token category and an unregulated category that includes utility tokens. Bringing utility tokens into the regulatory perimeter requires legislative change, but the FCA highlighted that feedback would inform the Treasury’s consultation later this year, as part of its CATF work on unregulated tokens.

Security Tokens

The Original Guidance stated that these are within the regulatory perimeter. Respondents generally agreed with this approach, although several Respondents highlighted the need for a more harmonised international approach.

Under the Final Guidance, the FCA recognised the importance of a harmonised international framework to prevent firms from gaming the system (regulatory arbitrage) or creating difficulties for firms that operate in multiple jurisdictions.

However, the FCA acknowledged that there are inherent structural differences in different jurisdictions’ securities markets and legal and regulatory frameworks, that equally affect securities in a tokenised form, and make such harmonisation difficult to achieve. The FCA stated that it will continue to work with other regulatory agencies to encourage regulators to approach cryptoassets in a consistent manner.

The security tokens category has also been slightly amended in the Final Guidance to specifically exclude e-money from this definition.

E-Money Tokens

The Original Guidance set out that there are likely to be certain types of utility tokens, including those referred to as stablecoins, which meet the definition of e-money.

The FCA recognised that as the cryptoassets market evolves a flexible approach is required to ensure the regulatory regime remains accurate. Therefore, drafting changes have been made to create a new category of cryptoassets that covers the definition of e-money.

Several Respondents highlighted that categorising e-money tokens within the utility tokens category created confusion. Respondents felt the Guidance should explain precisely when utility tokens meet the definition of e-money and that a separate category of e-money tokens would make it clear that firms using these types of tokens would have to follow appropriate rules, permissions and regulations including being authorised as an e-money issuer.

Stablecoins

A large minority of Respondents requested clarity on stablecoins. However, whilst these tokens may have a common purpose they vary greatly in their structure and arrangement making, them inappropriate for any single categorisation.

Many stablecoins will not meet the definition of e-money or a security token and will therefore be unregulated. For example, a token that is backed with fiat currency, but can only be spent with the issuer will not constitute e-money, as it is not accepted by a person other than the issuer. Whether stablecoins will fall within the perimeter has to be treated on a case-by-case basis.

Respondents also highlighted that other tokens aside from exchange tokens can be used to facilitate regulated payments. The FCA acknowledged that this is particularly true of stablecoins and minor drafting changes have been made to reflect this feedback.

Market Observations

Whilst the Original Guidance covered the main types of business models and tokens being developed in the market, Respondents highlighted several other use cases that had not been covered. These include bank settlement tokens, non-fungible tokens and equity and debt tokens.

Respondents particularly felt that splitting out the categorisation between equity and debt tokens would provide more clarity. However, as these are types of security tokens the perimeter analysis will be the same.

Respondents highlighted the issue of dual tokens i.e. tokens that move between categories during their lifecycle and sometimes work in tandem with other tokens during the launch of a new network. The FCA have clarified that in either case their regulatory treatment depends on their intrinsic structure.

Airdrops

A minority of Respondents requested greater clarity around Airdrops i.e. the distribution of tokens to consumers, usually for free. These are often used by new networks as a method of attracting new users or existing networks to generate an increase in users.

Importantly, a specified investment is not contingent on it being purchased for value, and a token can be a security token; as such, a token with the right characteristics can fall within the regulatory perimeter even if no value is received for it.

Our Thoughts

It is clear from the Final Guidance that the existing regulatory perimeter is not comprehensive enough to deal with the fast evolving area of cryptoassets. Whilst the Final Guidance is undoubtedly helpful, it also highlights that new legislation is urgently needed to control risks and provide further clarity to both businesses and consumers.

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