FCA: “any token that is not a security token, or an e-money token is an unregulated token.”
The UK Financial Conduct Authority (FCA) has published its much anticipated final guidance on cryptoassets following a feedback period on prior commentary. The FCA has now established which sector of crypto is regulated by the authority and which digital assets fall outside their remit. The FCA said the majority of respondents had supported their previous proposals on a regulatory approach. Additionally, the agency noted that few changes had been made since the prior document with the exception of “reframing” the taxonomy of cryptoassets to provide greater clarity for firms operating in the sector.
The FCA said that 92 different firms and individuals provided feedback ranging from big banks, to crypto exchanges, issuers, and individuals.
The FCA provided an important caveat stating the Guidance should act as a first step for market participants to understand whether authorization is required and should be read in conjunction with PERG [Perimeter Guidance Manual]. Where market participants are unsure and require regulatory feedback, Innovate support functions such as the Sandbox or Direct Support can provide this help for requests that meet the eligibility criteria for support. Market participants should also consider obtaining appropriate external advice.
E-Money and security tokens fall under FCA regulation but everything else, depending on the specific characteristics of the cryptoasset, do not fall under the watchful eye of the UK regulator
The Guidance follows a report published last fall from a crypto task force which included HM Treasury, the FCA and the Bank of England.
In an accompanying release, FCA Executive Director of Strategy and Competition Christopher Woolard stated:
“This is a small, complex and evolving market covering a broad range of activities. Today’s guidance will help clarify which cryptoasset activities fall inside our regulatory perimeter.”
The FCA advised consumers to remain cautious on the emerging sector of Fintech due to intrinsic risk noting that unregulated cryptoassets fall outside the Financial Compensation Scheme and there is no recourse to the Financial Ombudsman Service.
Digital assets, as defined by the FCA, fall within four separate categories.
- Specified investments under the Regulated Activities Order (securities)
- e-money under the E-Money Regulations
- captured under the Payment Services Regulations
- outside of regulation
Regarding specific token types, the FCA updated the previous delineations as outlined below:
- Security tokens: this category does not change materially from the Guidance that we consulted on and refers to those tokens that provide rights and obligations akin to specified investments as set out in the RAO, excluding e-money. We have now specifically removed e-money from the definition of a security token, to create a separate category. These remain within the regulatory perimeter.
- E-money tokens: this category refers to any token that reaches the definition of e-money. These tokens are subject to the EMRs and firms must ensure they have the correct permissions and follow the relevant rules and regulations. This category formerly sat within the utility tokens category. These tokens fall within regulation.
- Unregulated tokens: this category refers to any token that does not meet the definition of e-money, or provide the same rights as other specified investments under the RAO. This includes tokens referred to as utility tokens, and exchange tokens.
- These tokens can, for example, be issued centrally or be decentralised, give access to a current or prospective good or service in one or multiple networks and ecosystems, or be used as a means of exchange. They can be fully transferable or have restricted transferability. These tokens fall outside the regulatory perimeter.
While “exchange tokens” were deemed not to be regulated by the FCA, the report noted that “5AMLD” will bring in an anti money laundering (AML) regime for cryptoassets including exchange tokens. 5AMLD is the Fifth Anti-Money Laundering Directive by the European Union that is an enhancement of existing rules (4AMLD). 5AMLD has provisions for virtual currencies and EU member states must implement provides by January 2020. While exchange tokens like Bitcoin may not be directly regulated, firms using these tokens on either side would be subject to Payment Service Regulations (PSRs).
Regarding stablecoins, some of which are backed by fiat currency such as US dollars or British Pounds, the FCA had this to say:
“…not every ‘stablecoin’ will meet the definition of e-money, or a security token.”
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 issuer
- issued on receipt of funds for the purpose of making payment transactions
- accepted by a person other than the issuer
- not excluded by regulation 3 of the EMRs [E-Money Regulations]
Exchange tokens as they fall outside the FCA regulatory perimeter. This means that the transferring, buying and selling of these tokens, including the commercial operation of cryptoasset exchanges for exchange tokens, are activities not currently regulated by the FCA. If you are a crypto exchange that deals in Bitcoin, Ether, etc. you are not carrying out a regulated activity.
A Security is a Security But it Still Depends…
To quote the FCA:
“For our taxonomy, we specifically refer to security tokens as only those that reach the definition of specified investments under the RAO. The category has been slightly amended to specifically exclude e-money from this definition.”
The RAO references the Regulated Activities Order as defined by the Financial Services and Market Act legislation. The FCA Guidance is the first step but “definitive judgments can only be made on a case-by-case basis.” This is indicative of ongoing ambiguity within the crypto sector.
Utility Token Clarity
Utility Tokens are unregulated tokens that do not provide rights or obligations akin to specified investments (like shares, debt securities and e-money). While Utility Tokens remain unregulated this may change but only by an act of legislation, according to the FCA. HM Treasury is said to be reviewing this issue.
Utility tokens may be centrally issued, decentralized, 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.
The FCA states that “the key thing to note is that any token that is not a security token, or an e-money token is an unregulated token.”
Of note, the FCA states that Utility Tokens may trade on a secondary market and change in value. This is key as this allows for speculation by purchasers.
The Guidance as provided by the FCA differs dramatically from that of the US but is similar in nature to some European countries.
In the US, any token issued in advance of a fully-fledged, operational network would be considered a security. Once the network is live it can morph into something else. A token that can trade at a variable price due to market forces regardless of any utility nature would be deemed a security in the US – in stark contrast to the Brits. Perhaps, the FCA had France in mind when allowing non-security tokens to trade on exchanges as the French Pacte Law (Loi Pacte) provided clarity on utility tokens.
While the Guidance is “final” that does not mean it will not change. As indicated above, action by Parliament could impact the ecosystem.
The FCA explains:
“… as the cryptoasset market evolves, we need a flexible approach to ensure our regulation remains accurate and appropriate.”
E-Money and security tokens fall under FCA regulation but everything else, depending on the specific characteristics of the cryptoasset, do not fall under the watchful eye of the UK regulator.
See the FCA Cryptoasset Final Guidance below or download it here.
FCA Guidance on Crypto Assets 7.31.19 ps19-22