Of charlatans and poor choices: how restrictions on crypto assets are growing worldwide

‘Crypto’ has become the modern shorthand for the digital value changing hands in cyberspace – beyond traditional banks and monetary authorities. Call them crypto assets or cryptocurrencies, they are flourishing in the digital age.

Yet the ancient origin of the word goes to the essence of today’s regulatory tension: ‘crypto’ has its origin in the Greek word ‘kruptos’, meaning ‘hidden’. Governments and regulators around the world are working to bring crypto assets into view.

In late January, the United Kingdom joined nations taking a decisive step towards regulating crypto assets, by restricting who can promote them and how. The final rules are expected in the northern hemisphere's summer.

That’s potentially less than six months away.

The requirements will establish a high bar and operational changes for affected businesses – both in the UK and offshore – are critical.

Our global team shares a snapshot of international developments in this insight.

Approaches might differ but the overarching objectives are usually similar: protecting consumers, building trust, boosting transparency – all while encouraging the development of a thriving, rising, legitimate industry to ensure competitiveness in a global digital economy.

Differences in approach tend to line up with local policy objectives – where one jurisdiction sees “metaverse” opportunities, another sees capital flight.

What is happening in the UK?

• The UK financial regulator plans to bring ‘qualifying crypto assets’ into its financial promotions regime, regardless of whether those assets are themselves regulated investments.
• The regime will capture local and overseas promoters.
• Financial promotions requirements cover who can issue a promotion, the format and content of materials, and how risk is presented.
• Firms dealing in previously unregulated crypto assets will have to make operational preparations and adjustments.

Final rules are expected sometime around the middle of 2022.

The efforts date back to 2020

Up until now, the reach of the UK financial regulator – the Financial Conduct Authority (FCA) – has extended to a relatively slight slice of crypto assets: those with characteristics sufficiently similar to that of securities or e-money to designate them as ‘security tokens’ or ‘e-money tokens’ under the FCA’s jurisdiction. 

In July 2020, the UK government consulted on bringing certain crypto assets into the scope of the Financial Promotions Order, which governs the issuing and approval of advertising and promotional activities around regulated products and services. The FCA has used the time since to compile evidence, finding:

• ownership of crypto assets has gone up but consumer understanding has declined; and
• advertising targeted at retail clients often overstates benefits without warning about volatility.

The FCA has set out to tackle the resulting unacceptable level of consumer risk in its Consultation Paper, “Strengthening our financial promotion rules for high risk investments, including crypto assets”, published on the 19^th of January 2022 (CP 22/2).

The FCA intends to follow the UK government’s definition of ‘qualifying crypto assets’ (as confirmed in its consultation response of 18 January 2022).

This change – bringing a new raft of crypto assets within the promotions’ regime – does not affect the regulatory status of the underlying activity. Crypto assets that do not amount to security or e-money tokens according to the FCA definition will remain otherwise unregulated at the product level, at least for now.

Crypto assets as a restricted mass-market investment

The proposed rules will capture so-called ‘qualifying crypto assets’ – in essence, investments and speculative trade.

The technical definition set for ‘qualifying crypto assets’ is any cryptographically secured (that is, it is impossible to work out the future code – it is randomly generated) digital representation of value or contractual rights which is:

• Fungible (that is, interchangeable / replaceable by an equivalent); and
• Transferable or confers transferable rights (or is promoted as such) except if this is only to one or more vendors or merchants to pay for goods or services.

The FCA will include ‘qualifying crypto assets’ within its new, rationalized product categories for financial promotion marketing restrictions as ‘Restricted Mass Market Investments’ (RMMI). This means that a wide spectrum of tradeable assets as well as rights to or interests in those assets that have been bought and sold in an unregulated environment are going to have to comply with a variety of onerous requirements before they can be mass marketed.

UK rules, global reach

The financial promotion restriction applies to any promotion covered by the legislation capable of having an effect in the UK, even if that communication comes from outside the UK. Overseas crypto firms that want to promote 'qualifying crypto assets' to UK customers will have to ensure promotions are signed off by an appropriately experienced firm with an FCA license (or obtain that license themselves) and that any such promotions comply with all the new requirements. 

What is happening in...

Australia: early days, dramatic shifts ahead

In Australia, the number of people using crypto assets for transactions jumped by 63% in 2021. However, the Australian regulatory regime for this sector is still at a relatively early stage. Current rules for crypto assets that are not securities, derivatives or other regulated instruments are primarily restricted to anti-money laundering and counter-terrorist financing (AML/CTF) controls for in-scope exchanges registered with AUSTRAC.

The Australian Securities and Investments Commission (ASIC) is also acutely aware of the “finfluencer” problem. That is, social media gurus touting investment opportunities, price action, tips, gossip and “things you must do now”, often riddled with conflicts of interest.

To be clear, social media can be a valuable and legitimate channel for consumer engagement, but lines in the legal sand are routinely ignored and enforcement is tough. 

Increasingly, investment risk disclosures we write need to include warnings about social media – after all, the effects of a single post can be devastating. Commissioner Cathie Armour penned an article on the issue in November 2021. Part warning shot for finfluencers, part awareness-building for companies themselves, Armour noted “most finfluencers do not hold an AFS licence” and may have a conflict of interest due to income from clicks, views and sponsorships. ASIC is seeing a rise in “pump and dump” schemes, Armour wrote.

ASIC has indicated that it is taking compliance action, telling a parliamentary committee in 2021: “We are currently undertaking a review of selected financial influencers (‘finfluencers’) to understand their business models and how the financial services law applies to this activity. We are also engaging with a selection of social media platforms and their moderators.”

Singapore: advanced regulatory regime, limits emerging

Singapore has also long held the reputation of a fintech-friendly and welcoming environment for crypto assets, but a limit is emerging.

Singapore has one of the more advanced regulatory regimes for crypto assets, in the form of its digital payment token (DPT) regime under the Payment Services Act introduced in 2020 and administered by the Monetary Authority of Singapore (MAS). A long queue formed for licenses, with the first granted in late 2021 and many other applicants still under a temporary exemption arrangement.

In January 2022, MAS issued its “Guidelines on Provision of Digital Payment Token Services to the Public”, applicable to a range of regulated entities and licensing applicants. 

Of particular interest, it banned the advertisement of digital payment token-related activities:

• in public areas – broadly and non-exhaustively defined and capturing the likes of buses, train stations, public websites, social media platforms, ATMs and classic media channels; and
• through social medial influencers and other third parties.

The remaining channels were companies’ own corporate websites, mobile apps and official social media accounts.

The rationale was clear and linked with the perceived risk of crypto assets. As the MAS stated in the guidelines: “trading of digital payment tokens… is highly risky and not suitable for the general public. The public should not be encouraged to engage in the trading of DPTs.”

There is also another rationale that might be inferred for such measures – the perceived risk to the regulator that it is blamed for granting a licence or at least is faced with a torrent of complaints when investments go south. The experience of the financial crisis of 2007/08 indicates this is not farfetched. However, Singapore has (so far) stopped short of restricting retail investors from accessing crypto assets altogether, unlike proposals in Hong Kong SAR (see below).

Hong Kong SAR: limited activity but retail bans possible

Hong Kong SAR is still some way behind other jurisdictions in Asia like Singapore, the Philippines and Indonesia that have regulated virtual assets as a distinct asset class. This is currently under consideration to ensure Hong Kong SAR meets FATF Recommendations, but it’s likely that any changes are still several months away (read our summary of the 2021 proposals of the Financial Services and Treasury Bureau).

This means that advertising requirements currently depend on whether some other regulated offer or activity is involved (such as to trigger existing financial services or other laws). Besides that, general principles relating to advertising apply.

However, the regulator most active in the sector, the Securities and Futures Commission (SFC), has for many years responded to complaints and proactively reviewed the status of unregulated market participants perceived to be operating in Hong Kong SAR or targeting Hong Kong SAR persons. In many cases it is unable to take formal action for lack of jurisdictional or thematic nexus, but it maintains an “Alert List” and issues periodic warnings. For example, in July 2021, it published a circular relating to stock tokens offered by Binance (pulled from the Hong Kong SAR market) that recognised the limitations of its enforcement reach but still took the time to make clear that stock tokens were regulated under the securities regime.

Pending further reforms, the SFC’s focus is on its ability to control the activities of its licensed corporations in selling, managing and trading crypto assets. 

On 28 January 2022, it issued a joint statement with the Hong Kong SAR Monetary Authority with a number of further expectations, including that their respective regulated entities only partner with crypto firms licensed with the SFC (currently a very short list). 

The key message here is that regulators often need to work with what they have – especially when faced with a tidal wave of innovation.

Looking ahead, a key constraint that Hong Kong SAR may implement if the Hong Kong SAR Proposals proceed is a ban on retail – that is, only allowing professional investors to access the “virtual asset trading platforms” that it proposes to regulate, at least initially. Arguably, this might exacerbate risk if frustrated Hong Kong crypto enthusiasts head to unregulated offshore platforms that are readily available over the internet.

A balance may need to be struck.

The EU: proposed EU-wide crypto asset regulations

The European Commission aims to establish an EU-wide regulatory framework for crypto assets for both issuers and service providers.

The framework is detailed in the proposed “Regulation on Markets in Crypto-assets” (MiCA). Released in September 2020 as part of a package of measures to further enable and support the potential of digital finance in the EU (the Digital Finance package), the proposal is working its way through the legislative process.

Detailed regulations will cover the different aspects surrounding crypto assets, including consumer protection and marketing communications. For most crypto assets, the regulation is modelled after applicable rules for securities offerings, with more extensive regulations for asset-referenced and e-money tokens.

The US: bringing crypto into disparate existing regimes

In the US, regulators are trying to bring cryptos into existing regulatory regimes. 

At a federal level…

The securities regulatory regime applies to as many tokens as possible. The US Securities and Exchange Commission has provided very narrow exemptions/exclusions to crypto tokens from the regime, determining only a couple of widely circulated tokens as non-securities. For all other tokens, any offer, sale and dealing will have to comply with the applicable securities law.

This approach has also affected celebrity boosters, promoters and other third parties, via securities law concepts such as illegal offering, fraud and unlicensed intermediation in securities transactions. The SEC is quite proactive in pursuing influencers, including former professional boxer Floyd Mayweather and social media influencer Jay Mazini.

The Commodity Futures Trading Commission (CFTC) has pronounced all tokens are commodities. The position in and by itself does not trigger immediate CFTC regulation, as CFTC’s jurisdiction only extends to futures contracts, forward sales, leveraged retail-targeted sales and swaps on commodities. Spot sales on an unleveraged basis generally would not fall under CFTC’s regulatory regime.

The Office of the Comptroller of the Currency (OCC – the primary bank regulator) and other US federal banking regulators have dealt with cryptos from the angle that banks are most likely get involved in providing custody services for crypto assets. Overall, the banking regulators are guided by the “safe and sound” regulatory principle in crafting appropriate banking rules in regards cryptos.

At the state level…

Most states have tried to capture crypto business through respective money-transmission regulations, but there are exceptions. The state of New York, for example, has enacted laws specifically tailed to crypto business in its BitLicense regulation.

Yet not all agree with this traditionalist approach.

Dissent has arisen, mostly in Congress and among a minority of federal regulators.

•  Some members of Congress have proposed legislation designed to create a new and crypto-friendly separate regulatory regime.
• Among the regulators, SEC commissioner Pierce is a notable example. Pierce has proposed a generally less burdensome approach to crypto regulation, meant to help the new technology grow.

The path ahead

The path to a crypto regulatory framework is familiar: in the UK, other regulated businesses (for example, contracts for differences dealers and payday lenders) have encountered an escalating journey to increased regulatory oversight that kicked off with FCA scrutiny of financial promotions. 

The key goal in the UK is consumer protection, but businesses that can keep pace with regulations should have a competitive edge – both at home and abroad.

The surge in crypto use, especially in a heavily digitized Covid-era world, will drive governments and regulators around the world to bring them into traditional frameworks.

Against this backdrop, international harmonisation is growing, but disparities will remain – while some push ahead with highly favourable enabling frameworks (and even structures for decentralised autonomous organisations or DAOs), some like Chinese Mainland are pursuing heavily restricted strategies shutting out everything from mining to trading and even rendering transactions void and unenforceable in courts. Somewhere in the middle are more classic regulatory strategies of licensing, conduct rules, consumer protection standards and taxation. From recent news, this is also an approach that India appears to have chosen, turning away from an outright ban that was widely speculated.

Can we help you?

We are working with multiple clients on “squaring the circle” of creating global digital economy platforms, social media strategies and broadcasting arrangements that are compliant with regulation but also internationally competitive.

Please contact us anytime if we can assist you.
 

Thanks to Ariel Shi and Lucia Chen for assistance.

This insight is not intended to be legal advice.

Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China".