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Financial Promotions: Zumo’s detailed review of FCA’s latest guidance

Financial Promotions: Zumo’s detailed review of FCA’s latest guidance
by Daniel Taylor August 2023

Zumo feeds back on new consumer-targeted rules governing the promotion of cryptoassets.

The financial promotions regime as extended to cryptoassets is a comprehensive package of measures designed to tighten up on the promotion of cryptoasset investment products to retail customers (the definition of which includes some businesses).

As we march to regulatory clarity, now from 8 October 2023, all firms marketing qualifying cryptoassets to UK consumers – including firms based overseas – will need to comply with the new rules via one of the four lawful routes.

Qualifying cryptoassets will be classified by the FCA as restricted mass market investments and firms will be obliged to embed risk warnings, personalised risk pop-ups, 24-hour cooling off periods, client categorisation, appropriateness assessments and financial promotions due diligence into their consumer journey and ongoing compliance processes.

Anyone found not to be in compliance could face two years’ imprisonment, unlimited fines, or both.

From the outset, Zumo has taken a strict compliance-first approach to its business, positioning Zumo in a uniquely to help Fintechs and other cryptoasset firms in the UK to roll out compliant and sustainable digital asset proposition to their customers in the UK.

Informed by our own preparations for the implementation of the financial promotions regime for cryptoassets, below we summarise our response to the FCA’s guidance consultation on the implementation details of these new rules that focused on the ‘fair, clear and not misleading’ component as outlined in GC23/1. For further information, and help getting ready for financial promotion your own cryptoasset firm please get in touch.

Zumo’s executive summary on Financial Promotion consultation questions

  • We appreciate the guidance that has been provided by the FCA on the matter of financial promotions of cryptoassets.
  • We support the encouragement of considered, informed decision-making among consumers, and believe many of the information and risk disclosures suggested in these guidelines will work to help achieve this.
  • Our overall position remains that such efforts must keep the ‘balanced view’ as their unifying guiding principle, with guidelines that are developed to be appropriate and proportionate in their application.
  • Our responses are based around this position accordingly, with a note that, as the accompanying crypto legislative framework unfolds, active monitoring and updating of these guidelines with the consultation of industry will be paramount.

Understanding the context of cryptoasset financial promotions

  • We are in broad agreement with the context of the cryptoasset financial promotions regime.
  • However, we believe there is some confusion in the language around ‘qualifying cryptoassets’ and the extension of that term (paragraph 14) to ‘certain investment arrangements’ including cryptoasset staking, lending and borrowing.
  • Paragraph 15 suggests such investment services are qualifying cryptoassets subject to the financial promotions restriction; whereas paragraph 16 offers a potentially contradictory reading in the mention of collective investment schemes in the context of specified investments.
  • For the avoidance of doubt, we suggest a clearer communication would be to replace the descriptor ‘qualifying cryptoassets’ with ‘qualifying cryptoassets and cryptoasset investment services’ and include a specific clarification on the regulatory status of the cryptoasset staking, lending and borrowing models (and any intended others) mentioned in paragraph 14 to make clear that these come under qualifying cryptoassets and not controlled investments (which we interpret to be the current intended meaning).
  • There may be multiple such ‘grey areas’ that arise over time in the inter-relationship between qualifying cryptoassets and specified investments – from an industry perspective, the ideal solution would be a maintained running list/simple diagram visualisation of what falls in or out of scope.

Setting the standard: fair, clear, and not misleading crypto promotions

  • We echo the view of industry bodies that worked examples of good practice would be useful to understand the new guidelines and what is considered appropriate and proportionate in terms of reasonable effort endeavour.
  • Given the diversity of qualifying cryptoassets and their different risk profiles, history and extent of available information, this may require some segregation/additional guidance to recognise that investing, for instance, in Bitcoin is not the same as investing in the most obscure token – and, by the same coin, how this should be addressed in communication and promotion and the standards that are applied in individual cases.
  • While we remain very much in agreement with the ‘balanced view’ and ‘fair, clear and not misleading’ objectives put forward in ensuring the presentation of full and accurate information, there is a concern that this ‘balanced view’ language jars with the tone of the required risk warnings put forward in the surrounding consumer journey, which seems much more reflective of FCA’s stated view that ‘we continue to believe that cryptoassets are high-risk investments and that investors may lose all the money they invest’ and a cost-benefit analysis that is based around investor deterrence.
  • We therefore suggest that risk warnings could over time be adjusted on some sort of more nuanced ‘scale’ based on the assessed risk of a particular subset of cryptoasset and its evolving regulatory status, and would more generally expect a tempering of language and treatment as more regulation comes into effect and the asset class as a whole becomes further mainstreamed.
  • In our view, the emphasis should be placed more on comprehensive, accurate and good-quality information and less on deliberately leading the conclusions investors should draw from that information.

Dissecting stablecoins: promotions and fiat currency linkage

  • We strongly agree that care must be taken to communicate the backing mechanisms and risks of any ‘stablecoin’ cryptoasset.
  • We would however note that depegging events have occurred in the largest fiat-backed, crypto-reserved and algorithmic stablecoins alike, and therefore question the distinction of fiat-backed from crypto-reserved and algorithmic stablecoins in an implicit hierarchy.
  • Most specifically, we do not believe that crypto-reserved and algorithmic stablecoins should be treated in the same category (paragraph 39), algorithmic stablecoins in fact bearing much higher levels of risk (being generally entirely, or almost entirely, unbacked) than deliberately overcollateralised crypto-reserved versions.

Behind the token: financial promotions for commodity-backed cryptoassets

  • We agree with the guidance. Similarly to question 1, we believe specific supplementary guidance/diagram illustrations of which asset-referenced tokens represent specified investments would be helpful, especially in non-obvious cases, and would expect this to be an increasingly relevant concern as the range of (real-world) assets being ‘tokenised’ continues to grow.

Decoding complex yields: guidelines for their financial promotions

  • We agree with the guidance provided and have no further comment at this time beyond echoing the point made in Q1 that the guidance leaves ambiguity as to whether or not such arrangements are specified investments or not.

Crypto in the social sphere: guidance on promotions via social media

  • We agree, and welcome the additional social media guidance consultation published on 17 July 2023 to add further context to this element.
  • In particular, we agree with the extra detail and focus given in this consultation to influencers and social media promotion channels, which we agree is where a large portion of promotion is taking place.
  • We would note that the cryptoasset industry has the particular feature that cryptoassets as an investment or financial product may be easily issued and promoted by any individual or group of individuals anywhere in the world without the need for or dependency on any firm or asset issuer in the traditional sense.
  • As such, promotion is likely to be undertaken ‘on own initiative’ as much as it is to depend on an identifiable firm or entity and in our view, an approach that recognises this feature and focuses attention accordingly maximises its chances of minimising harm.

The pre-promotion checklist: due diligence in financial promotions

  • We consider there remains significant ambiguity in the guidance on due diligence.
  • In our view, it is unclear what constitutes appropriate endeavour and the exact obligations/standards to which firms will be held. This covers issues such as: the extent of legal/professional adviser opinion required for each individual asset and the cost burdens this will present; the format expected for reporting on technology and ESG features; the process for missing/unavailable information; and the fact that any cryptoasset may be linked to fraudulent activity.
  • What would be helpful to the industry would again be worked template examples for the varying types of cryptoasset and a clear checklist of the criteria and how they are enforced.
  • We also observe that the guidance is narrowly focused on promotion of a single cryptoasset, and wonder what the approach would be when promoting a platform or proposition that gives access to a range of cryptoassets.
  • We might imagine, for instance, a platform that gives access to cryptocurrencies of different mechanisms; stablecoins; governance/utility tokens; and tokenised real-word assets representing specified investments all in a single venue. These require their own tailored risk disclosures and it is unclear how they are to be addressed in aggregate.

Transparency in token ownership: disclosing legal and beneficial ownership

  • We strongly support disclosing legal and beneficial ownership of cryptoassets.
  • As well as the staking relationship specifically mentioned in paragraph 62, we consider it could be appropriate, from consumer perspective, to also refer specifically to custody arrangements, bearing in mind that high-profile platform failures such as Celsius or FTX revolved around the non-transparent ‘unsecured creditor’ relationship that occurred when customers placed assets onto custodial platforms.
  • For this to be satisfactorily addressed, the disclosure of legal beneficial ownership must be paired with trading venue regulation (as in progress through HMT) that provides concrete assurances and safeguards for investors on regulated platforms in the event of platform failure.
  • The situation to be avoided is disclosures and warnings that come without any investor protection or guarantees. This is particularly the case given that, with a few notable exceptions, headline consumer losses in cryptoassets have resulted from platform shortcomings, not risks inherent to the cryptoassets themselves.

Regulated status disclosure: how firms should communicate their standing

  • We agree in principle, though noting the limited shelf-life of the current guidelines given the proposed phasing out of the MLRs registration pathway under the future financial services regulatory regime for cryptoassets.
  • In this regard, we consider there may be particular challenges arising out of the phased approach of the proposed regulatory regime, where at particular points in time certain activities may be regulated and some may not, and likewise some cryptoassets may be regulated and some not. During this transitional period, it will be difficult to communicate these nuances to the customer with any consistency of experience, and additional guidance will likely be warranted.

Expanding the horizon: potential additions to the financial promotion guidance

  • Given our responses above, we believe it would be useful to add a more comprehensive section outlining the formal process for review and updating of these guidelines, the intended alignment of financial promotions with other ongoing regulatory initiatives, and how any changes will be consulted upon.