FCA Circles The Wagons Over Cryptoassets

Hot on the heels of the crackdown on advertising cryptoassets in the UK, the Financial Conduct Authority has also sent a notice to all the firms it supervises who 'interact' with cryptoassets or related services. There's nothing new here but a sense that the FCA has suddenly realised that the UK authorities are way behind the crypto-curve (particularly in light of recent sanctions), and there's a mad scramble to avoid another LC&F scandal - or worse.

The FCA expects firms to ensure that consumers understand what aspects of their services are regulated and clearly distinguish those elements which are not regulated. The firm is responsible for identifying and managing potential risks related to cryptoassets. 

There is a reminder that it is a criminal offence to provide cryptoasset exchange services or custodian wallet services by way of business in or from the UK without being registered with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (or have temporary permission to do so while your application is pending). 

All authorised and registered firms must have appropriate systems and controls to counter the risk of being misused for financial crime, so firms should be reviewing whether cryptoasset businesses they interact with are listed on the FCA’s Unregistered Cryptoasset Businesses page, for example. 

The FCA's Dear CEO letter also remains relevant in terms of how to achieve best practice where clients and customers may be using cryptoassets, or where firms are providing services to customers offering cryptoassets. 

Firms should assess the risks posed by a customer whose wealth or funds derive from the sale of cryptoassets, or other cryptoasset related activities, using the same criteria that would be applied to other sources of wealth or funds (even if the evidence trail may be weaker). 

While there are no specific prudential (capital) treatments that explicitly mention cryptoassets, firms subject to the investment firm prudential regime (IFPR), have obligations (under MIFIDPRU 7) to assess and mitigate the potential for harm to clients, to the markets in which the firm operates and to itself, that could arise from all of their business - even if the activity is unregulated or carried out on a principal, agency some other basis. Assessing adequate financial resources should involve assessing and managing risks and exposures from cryptoassets and deducting from regulatory capital any cryptoasset that is accounted for as an intangible asset.  

All FCA regulated firms must observe the Principles for Business in the Handbook, and Principle 10 requires a firm to arrange adequate protection for clients’ assets. The FCA’s Client Assets Sourcebook (CASS) provides detailed rules for firms to follow when holding regulated assets in custody, as part of their investment business. Where cryptoassets are security tokens (and so count as specified investments), firms carrying out regulated activities involving custody of those cryptoassets are likely subject to CASS. 

The FCA will continue to monitor the use of cryptoassets in custody arrangements and act where appropriate.

 

ASA Goes Postal On Crypto

Just in case you thought the Advertising Standards Authority was on a frolic of its own when issuing its recent guidance on cryptoasset advertising, yesterday it went postal, literally, by issuing an Enforcement Notice to 50 advertisers whose advertisements it considers do not comply with specific rules in its Non-broadcast Code. Advertisers have until 2 May 2022 to rectify the problems, after which the ASA will commence targeted monitoring and potentially sanctions (including adverse publicity and referrals to Trading Standards for enforcement).

Unlimited fines, jail time and confiscation of assets as the proceeds of crime are all possible results of Trading Standards enforcement activity. 

It is also clear that the ASA is working closely with the Financial Conduct Authority in determining whether any financial regulations are being infringed, with similar potential consequences.

The ASA's Enforcement Notice includes more detailed guidance and illustrations of what is - and is not - acceptable by way of cryptoasset advertising. No need to recite that here.

Regardless of concerns from a policy or philosophical perspective, and any efforts to sway the approach to cryptoasset regulation being taken by the ASA, Treasury and/or FCA, anyone advertising cryptoassets in or from the UK should take care to heed the ASA guidance for now.

Are NFTs Really Non-Fungible?

This question has been bugging me for ages. It has nothing to do with whether the owner of an NFT has any right in a pre-existing/underlying image or asset to which the NFT is linked (the owner of the NFT does not (necessarily) have any rights in the underlying image/asset). My question relates to the token itself. There could be significant regulatory consequences if NFTs are not actually "non-fungible" since the UK Treasury, for example, has said that NFTs will not be subject to financial marketing restrictions.

TechnoLlama has pointed out that certain NFTs, such as profile picture (PFP) collectibles might not be protected by copyright. PFPs can be 'minted' with little human intervention beyond the creation of the very first stock character to which each newly minted NFT adds some 'unique' characteristic(s). The "consequence could be that if all of these thousands and thousands of profile pictures have no copyright, then anyone can do whatever they want with them." 

If an NFT is not protected by copyright so that anyone can mint the same image, then surely that NFT is fungible? I mean, if someone wants the image, they just mint it. They don't need the original token, right? And if I 'buy' that image, I might not care which of the many 'NFTs' that have been minted with that image is actually sent to me (maybe the lowest priced).

Similarly, as recently mentioned, ISDA has also considered the issue of fungibility in the context of voluntary carbon credits (which might themselves be tokenised into 'NFTs'). To aid liquidity, it is likely that two or more VCCs would be interchangeable for the purposes of satisfying VCC transfer obligations between traders, even if it was originally critical that the VCCs were uniquely generated in relation to different, specific projects/owners. In essence, the traders are likely only really interested in the fact that a VCC represents a tonne of CO2 reduced or removed (tCO2e). An airline might acquire VCCs generated from a forestry project to offset fuel emissions. Fungibility is therefore not a feature of the asset itself but a matter of context. As ISDA points out by way of example, banknotes are fungible to satisfy payment obligations, but are not fungible for tracing purposes (each note is serialized). Equally, therefore, a unique serial number does not preclude a VCC from being fungible. Accordingly, the issue is whether and in what circumstances different VCCs (or NFTs for that matter) will be treated as interchangeable.

In any event, if an NFT is not actually 'non-fungible' (e.g. by virtue of copyright or in some other context), the next question from a financial regulator's standpoint would be whether the token falls within either a regulated category of token, benefits from another express exemption or is still out of scope of regulation but for some other reason...

Can You Advertise CryptoCurrencies and Other Cryptoassets?

The UK's Advertising Standards Authority has just updated its guidance on advertisements for cryptoassets. I call it 'guidance' even though it claims to be 'advice' (but not 'legal advice' or binding on anyone). I have problems with it from a financial regulatory standpoint, but it's good to know that the ASA is watching the crypto advertising space more generally. Tougher rules on promoting or marketing certain 'qualifying cryptoassets' in the UK are also on the way. If you have concerns about the status of your cryptoasset or related advertising, please get in touch.

Are Cryptoassets Regulated?

On this question, the ASA's guidance functions more as a plea for directly regulating cryptoassets (as is slowly happening) than a reliable guide to whether cryptoassets or related activities may be regulated already, or what 'unregulated' really means. 

The ASA insists that "advertisers must clearly state that cryptoassets are not regulated by the FCA" and are not subject to protections afforded by either Financial Ombudsman Service or the Financial Services Compensation Scheme. 

It's all very well to say that 'cryptoassets' themselves are not regulated, but the real question is whether the cryptoasset could also be another type of instrument that is regulated.

I see new proposals for cryptoassets all the time which would be caught by existing regulation (and could yet be caught by new UK financial promotions rules and other regulation that is being consulted upon in the UK and the EU). 

Few people seem to be focusing on what 'fungible' really means in the context of allegedly 'Non-fungible' tokens (NFTs), for example. 

Equally, activities such as operating a cryptoasset exchange or custodian wallet are regulated and require the person or firm carrying on those activities to be registered (for anti-money laundering purposes), even if the cryptoassets being exchanged or safeguarded are not regulated instruments.

In this context, the ASA's statement that "The vast majority of cryptoassets, such as cryptocurrencies are not currently regulated by the Financial Conduct Authority (FCA)" implies that the thousands of cryptoassets and related activities have all been assessed and found not to be regulated by the FCA (or another country's regulator), and that is very doubtful indeed.

Ironically, it may therefore be misleading for an advertisement to state that a cryptoasset is "not regulated by the FCA" unless (at the very least) legal advice to that effect has been obtained. 

Other Reasons Why Ads For Cryptoassets Might be Banned by the ASA

Of course there are other ways that an advertisement for a cryptoasset can be problematic, and the ASA's guidance on that is more helpful. 

For instance, snowing consumers with jargon, concealing or trivialising the risks or tax implications will result in the ASA concluding that you're preying on consumers' inexperience or 'credulity' (gullibility). 

Missing key information and/or failing to explain that values can go down as well as up, or the basis used to calculate any projections/forecasts, will also mean your ad falls victim to the ASA rules, as will missing a statement that past performance is not a guide to a cryptoasset's future performance.

If you have concerns about the status of your cryptoasset or related advertising, please get in touch.

 

How To Fix The UK Card Acquiring Market for SMEs

The Payment Systems Regulator (PSR) is consulting on remedies to address its findings that the payment card acquiring market does not work well for merchants with turnover of up to £50m a year - by far the majority by number! Responses to the consultation are due on 6 April 2022. If my experience of working in the card acquiring market for several decades is anything to go by, the kind of remedies that the PSR is recommending seem likely to improve the experience of all participants...

Key Problems in the Card Acquiring Market 

The PSR identified three features of the acquiring market that restrict the ability and willingness of merchants to shop around for acquiring services and switch between card acquirers to get a better service at better prices: 

• Lack of published pricing for card-acquiring services: pricing structures and approaches also differ, making it hard to compare prices across independent sales organisations (ISOs), acquirers and ‘payment facilitators’ who gather together transactions from small merchants (those with the GBP equivalent of less than 1 million USD turnover each year).
  

• The indefinite duration of acquiring service contracts: there is no clear trigger for merchants to think about shopping around and switching. 
  

• Point of sale (POS) terminals and leases: terminals won’t work with a new card-acquirer, so need to be replaced; and there may be a charge for terminating an existing terminal lease (which spreads the cost of terminals over a period of up to 5 years while the related acquiring contract has a minimum term of 12 months). 

Remedies Being Considered 

To help resolve these problems, the PSR is considering four remedies in combination: 

• Summary information boxes 
• Boosting the use of digital comparison tools by merchants 
• Trigger messaging 
• Removing barriers to switching to that arise from POS terminals/leases.
  

The combination is important. Summary boxes may not work as expected, and transparency is more effective to aid shopping around and switching when combined with remedies that facilitate service comparison, personalised information on product use and trigger remedies. Price simplification may also be required if other remedies prove ineffective. 

To aid in the design of the remedies, the PSR is asking card acquirers to provide: 

• mock summary boxes and trigger warnings; 
• technical specifications for summary boxes, trigger warnings, the submission of data to DCTs and POS terminal portability; and 
• an explanation of system changes required. 

Summary information boxes 

Acquirers would have to provide standardised key facts information setting out key price and non-price features, both in bespoke format provided to each merchant, and in generic format which would be published more widely: 

• Bespoke individual summary: tailored information for each merchant about the pricing and other service information, with consumption data and information on options to migrate to other tariffs or how to switch acquirer.
  

• Generic summary: information for all customers and potential customers on acquirer websites to enable merchants to quickly assess pricing and service options across a range of acquirers. 

Boosting digital comparison tools (DCT) for merchants 

DCTs are simply online intermediary services used to compare and potentially to switch or purchase products from a range of providers. DCTs are not as well established in the acquiring market as they are in markets for consumer services such as loans, insurance and utilities. The PSR found that merchants tend to land on ISO ‘lead-generation’ web sites when looking for an acquirer. 

To work effectively, experience from consumer markets shows that DCTs for card acquiring should cover both pricing and non-price service elements of card-acquiring services. This would involve: 

1. acquirers publishing and updating their pricing and other service data regularly in formats which are consistent and easily usable, so DCTs could collate comparative pricing and other service data; and 
2. merchants being able to share their acquirer transaction data, so that DCTs and other third parties could: 

• determine the key service parameters, such as brand and category of card, types of transaction (e.g. card-present/not-present, MOTO), frequency of each transaction type; and 
• use the merchant’s specific transaction data to calculate whether the merchant would be better off with a different acquirer. 

It would also likely improve merchant trust in DCTs if the PSR were to audit DCTs’ comparison methodologies and tools (as Ofcom does, for example). The PSR plans a feasibility study in this respect. 

Trigger messages 

A ‘trigger message’ would be a standardised message sent by acquirers to merchants ahead of say, the expiry of the initial contract term, to prompt a search of the market and switching. 

 The PSR is considering fixed term contracts, so that the expiry acts as a trigger for comparing switching options; but also trigger messages such as a cheaper tariff becoming available. 

Information items in the messages could include how much the contract price has increased, how much would be saved by switching to the lowest tariff and how to switch to new POS terminals. 

The PSR also notes that the FCA’s work on current account and home insurance switching suggests that SMEs will respond better to personalised information on the financial impact of switching, as well as non-price benefits. Ofcom’s experience also suggests that such messages should be kept short and simple, action focussed, personalised, designed to remind customers and give them a deadline, designed to help customers plan, and be tested with a target audience. Visual presentation of information was helpful where complete, precise, specific and jargon free. 

Trigger information is best presented when customers log-in to their account, whereas calls and text messages are not as effective for communicating this type of information.

POS Terminals as Technical Barriers to Switching Acquirers 

Point of Sale (POS) terminals are the devices used by merchants to capture card details from customers when a transaction is made. 

POS terminals may be offered by or through an acquirer or separately by an ISO, but they typically operate with only one acquirer. So a merchant wishing to switch acquirer will also need to terminate both the ‘merchant service’ contract for card-acquiring as well as a lease for their POS terminal. But card-acquiring contracts are usually for a term of 12 months while POS terminal leases last up to five years and renew automatically for up to 18 months, and may involve termination charges. 

In addition, merchants and their staff may be used to a certain POS terminal, so may be reluctant to switch to a different unit offered by a different acquirer. 

The PSR is looking at both the contractual and technical barriers to switching POS terminals and contracts, but has a preference for removing technical barriers first. 

The technical barriers include physical reconfiguration that may be required to make a POS terminal work with a new acquirer’s systems; certification required by each new card-acquirer and for each payment scheme; and the fact that the new acquirer’s terminal manager may not support terminals from a previous acquirer (changing terminal manager will require unlocking and resetting cryptographic keys). 

Technical remedies could involve requiring a new acquirer to replace the merchant’s POS terminals, but the PSR would prefer to focus initially on trying to ensure that POS terminals are portable between acquirers. 

Conclusion

Merchants don't need to wait for the PSR remedies to switch acquirers, but the problems and remedies do show the kind of effort required to search for the right acquiring service and organise a switch. I've advised merchants of all sizes and card acquirers, ISOs and payment facilitators. Even large merchants struggle with the challenge of switching, and they retain experienced consultants to help determine the service/features required; the most efficient way to meet those needs; and to evaluate which acquirers can genuinely deliver and at what price. 

But that process is time-consuming and frustrating for acquirers as well. And even at the smaller end of the market there is plenty of scope for both the merchant and the acquirer to misunderstand the merchant's requirements and the acquirer's ability to deliver.

The kind of remedies that the PSR is recommending therefore seem likely to improve the experience of acquirers, payment facilitators, ISOs and merchants alike.