Cryptoasset derivatives trading has been steadily gaining popularity among investors worldwide. According to a calculation based on 42 cryptocurrency derivatives exchanges, the trading volume of the cryptocurrency derivatives market was $2.159 trillion in the second quarter of 2020. This represents a 2.57% increase from the previous quarter but a whopping year-on-year increase of 165.56%.
“Cryptoasset derivatives” are financial contracts that relate to the future value of an underlying cryptoasset or a collection of cryptoassets. The complexity and volatility of these financial instruments has led the UK’s Financial Conduct Authority (the FCA) to deem them inappropriate for retail consumers. As discussed in an earlier post on this blog, the FCA has previously consulted on a proposal to ban the sale, marketing and distribution to retail clients of derivatives and exchange traded notes (ETNs) that are based on unregulated transferable cryptoassets. The decision has now fallen and the ban will come into effect on 6 January 2021.
Why is the FCA intervening?
The FCA’s assessment is that cryptoasset derivatives are not suitable for retail consumers and, according to FCA estimates, consumers may save between approximately £19 million and £101 million a year as a result of this ban.
The ban is intended to protect consumers from the harm that these products may pose, e.g. financial loss from the difficulties of assessing the value of the product, market abuse and financial crime in the secondary market as well as substantial price volatility. The FCA also believes that retail consumers lack understanding of these assets and do not have a legitimate interest or investment need for them. This is due to the FCA’s finding that feedback from consumers suggests that such products are primarily used for speculative purposes.
Who is affected?
In short, retail investors. Essentially individuals who are not investing professionally and may not have the capacity to absorb the potential investment loss. Thus, firms will no longer be able to market, distribute or sell cryptocurrency derivatives in or from the UK to retail consumers. The ban will apply to UK firms, authorised branches of third country firms and EEA investment firms operating in the UK under a temporary permission after the Brexit transition period. Unauthorised third country firms are already prohibited from dealing in derivatives in the UK under the general prohibition in s19 of the Financial Services and Markets Act 2000.
The FCA’s ban would not, however, extend to UK retail clients that actively seek out the products from non-UK firms that do not actively sell cryptoasset derivatives in the UK (“reverse solicitation”). This limitation of the territorial application of the ban is one of the risks to the effectiveness of the new regime that the FCA acknowledges in its Policy Statement, noting that FCA’s supervision in the coming period will focus on any attempts by the firms to avoid the effect of the ban by “moving retail consumers to associated non-UK entities”.
The FCA is also committed to monitoring attempts to opt up consumers to elective professional clients, which do not enjoy the same consumer protection rules, in order to circumvent the ban.
Which products are affected?
The FCA’s ban covers derivatives (contracts for difference, options and futures) and ETNs related to unregulated transferable cryptoassets, i.e. cryptoassets which have the following features:
- they are capable of being traded through a platform or other forum;
- they are not limited to being transferred in exchange for a good or service, or to an operator of a network that facilitates its exchange for a good or service;
- they are not a representation of ownership or other property right in a commodity; and
- they are not money issued by a central bank, “specified investments” or e-money.
This definition would capture derivatives that refer to Bitcoin, Ethereum, Ripple and other exchange tokens, but will not extend to direct sales of cryptocurrencies to consumers and products based on security tokens or other cryptoassets such as central bank digital currencies and potentially stablecoins (as the later may be considered e-money (as discussed by the FCA)).