On October 6, 2020, the Financial Conduct Authority (‘FCA’) in the United Kingdom (‘UK’) published the final rules on banning the sale of derivatives and exchange-traded notes that reference certain types of cryptoassets to retail customers (officially under the PS20/10 Policy Statement and named as the Conduct of Business (Cryptoasset Product Instrument 2020) (‘banning rules’). The banning rules shall prohibit any sale of crypto-derivatives and exchange-traded notes that reference cryptoassets as an underlying value. The banning rules shall take effect from January 6, 2021. The main reason cited for the move of introducing the banning rules is that cryptoassets as an underlying asset do not have any dependable basis for valuation.
It shall be noted that the banning rules shall not affect a) security tokens; b) e-money tokens; c) tokens that have limited transferability; d) crypto-commodities or commodities which are recorded on the blockchain; and e) central bank digital currencies (‘CBDC’). The banning rules are strictly aimed at derivatives which have reference to unregulated cryptoassets.
The FCA had published a Consultation Paper- (CP)19/22 (‘ FCA Consultation’) in July 2019 for consulting on the formation of the banning rules. The banning rules are most likely to affect companies that are distributing, marketing, creating, products that refer to certain kinds of cryptoassets. The FCA Consultation outlined concerns around the volatility of cryptoassets and their non-reliability as underlying assets, which according to the FCA, will lead to potential harm to consumers of such derivative products having reference to cryptoassets. Firms carrying out the above-stated activities have been directed to cease them by January 6, 2021.
According to the FCA, even if the purview of the Fifth-Anti Money Laundering Directive (‘AML Directive’) is brought in the underlying cryptoassets, the AML Directive will not diminish the risks pertaining to abusive trading and cyber-theft of unregulated tokens.
The banning rules or the Conduct of Business (Cryptoasset Products) Instrument 2020 defines a cryptoasset derivative “as a derivative where the underlying is, or includes, an unregulated transferable cryptoasset or an index or derivative relating to an unregulated transferable cryptoasset”.
The introduction of the banning rules will indeed falter the growth of investments in the derivatives segment in the UK, especially given a time that the European Union is considering a wide regulation for the promotion of cryptoassets and stablecoins. Most consumers may choose to disinvest and shall be directing holding firms of crypto-derivatives and exchange-traded notes to close out such positions. The banning rules shall affect FCA regulated institutions, including banks, in the UK, and also any overseas firms which are headquartered in the UK. Moreover, the European Economic Area Firms, which shall be using the ‘temporary permission regime’ to continue providing financial services in the UK post-BREXIT shall also be affected by the banning rules. In this regard, there is a possibility that firms may consider moving crypto-derivative customers to non-UK established firms to continue services.
Authored by Shivani Agarwal, Founder, and Samaksh Khanna, Co-founder.
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