Considered in Grand Committee
My Lords, this Government have a clear vision for financial services—that is, for an open, sustainable and technologically advanced financial services sector that is globally competitive and acts in the interests of communities and citizens by creating jobs, supporting businesses and powering growth across all four nations of the UK. The two statutory instruments that we are debating today complement some of the measures that are being delivered through the Financial Services and Markets Bill, which is currently before this House. I note that both statutory instruments were raised as instruments of interest by the Secondary Legislation Scrutiny Committee.
I turn first to the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023. In recent years, multiple reports from the Cryptoasset Taskforce and the Financial Conduct Authority have identified that misleading advertising and a lack of suitable information are key consumer protection issues in crypto asset markets. This statutory instrument seeks to address those issues by ensuring that crypto asset promotions are held to the same standards as broader financial services products carrying similar risk.
To do this, the SI expands the scope of the financial promotion restriction provided by the Financial Services and Markets Act 2000 by amending the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 to include financial promotions in respect of in-scope crypto assets. This will mean that businesses that intend to make qualifying crypto asset promotions would need to have their promotions approved by an authorised person under the Financial Services and Markets Act if they are not FSMA-authorised persons or exempt.
At present, most crypto firms do not hold such FSMA authorisation in respect of their crypto activities under existing regulations, so the requirement to be authorised means that most crypto firms will not be able to communicate their own promotions, unlike other financial services firms. As set out in the February 2023 policy statement, there is also evidence of a lack of suitable FSMA-authorised persons in the market willing and able to approve crypto promotions.
In practice, the net effect of these issues would be to restrict significantly or amount to an effective ban on crypto asset financial promotions because there are unlikely to be FSMA-authorised persons willing to approve the promotions of unauthorised firms. To avoid the unintended consequence of an effective ban on crypto asset promotions, the SI introduces an exemption for crypto asset firms registered with the FCA under its anti-money laundering regime. This will enable qualifying firms to communicate their own crypto asset financial promotions without seeking approval from a FSMA-authorised person.
Crucially, the SI confers powers to the FCA to ensure that AML-registered crypto asset businesses relying on this exemption will still be subject to the same financial promotion rules as FSMA-authorised persons communicating equivalent promotions. Firms using this exemption will not be able to approve others’ financial promotions or to communicate their own financial promotions in relation to other controlled investments.
The Government intend this AML exemption to be temporary in nature. It will be in place only until the proposed broader regulatory regime for crypto assets is established. The Government are preparing to bring stablecoins used for payment into the scope of regulation and are also consulting further on their regulatory approach to unbacked crypto assets.
When in force, the SI and the FCA rules will apply to all businesses making crypto asset promotions to UK-based consumers, whether from the UK or abroad. The SI provides for a four-month implementation period, which will commence when this SI is made and on the publication of the FCA’s detailed rules subsequent to this SI. As set out in the policy statement published in February 2023, this period is intended to ensure that crypto asset firms have suitable time to understand and prepare for the financial promotions regime before it comes into force.
This SI will reduce a key risk to consumers, particularly that of consumers suffering unexpected or large losses without regulatory protection as a result of buying crypto asset products while being unaware of the associated risks. This complements and forms part of our wider, proportionate approach to regulation, harnessing the advantages of crypto technologies while mitigating the most significant risks.
Turning to the Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023, this second instrument reduces the burdens that firms face when determining their trading in commodity derivatives and emission allowances by requiring them to be authorised as an investment firm. Effective commodities markets regulation is key to ensuring that market speculation does not lead to economic harm. The regulator should be able effectively to regulate and supervise firms that trade commodity derivatives for investment purposes.
As well as financial services firms, a number of corporates trade on commodity markets to protect their business from market fluctuations. In regulation, this is referred to as trading that is ancillary to the main business. The regime that we have inherited from the EU uses something called the ancillary activities test to determine whether the activities of a firm trading commodity derivatives are primarily for investment purposes or only support the firm’s commercial business. The ancillary activities test currently requires firms to undertake complex calculations; they are also required to notify the FCA about the outcome of these calculations on an annual basis.
Taken together, this regime is overly burdensome for firms. Prior to the implementation of the ancillary activities test in EU law, the UK had a simpler test for determining whether firms were trading in commodity derivatives or emission allowances as an ancillary activity. This regime was cheaper for firms to comply with and resulted in the same outcomes as the current regime.
In 2021, as part of the wholesale markets review, the Government consulted on reverting to a simpler regime while maintaining the same regulatory outcomes. The proposal was to remove the annual notification requirement and revert to a principles-based approach. Respondents to the consultation agreed with the proposed changes, stating that the current regime was onerous and complicated. Consequently, the Government committed to bringing forward these changes when they responded to the consultation last year.
This SI delivers on that commitment by removing the annual notification requirement and omitting references to the calculations, which are no longer needed in legislation. This will pave the way for the Financial Conduct Authority to adopt a simpler and more streamlined approach to determining whether firms need to be authorised, alongside this SI. To reflect the FCA’s adoption of a simpler approach, this instrument also amends part of the regulated activities order, which exempts firms from having to perform the current calculations. As the FCA’s new approach will be based on different information, this exemption is no longer relevant.
The SI will come into force on 1 January 2025. This will ensure that industry has sufficient time to reflect on the changes that the FCA will be making and to make the necessary system changes. I understand that the FCA plans to consult on these changes later this year.
Maintaining the ancillary activities test as it currently stands would impose continuing costs on both firms and the FCA, as evidenced by feedback received through the consultation process. The changes outlined will reduce costs for firms and make the UK a more attractive place to do business, while maintaining high regulatory standards. I beg to move.
My Lords, we support both of these instruments, with some reservations and a few questions.
I will speak first to the commodity derivatives and emission allowances order. As the Minister said, it proposes a very sensible reduction to regulatory burdens. I note that the procedure followed in this case was a kind of super-affirmative, as prescribed in Schedule 8 to the European Union (Withdrawal) Act 2018. The instrument was published in draft to enable recommendations to be made by a committee of either House; no such recommendations were made but some questions nevertheless arise.
Perhaps the key question is when we will see the FCA’s new replacement regime, mentioned in paragraph 7.8 of the Explanatory Memorandum. Paragraph 10.2 of the EM notes that respondents to the consultation
“did not want to return to a wholly qualitative definition of ‘ancillary trading’”
“were in favour of the FCA developing a simplified method to determine when an activity is ancillary”—
one that would give them the legal certainty that qualitative definitions would not. I think this means that, until January 2025, when the SI comes into force, the current rules continue to apply. If that is the case, and if the current regulatory burden is so obviously unnecessary, why do we have to wait so long for the new regime?
The EM also notes:
“HMT is committed … to ensuring that the FCA has the right powers to set any transitional provisions that may be necessary to deal with the situation in which a firm’s trading activity can no longer be regarded as ancillary”.
I take this to mean that the FCA does not currently have these powers. If that is the case, perhaps the Minister can say why the usual transitional powers article was not included in this SI.
I now turn to the financial promotion SI. I agree that that it is vital both to increase consumers’ understanding of the risks associated with crypto assets and to ensure that the promotion of these assets is subject to the same standard of regulation as is the case for broader financial services; I welcome the proposed order. I am glad to see that the proposed implementation period has been reduced from six months to four months but I wonder whether this is still too long and invites an avalanche of unregulated promotion in those four months. Can the Minister explain why the four-month period was chosen and say what consideration was given to a shorter period? I would also be grateful for more explanation of the exemption mentioned in paragraph 6.4 of the EM— specifically why it is necessary and how long it will last—and for an assurance that it does not create any unhelpful loopholes.
Paragraph 7.8 of the EM notes that the Government are
“preparing to bring stablecoins with propensity to be used for payment into the scope of regulation and is also consulting on its future regulatory approach to unbacked cryptoassets”,
as the Minister pointed out. We welcome this but we would be grateful for an assurance that this current SI does not extend the reach of the FSCS and that extension—or not—of this reach will be a major consideration in the future regulatory approach. It would be very helpful if the Minister could give the Committee some indication of the timescale involved in this future extension to the regulation of crypto assets. The potential for significant customer losses is obviously high and we see the need for urgency in bringing new regulations into force.
Paragraph 6.8 of the EM makes explicit that this current SI does not extend to non-fungible tokens. This seems a curious omission. Until very recently, the Treasury was enthusiastic about NFTs, going so far as to commission the Royal Mint to produce a collection of them. However, a couple of weeks ago, the Treasury publicly abandoned the scheme. The timing seems rather odd, coming as it does at a time of strong growth in NFTs worldwide and in the trading of NFTs. In February, the NFT sales volume was just over $2 billion, up 117% from January. In the UK, the NFT segment was projected to reach $85 million this year and to grow annually at around 20%, rising to $184 million in 2027 according to Statista data. Also according to Statista, we can expect the number of UK users to reach 340,000 at around the same time.
This is obviously a fast-growing and unregulated sector, full of perils for incautious or uninformed purchasers—perhaps especially for younger investors. Will the Minister urgently reconsider the inclusion of NFTs in the new financial promotions regime? It would be easy to do and would provide some protection before the sector becomes damagingly large.
Finally, I shall make a more general observation about consumer protection. The SI before us will regulate promotion but will not educate, inform or warn. The FCA website tries to do those things. I would be interested know what the traffic to those FCA website pages is and how it measures their effectiveness. When I looked at them, they seemed to me to be a little overcomplicated and perhaps rather difficult to understand. It would be better to be more direct and, more importantly, to have an effective outreach and education campaign that does not chiefly rely on visits to the regulator’s website. I am sure that the Minister has noticed that many tokens are obviously directed at young people, who are perhaps not the most natural or frequent visitors to the FCA’s site and are probably most at risk in making token purchases. I would be grateful for the Minister’s thoughts on the matter. Finally, I repeat that we support both the SIs we are discussing.
My Lords, I am going to talk to the crypto assets SI only. This is a vital SI at this point in time. I am delighted that the objectives are,
“improving consumers’ understanding of the risks associated … and ensuring that cryptoasset promotions are held to the same standards as for broader financial services”.
The taskforce reported way back in 2018 and, my goodness, the world has changed dramatically since then. Paragraph 7.3 of the Explanatory Memorandum records what happened to the market a few months ago. Recent failures happened in November and, for all we know, there may be some just around the corner.
My noble friend and those who decide these things are absolutely right that the FCA should now be involved. However, I, too, question whether the four-month gap after the SI is passed is really necessary. In today’s modern world, I would have thought three months would be the absolute maximum—if even that long is needed. We also know, as highlighted in paragraph 10.3, that since the publication of this SI, the Government have recognised
“that risks to consumers have increased”
and they are still increasing.
I am no longer involved in the world of advertising and promotion, but I was in a previous incarnation. People are extraordinarily creative when it comes to financial promotion. Direct mail, in all its varying forms, and telephonic communications, in all their current sophisticated manners, are a very difficult area to control and to have a regime for. Therefore, His Majesty’s Government must look at this very carefully, take the best advice of those doing the communicating—I hope my noble friend has access to the genuine people who are communicating—and look at what developments are happening in communication. In paragraph 13.4 the Government quite rightly say that they do
“not have an estimate of the number of small or micro businesses in the UK that are liable to be affected by this measure”.
I know from experience that number is growing. Therefore, this is needed urgently. Again, I emphasise that four months is a little too generous.
Finally, I see in paragraph 14.3 that the Minister with responsibility for small business, enterprise and employment has claimed that this SI does not need a review clause. If there is a market that really needs a review clause, this one is a wonderful case history. I cannot believe that we really believe that. It is up to His Majesty’s Government to decide at what stage there should be a review, which is entirely right, but this is a market that needs to be kept in total focus, otherwise things will go wrong again.
My Lords, I am grateful to the Minister for introducing these orders. Let me also express thanks to the Secondary Legislation Scrutiny Committee for flagging the orders as instruments of interest in its 36th report of the Session. As the Minister outlined, the first order brings crypto assets into the regulatory regime for financial promotions. This is not the first time we have debated the risks associated with crypto assets, and I doubt it will be the last.
As the Explanatory Memorandum notes, crypto assets have been subject to severe market instability in recent years. Some assets have seen significant reductions in their value, and we have also witnessed the failure of several high-profile firms, including the bankruptcy of FTX late last year. With that instability in mind, we welcome any steps to reduce the risk posed to consumers, particularly through the misleading advertising which seems to have become commonplace as crypto popularity has soared.
However, this order is only one piece in an increasingly complex regulatory puzzle, with supplementary steps being taken through other vehicles, including the ongoing Financial Services and Markets Bill. I hope the Minister can provide assurance that the Treasury and the regulators are moving as quickly as they can in this area. Financial regulation is iterative and new measures need to be properly consulted on, but the Minister will understand concerns that remaining regulatory gaps will continue to be exploited. The implementation period for this measure has been shortened, which appears to be a sensible step. Can the Minister comment on the likely implementation period for related future measures?
The Explanatory Memorandum helpfully explains the exemptions granted to UK-based businesses on the FCA’s anti-money laundering register. However, the SLSC’s comments on the exemption raise an important question: if it is intended to be temporary, why has no end date been specified? I appreciate that this order is part of a bigger package but, in the interests of good legislating, can the Minister identify at what point a review of the exemption is likely to be carried out?
Finally on this topic, the Minister will be familiar with the suggestion that the Government regulate stablecoins in a similar way to bank deposits—that is, protect funds under the Financial Services Compensation Scheme. What consideration, if any, is the Treasury giving to that proposal? If the Government do not plan to take that approach, how will the Treasury and the FCA ensure that consumers are aware that their stablecoins holdings are not protected?
The second order relates to commodity derivatives and emission allowances, specifically when relevant firms will need to be authorised as investment firms. The Explanatory Memorandum promises
“a simpler and therefore lower cost regime”,
with the EU-derived markets in financial legislation regulations rolled back in favour of a new principles-based approach, to be implemented by the FCA. Again, this is part of a broader reform package being undertaken by the Treasury, with part of that package contained in the Financial Services and Markets Bill.
We recognise that the current ancillary activities test is too complicated and burdensome. However, can the Minister outline the proposed timelines associated with these changes, with a particular focus on the FCA’s creation of the new regime? As with crypto assets and many other areas of financial regulation, the FCA is being left to do a lot of heavy lifting but questions remain as to whether current parliamentary oversight of the financial regulators is sufficient. I realise that there are ongoing discussions on this subject between the Minister and interested colleagues across the House, but does she feel that we are getting any closer to a satisfactory outcome? While the risks associated with changes to these elements of financial regulation might be low, that should be as much a judgment for legislators as it is for Ministers and regulators. I hope that we will be able to achieve consensus on that matter as the aforesaid Bill proceeds to Report.
We support the passage of these orders but, as I am sure the Minister will acknowledge, they do not offer the final word on either subject. These are small pieces of a much bigger, more complicated puzzle. I hope that she will be able to speak to that bigger picture in her response and provide both answers and reassurance around some of the issues raised in this debate.
My Lords, I thank noble Lords for participating in today’s debate. I turn first to the changes to the financial promotions regime in respect of crypto assets. Several noble Lords asked about the exemption that applies to anti-money laundering regulated firms. I set out some of this in my opening speech but it is worth returning to it now. As set out in the policy statement published in February this year, the anti-money laundering exemption will exempt firms that are not FSMA-authorised but are included on the FCA’s anti-money laundering register from the requirement to have their crypto asset promotion approved by a FSMA-authorised firm. This is subject to said promotions also complying with the same rules set by the FCA for equivalent promotions made by FSMA-authorised firms. The purpose of the AML exemption is to avoid the unintended consequence of an effective ban on crypto asset financial promotions as there are not currently sufficient numbers of FSMA-authorised firms in the crypto space.
The decision to introduce the AML exemption reflects the FCA’s rigorous process of assessing crypto asset businesses for registration under the AML/CFT regulations, in line with the Financial Action Task Force’s agreed standards. The exemption is intended to be temporary, in that it will be in place only until the proposed broader regulatory regime for crypto assets is established. As noble Lords have noted, we are preparing to bring stablecoin used for payment into the scope of regulation; we are also consulting on our future regulatory approach to unbacked crypto assets. When in force, these regulatory regimes will enable more crypto asset firms to apply instead to become FSMA-authorised, removing the need for the AML exemption as, when FSMA-authorised, more firms could issue their own crypto promotions or approve suitable promotions for unauthorised firms. This approach balances enhancing consumer protection with continuing to promote responsible innovation.
To answer the noble Lord, Lord Tunnicliffe, on the temporary nature of this exemption, it is there until we have the broader regime in place for crypto asset regulation. When it will be replaced is not time-limited but policy-limited. The question of the noble Lord, Lord Sharkey, which I will address specifically, was perhaps on the most important point: does this create loopholes or a difference in treatment, apart from the fact that an AML authorisation can be used rather than a FSMA authorisation? We are clear that it will not and does not. It will apply the same standards to those promotions as would be expected without this exemption. That is very much the intention behind the policy.
I believe that both noble Lords asked about FSCS compensation in looking to extend the regime. They will know that this SI extends the scope of only the promotions regime. It would not be appropriate to extend the FSCS here, but the Government will continue to consider consumer protection measures as we develop a more comprehensive regime. On that regime, the Government have sought in our approach to crypto assets to look at the highest risk areas first and take swifter action in them, while also developing the more comprehensive approach that noble Lords can see in the consultation that is out at the moment on crypto assets. That is why we are tackling financial promotions in this SI, and why we have the provisions on stablecoins in the Financial Services and Markets Bill and the more comprehensive approach that we are also consulting on.
My noble friend Lord Naseby welcomed this change and asked what engagement we have had with industry. The Government and the FCA have engaged closely with industry throughout the policy development process. One outcome of this was that, in our 2022 consultation response, the Government announced a six-month transition period for the implementation of this regime. I think all noble Lords asked about the timelines for that. That six-month implementation period was introduced to allow industry suitable time to understand how the regime will be implemented practically and to prepare for it, with the aim of ensuring compliance across the industry.
However, we also recognise that crypto asset market instability continues to be a significant factor, underscoring the risk to consumers. We have seen that in recent market volatility, including the collapse of FTX. We have therefore reduced the implementation period to four months. We think that strikes the appropriate balance between providing industry with suitable time to prepare for compliance with the regime with ensuring that suitable consumer protections are in place.
The noble Lord, Lord Sharkey, asked about the extension of this regime to NFTs. A qualifying crypto asset is defined as
“any cryptographically secured digital representation of value or contractual rights”
which is fungible and transferable. For the purposes of this regime, the Government do not currently consider NFTs to be used primarily as investments, but we will continue to monitor the market when it comes to NFTs.
I turn to the SI on ancillary activities. There were a number of questions on the timing of this approach and how the FCA intends to take forward its rules under the SI. The Treasury consulted industry on the timeline, and we are keen to ensure that it has certainty about what the new regime will look like before making any changes to its internal systems. Delaying entry into force until 2025 is necessary to ensure that the FCA can consult this year on changes to the ancillary activities exemption and that industry can engage with this. then adapt its internal processes to take account of the future regime.
Although I accept the point made by the noble Lord, Lord Sharkey, about the burdens the current regime places on businesses, we have taken this approach in consultation with industry about the processes needed to transition to a new regime. The FCA has already been using its supervisory powers to waive the most bureaucratic requirements and therefore ease some of the burden. More broadly, the FCA already has the necessary powers to put in place the new regime. This SI paves the way for that by making consequential amendments to legislation for elements of the previous regime that were set out in legislation.
The noble Lord asked about the reference in the Explanatory Memorandum for the second order to
“transitional provisions that may be necessary to deal with the situation in which a firm’s trading activity can no longer be regarded as ancillary under the terms of the test”.
To explain what we mean by this, the regulated activities order included an exclusion that removed the need for firms to do the market threshold calculation, which formed part of the quantitative test, if there was no data available to perform that test. It also provided a firm with relief from the need to seek authorisation if it could meet the other components of the ancillary exemption. Feedback from firms suggests that this exemption gave them important legal certainty. This exclusion was based on EU data which is no longer produced and relates to the AAT, which is to be revoked. In any case, as we move towards a more proportionate approach, this exemption is no longer relevant. However, we want to ensure that the FCA can continue providing the legal certainty that firms need, and we are currently discussing this with the FCA.
On the question of how the FCA will carry out these changes more broadly, the FCA worked closely with what was then Her Majesty’s Treasury on the wholesale markets review in 2021, and has been involved in subsequent discussions about what the ancillary activities exemption and test will look like once changed. The FCA will take the outcome of the consultation and follow-up discussions into account when progressing its work on the ancillary activities test. It will also be required to consult on specific changes, following its normal processes. As the noble Lord, Lord Sharkey, noted, maintaining this obligation as it currently stands would impose continuing costs on firms and the FCA. Therefore, we hope that this work happens with sufficient pace, but we have also allowed sufficient time for firms to put in the arrangements that they need to.
A number of detailed questions were asked on both the SIs that we have discussed. I have endeavoured to answer most of them, but I will read Hansard back to see whether there are any that I have missed out.
In terms of setting these statutory instruments in the context of the Financial Services and Markets Bill, which is before the House, and our future financial regulation process, in some respects the noble Lord, Lord Sharkey, noted how this area is different because we are still operating under the previous provisions, so we have had the SIs—or at least one of them—out for consultation. However, it shows us how some of this regulation will be taken forward; we can reflect on that as we continue to reflect on the Financial Services and Markets Bill. I will continue to engage with all noble Lords as we move towards Report on that Bill.