Background to the FCA prohibition on UK firms offering or selling crypto derivatives and cETNs

In January 2020, the FCA introduced a ban on UK firms offering or selling crypto derivatives and ETNs referencing certain types of cryptoassets to retail consumers.  ETNs are debt securities that track an underlying asset but are traded and settled through a central market entity such as an RIE.  The ban remains in place as part of the FCA’s Conduct of Business Sourcebook (COBS) rules and applies to any cETNs that are admitted to trading.  The FCA put the ban in place to ensure an appropriate degree of protection for consumers and to advance its objective of protecting and enhancing the integrity of the UK financial system.  The FCA had previously communicated that it would continue to keep its position on cETNs under review, noting the concerns outlined in the joint HM Treasury/FCA/Bank of England Cryptoassets Taskforce final report of October 2018 that the UK should continue to support innovation whilst maintaining safe and transparent financial markets.

The FCA’s statement on 11 March 2024 shows that the FCA is now softening its stance on exchanges and professional investors who wish to invest in cETNs.  Further to the FCA’s statement, the London Stock Exchange (LSEG) also announced on 11 March 2024 that it will accept applications from issuers to list notes that are linked to bitcoin and ethereum ETNs.  From as early as next month, LSEG will accept applications provided that the underlying cryptoassets must be held in ‘cold storage’ (i.e. an offline depository wallet) and held by custodians that are subject to AML regulation in the UK, EU or EEA, Jersey, Switzerland or the United States.  

Regulators in other major markets have become increasingly comfortable with ETNs being offered to investors for example Hong Kong also signalled that it will approve ETNs at the end of last year.  At the start of this year the US approved spot bitcoin ETFs following countries in the EU as well as in Australia and Canada. India has also announced that retail and institutional investors will gain access to popular US bitcoin ETFs. By contrast, the UK rules on the distribution of collective investment schemes and the Consumer Duty pose obstacles to the wider distribution of UK crypto ETFs to retail consumers. It is unlikely therefore that the less burdensome cETNs will pave the way for UK crypto ETFs to be distributed to retail investors as we have seen in other jurisdictions. 

Why has the FCA changed its stance on cETNs?

The FCA states that due to increased insight and data as a result of a longer period of trading history, the FCA believes exchanges and professional investors should now be better able to establish whether cETNs meet their risk appetite. Although the FCA is currently collaborating with government, international partners and industry to develop a UK cryptoasset regulatory regime, the FCA underlines that in its view cryptoassets are high risk and remain largely unregulated for the moment. Those that do invest should be prepared to lose all of their investment.

How will the FCA approach RIEs who want to list cETNs?

An RIE will need to create a new UK listed market segment for listing cETNs with appropriate safeguards to ensure that the market segment is accessible to professional investors only.  The FCA will consider applications on a case-by case basis for the Official List. The RIE will need to ensure that the issuance and admission to trading complies with the UK Listing Regime. 

In addition, as per the RIE Recognition Requirements FCA Sourcebook (REC): REC 2.6.1, UK trading venues must make sure sufficient controls are in place to ensure trading is conducted in an orderly manner and to afford proper protection to investors, this could be particularly relevant in this context given the price volatility of crypto-linked instruments.  In addition, as per retained Delegated Regulation (EU) 2017/584 supplementing the Markets in Financial Instruments Directive (Directive 2014/65/EU) (MiFID II) (RTS 7), trading venues must have appropriate mechanisms in place to manage volatility. Exchanges must also make sure that they fully understand the nature of the risks of admitting crypto-linked instruments to trading and are satisfied that their admission to trading criteria and trading controls will adequately mitigate those risks. For example, a UK RIE will need to make appropriate arrangements to ensure that relevant information for determining the current value of the specified instruments (i.e. the cETNs) is made available to persons dealing in the specified investments on the UK RIE pursuant to REC 2.12.1 and REC 2.12.2. 

Next steps – why does this matter and how can we help?

The FCA’s endorsement of cETNs appears to open the door for broader institutional adoption for cryptoassets outside of the derivatives product set on UK trading venues -  albeit the door remains firmly closed for cETNs to be distributed to retail investors.  It remains to be seen how popular the take up for cETNs will be in light of the FCA’s new approach. The LSE has signalled its enthusiasm for cETNs in moving quickly to state that it will accept applications from issuers to list notes that are linked to bitcoin and ethereum ETNs.