The declaration of a crypto asset as a financial product: how does it affect financial planners?

The buying and selling of crypto assets have become increasingly popular. Clients often ask their financial planners about investing in crypto assets, like Bitcoin, and many financial planners have advised their clients to invest in crypto assets.

Many clients and financial planners have been caught in the hype surrounding crypto assets, without truly understanding the nature and risks of these assets, which in many cases, resulted in capital losses for clients. In consumer research conducted by the United Kingdom’s Financial Conduct Authority in 2021, it was found that even though 78% of UK adults had heard of cryptocurrencies (increasing from 42% in 2019), there is a decline in the understanding of cryptocurrencies, suggesting a risk of consumers engaging with cryptocurrency without a clear understanding of it. With the continuous emergence of new crypto and digital assets, it is difficult for anyone to keep track of, up to date with, and always fully understand, these assets, much less clients who may not be financially or tech savvy.

In the past, National Treasury and the financial sector regulators have issued several communications to alert consumers about the risks involved in transacting and investing in crypto assets.

The absence of a regulatory framework to regulate the rendering of financial services in respect of crypto assets, has left clients vulnerable to poor or incorrect financial advice. It has also resulted in a significant increase in crime involving crypto assets. It is estimated that scammers stole $14 billion in crypto assets in 2021.

Financial services before the declaration of a crypto asset as a financial product

The FAIS Act defines a financial services provider (FSP) as any person, who furnishes advice, renders an intermediary service, or do both. These activities are collectively referred to as ‘financial services’. A representative is employed or mandated by the FSP, to render financial services to clients on behalf of the FSP. 

The FAIS Act contains detailed definitions of advice and intermediary services. Both the definitions refer to activities that the FSP or representative undertakes in respect of a financial product. For example, advice is any recommendation, guidance, or proposal in respect of the investment into any financial product, and an intermediary service is an act, resulting in a client entering into a transaction with a product supplier. These are activities performed by many financial planners daily.  

Financial product is also defined in the FAIS Act, and it includes a wide range of security, instrument, and benefit types. It also includes other products similar in nature to those listed declared as financial products, products issued by foreign product suppliers, and combinations of the listed product types.

The reference to financial product in the definitions of advice and intermediary services, links financial products inextricably to the rendering of financial services. Though it must be noted that a recommendation, guidance, or proposal, in respect of a financial product, as described in the definitions, will still constitute advice under the FAIS Act, even if the advice does not result in a transaction, or name a specific product of a product supplier.

In other words (and very simplistically), the financial services rendered by an FSP, or a representative, will only be subject to the provisions of the FAIS Act, if it involves a product which has been included in the definition of financial product in the FAIS Act.

Bringing this back to crypto assets, crypto assets were previously not listed in the definition of financial product in the FAIS Act. Therefore, any financial services rendered relating thereto, were not regulated in terms of the FAIS Act.

That meant that a person who gave advice and rendered intermediary services in respect of crypto assets, was under no obligation to, amongst other requirements:

• be authorised as an FSP, or be appointed as a representative of an FSP;
• meet any of the compliance officer, financial accounting, or audit requirements prescribed in the FAIS Act;
• meet any fit and proper requirements applicable to FSPs and representatives;
• make any of the disclosures, manage any conflicts of interests, risks, advertising, and complaints, or comply with the provisions relating to the custody of financial products and funds, professional indemnity or fidelity insurance and guarantees, as prescribed in the FAIS General Code of Conduct;
• when giving advice, obtain information about the client’s needs and objectives, financial situation, risk profile, and financial product knowledge and experience, do a suitability analysis, or a record of advice, or, when replacing an existing product with a crypto asset, give the client a comparison between the replacement and terminated products.

This left the field wide open to all and sundry, whether competent and above board, or not, to ‘render financial services’ to the public in respect of crypto assets. Naturally, this left clients vulnerable to poor or incorrect financial advice, investing into high-risk products, possibly unsuitable for the clients, and scams, with none of the regulatory protection or recourse, afforded by the FAIS Act, against those persons, available to the clients. The only recourse clients possibly had, was contractual or delictual claims through expensive, drawn-out litigation or other court processes.

But it does not only affect clients, it also damages the financial services and planning industry’s reputation when clients suffer material losses or fall victim to scams, as a result of these unauthorised, unregulated, and sometimes incompetent persons’ actions.

Declaration of a crypto asset as a financial product

As the FSCA noted in the Policy Document Supporting the Declaration of a Crypto Asset as a Financial Product under the Financial Advisory and Intermediary Services Act, declaring crypto assets as a financial product under the FAIS Act, was a critical interim step towards protecting customers in the crypto asset environment, pending the conclusion of broader developments surrounding crypto assets through, for example, the Conduct of Financial Institutions (COFI) Bill.

Drafts of the COFI Bill, list the categories and subcategories of activities that will require licensing. It specifically references crypto assets in the descriptions of the activities of sales and execution, financial advice, investment management, general administration, and crypto asset custodial services. Once the COFI Bill has been enacted, the FAIS Act will be repealed, and crypto asset-related financial services will be addressed under the COFI Act.

However, in the interim, the declaration of a crypto asset as a financial product, under the definition of financial product in the FAIS Act, now brings financial services rendered in respect of crypto assets (subject to a few exemptions discussed below), within the scope of the FAIS Act and its subordinate legislation. This means that any person, including a financial planner, giving advice or rendering an intermediary service, in respect of crypto assets, unless specifically exempted, must be authorised as an FSP for crypto assets, or be appointed as a representative of an FSP in respect of crypto assets, and must comply with the requirements of the FAIS Act.

It is important to note that:

• crypto assets themselves are not being regulated, but rather the persons or entities that provide financial services in relation to such products; and
• FSPs providing financial services in relation to crypto asset derivatives, are already subject to the requirements of the FAIS Act and are not subject to the general exemption.

The declaration also brings complaints about financial services rendered in respect of crypto assets, within the jurisdiction of the Ombud for Financial Services Providers, and customers will now have recourse to the Ombud for their complaints against FSPs and representatives.

Even though some crypto asset service providers previously voluntarily complied with the Financial Intelligence Centre Act 38 of 2001, if they now fall within the scope of the FAIS Act as FSPs, they will be accountable institutions in terms of item 12 of Schedule 1 to the FIC Act, and therefore, must comply with the FIC Act and its subordinate legislation.

Exemptions

At the same time as publishing the declaration, the FSCA also published a general exemption. 

Persons, who as a regular business feature, rendered financial services in relation to crypto assets, at the time that the declaration took effect, may continue to do so, without contravening the FAIS Act, provided that they:

• submit a licence application between 1 June 2023 and 30 November 2023;
• immediately comply with the fit and proper requirements of honesty, integrity and good standing;
• immediately comply with the general duty to, at all times, render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry;
• comply with the FAIS General Code of Conduct (excluding section 13) by 1 December 2023;
• provide the FSCA with any information that it requests. Accordingly, the FSCA issued FSCA Information Request 7 of 2022 (FAIS): Request for Information – Crypto Asset Related Activities Performed by Crypto Asset FSPs, requesting information. Responses are due by 15 February 2023.

Crypto asset miners, node operators, and persons rendering financial services in respect of non-fungible tokens, are exempt from the provisions of the FAIS Act.

The FSCA has also considered the extent to which the existing requirements in the FAIS Act, and its subordinate legislation, can be applied to FSPs rendering financial services in relation to crypto assets, and proposed, for public comment (which was due on 1 December 2022), the following:

• the FAIS Act will apply as is;
• except for a general exemption in respect of section 13 (guarantees, professional indemnity, or fidelity insurance cover), the FAIS General Code of Conduct will apply; and
• the fit and proper requirements will apply, except for a few exemptions (some of them temporary) in respect of the competency and continuous professional development requirements.

What does this mean for persons or FSPs who want to render financial services in respect of crypto assets?

Persons who are not currently authorised as FSPs will have to go through the full FSP application process. This includes appointing key individuals, compliance officers and accountants or auditors. Persons who are currently authorised as FSPs, but who want to add crypto assets as a product category to their licences, will follow the application process for adding new product categories to existing licences.

If you, your entity, or FSP, as a regular business feature, already rendered financial services in relation to crypto assets, on 19 October 2022, the exemption conditions discussed earlier, will apply, but some of the below might also apply to you.

Persons who plan to render financial services in relation to crypto assets, in future, should:

1. apply to the FSCA for authorisation for crypto assets. The FSCA will be updating application forms FSP2, 4C, 4D and 5, to provide for a crypto asset product category. The updated forms are not available yet;
2. while your application is in progress, be extremely careful not to render any financial services in respect of crypto assets, especially advice. Keep in mind that advice includes any recommendation, guidance, or proposal of a financial nature furnished, by any means or medium, to any client, in respect of the purchase, investment, variation, or termination of a financial product;
3. once authorisation for crypto assets is granted, ensure that crypto assets are added to FSP and representative appointment and disclosure documents, the representative register is updated, updated licences are displayed, and that applicable fit and proper requirements are met;
4. keep an eye out for the final exemption and further guidance with regards to the application of certain provisions of the FAIS Act, the General Code of Conduct, and fit and proper requirements;
5. draft or review existing FSP and representative policies, procedures, disclosures, template documents (e.g. records of advice), and client mandates or service level agreements, to provide for crypto assets;
6. draft or review the FSP’s business plan and governance framework, including its risk profile, register, appetite, and controls, to take into account any risk brought about by the rendering of financial services in respect of crypto assets;
7. draft or review the FSP’s Risk and Compliance Programme in terms of the FIC Act, to determine whether it requires amendment, and if not already registered, register as an accountable institution with the Financial Intelligence Centre;
8. engage with the FSP’s compliance officer for further advice and guidance, and monitoring feedback; and
9. ensure that all the FAIS Act and FIC Act requirements relating to crypto assets have been implemented.  

Lastly, if you as financial planner intend to render financial services in respect of crypto assets, ensure that you understand the product and its risks fully, and that you are able to explain it to the client, to enable the client to make an informed decision, whether to invest in crypto assets or not.  

Financial planners who would like understand these requirements in more detail, or need assistance with their applications or document drafting or reviews, are welcome to contact me at: HLombard@Luculent-Consulting.com

Available documents for further reading and more detail:

• FSCA Communication 30 of 2022: Publication of Declaration of a Crypto asset as a Financial Product and Accompanying Exemption Notices
• General Notice 1350 of 2022: Declaration of a Crypto Asset as a Financial Product under the FAIS Act
• Policy Document supporting the Declaration of Crypto Assets as a Financial Product under the FAIS Act
• Annexure A Response Matrix: Draft Declaration of a Crypto Asset as a Financial Product
• FSCA FAIS 90 of 2022: Exemption of Persons rendering Financial Services in relation to Crypto Assets from section 7(1) of the FAIS Act
• Notice regarding the Publication of the Draft Exemption of Persons rendering a Financial Service in relation to Crypto Assets from Certain Requirements, 2022