Regulating financial DLT business is NOT ‘regulating cryptocurrency’ — an important distinction

Earlier this month the Government published the Financial Services (Distributed Ledger Technology Providers) Regulations 2017 (‘the Regulations’) to create the regulatory framework for DLT businesses in Gibraltar from 1 January 2018. Hot on the heels of that announcement the regulator has, very helpfully, proceeded to issue initial guidance on how it anticipates it will set out to give practical substance to the legal requirements contained in the Regulations. A number of key points have already emerged and what follows is a brief explanation of a number elements we consider important.

We are NOT regulating cryptocurrency

Regrettably there has been an element of misinformation emanating from industry circles that the publication of the Regulations was the first step towards regulation of virtual/cryptocurrencies. This is patently and, as explicitly communicated by the GFSC, NOT the case.

So what does it do?

The Regulations seek to regulate only entities “carrying on by way of business, in or from Gibraltar, the use of DLT for storing or transmitting value belonging to others.” Those involved in this activity who are doing it for their own personal benefit are not caught by the provisions. Equally, the Regulations are not designed nor do they capture investment advice activity in the crypto space nor does it capture advice on the launching of ICOs.

The DLT framework seeks to regulate financial DLT activity, not the technology itself.

If, for example, a regulated insurance company deploys an initiative to deliver certain products by means of smart contracts (say, flight delay insurance), the fact that DLT is deployed in this way does not mean the business will necessarily be caught by the new framework, given that, as an insurance company, it is already subject to extensive regulation.

At this stage, one key area of activity which is NOT captured by the new framework is the burgeoning Initial Token Offering (‘ITO’) activity, but read on for more on that.

Those businesses which fall within scope will be subject to a principles-based, outcomes-focused approach which the GFSC intends will be risk-based and proportionate. It is clear, as it will be to would be applicants, that the inherent flexibility of the system as designed should not be misinterpreted for a ‘soft’ or ‘light’ touch approach to regulating this business. The reality of the DLT space today is much like the internet was in the mid-nineties — Sian Jones illustrated the challenge for regulators around the world by suggesting that trying to write a manual for the internet in 1995 would have been a fool’s errand, as writing as manual for regulating financial DLT business would be today. By means of this flexible and responsive framework which has been specifically designed, it is hoped that the jurisdiction will be able to provide regulatory certainty and enhance consumer confidence in the space, always standing guard over Gibraltar’s reputation. Sian Jones explained that “Gibraltar succeeded in this in the gaming context — that’s our benchmark for the DLT space”.

As has been advanced now on a number of occasions, there are nine principles on which regulation of financial DLT business will be conducted. On the basis of those principles, the GFSC will issue Guidance Notes on how they see each of those principles can be met by licensees in the GFSC’s eyes — those guidance notes will be a ‘live document’, changing and adapting to developments in the industry. The GFSC will be appointing a Panel of Experts which will assist ensuring the ongoing relevance of the guidance notes.

So how will the process for applications work?

The whole process will, according to the GFSC, take 3 months and happen in 3 stages. A pre-application stage will see applicants engage a local adviser and enter into initial discussions about the scope of the project and the process involved with the GFSC. The second of three stages will see the GFSC assess the initial information it has available to it, based on which it will categorise the application based on a number of factors listed below and it will then notify the applicant of the categorisation. The third and final stage will consist of the full application being filed with the GFSC and a final determination being made by the regulator within two and a half months.

What determines the categorisation of my DLT business?

A variety of factors will be considered by the regulator in determining whether an activity is deemed a Category 1, 2 or 3, where 1 is the simplest and 3 is the most complex of activities.

The following list is non-exhaustive list which, itself, is/will be subject to periodic review:

  • The nature of the DLT and its maturity
  • The use of smart contracts
  • Whether client assets will be held or controlled
  • Types of customers
  • Number and variety of products and services
  • Interplay with other regulatory regimes
  • Investment related products or services
  • Outsourcing
  • Organisational Structure
  • Exposure/vulnerability to AML/CFT risks
  • Tried and tested
  • Scale and size

What will it cost?

All applicants will be required to make a £2,000 ‘down payment’ at the start of any interaction with the GFSC, a payment amount which will be deducted from the full final application fee as set out below:

For Category 1 firms the application fee is £10k, with the balance payable on filing of a full application £8,000. The annual fee for Category 1 firms is, as for the other two categories, the same as the application fee. For Category 2 firms the application fee is £20,000 and for Category 3, £30,000. The balance due on filing of a full application therefore for Category 2 and 3 licences is, respectively, £18,000 and £28,000.

And what of tokens?

The GFSC has announced that it is now actively looking at the Token Launch space and into how best we can, as a jurisdiction, strike the same balance that we are working to achieve in the wider DLT space by applying ourselves in a similar fashion to the token launch activity.

It is clear that is is just a matter of time before Initial Token Offering Regulations (‘ITOregs’) are published, although the GFSC, at this stage, is unable to say with any detail what those regulations will look like. The matters that it will be looking at in relation to ITOs is the promotion, sale and distribution of tokens as well as secondary market activities — aligning any ITOregs with the DLT Regulations and the principles which underpin them will be one of the key features.

“It is incumbent on advisers in this space”, Ms Jones continued, “in the time between now and when the regulatory framework for ITOs is settled, that we act as the guardians of Gibraltar’s reputation — to do that, advisers need to look at a number of various different issues: the accuracy/completeness of the information provided by clients; the risk disclosures made to consumers; the governance arrangements; the fitness and propriety of the founders/promoters; whether there’s a clear strategy that will follow a successful launch; the financial crime risks; and, of course, the reputational risks”

In conclusion

The GFSC has, this week, answered many questions in relation to the regime which we will be operating within from 1 January 2018. Many questions remain unanswered — indeed many questions are yet to be asked — such is the nature of the beast. As the jurisdiction continues to delve into and explore the space, as we grow in terms of the number of ICOs we conduct and the number of DLT entities we assist through the licensing process, so too will our command of all things DLT and, specifically, about DLT regulation.

The Author

Selwyn is the Head of Business Development at ISOLAS LLP. Selwyn forms part of the Fintech team at the firm and will be speaking at Coinagenda in Las Vegas, NV, next week. Contact him by email, on Twitter @selwynf and on LinkedIn