BetterNews #8: Updates On Money Laundering Regulations Toward The Cryptoeconomy

On June 21, 2019, the Financial Action Task Force (the FATF) published its long-awaited Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (the Guidance). The Guidance imposes anti-money laundering (AML) and counterterrorism financing (CFT) rules on activities related to Virtual Assets (VA), and Virtual Asset Service Providers (VASPs). The G20 Summit held in Osaka supported the FATF’s initiative.

The main purpose of the Guidance is setting the standards of AML/CFT compliance and approaches for the national regulators in FATF member states applicable to VA-related activities and cryptoeconomy in general. The FATF expects its members to implement the new rules within the next 12 months.

Definition of VA

Under the Guidance (and 2018 Amendments to FATF Recommendations) VAs are defined as a digital representation of value that can be digitally traded or transferred, and can be used for payment or investment purposes. Virtual assets do not include digital representations of fiat currencies, securities, and other financial assets that are already covered elsewhere in the FATF Recommendations.

According to the given definition, the Guidance applies in respect of cryptocurrencies (Bitcoin, Waves, XRP, etc.) but excludes so-called stablecoins and security tokens. However the definition is not limited to a digital representation of value associated only with the blockchain, so the scope of the Guidelines may get broader.

As it is seen, FATF does not stick to the general classification of tokens/virtual assets established in the different jurisdictions. In FATF’s view, such terms (as an example, FATF mentions utility tokens) do not have common understanding across jurisdictions or even in the industry.

Scope of the Guidance and VASPs

FATF Guidance expands the scope of AML/CFT rules to virtual-to-virtual transactions and crypto-related service providers such as custodians, exchanges, etc.

The Guidance defines VASPs as any natural or legal person who is not covered elsewhere under the FATF’s Recommendations and as a business conducts one or more of the following activities or operations for or on behalf of another natural or legal person:

• Exchange between virtual assets and fiat currencies;
• Exchange between one or more forms of virtual assets;
• Transfer of virtual assets;
• Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and
• Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.

In accordance with the Guidance VASPs are obliged to conduct an initial risk assessment in order to properly assess the risks associated with the VA activities and the VASPs’ products and services and mitigate them.

The Guidance contains the following examples of risk indicators:

• risks arising from the intersection of VA activities with the traditional financial system and the virtual system and with various jurisdictions;
• risks associated with centralized and decentralized business models;
• risks associated with anonymity-enhanced cryptocurrencies (“AECs”), “mixers or tumblers”, and other types of products and services that enable or allow for reduced transparency.

If VASPs cannot mitigate applicable risks then the FATF suggests refusing the listing of AECs.

The Guidance set the preventive measures that should be applied by VASPs including:

• Customer due diligence (subject to a threshold for occasional transactions of USD/EUR 1 000)
• Record-keeping (for at least five years), and
• Suspicious transaction reporting.

The Guidance also establishes “travel rule”: VASPs should not only keep records of users’ identities but also to share the required information regarding originators and beneficiaries (name, account/VA wallet number, address) with other VASPs when transferring virtual assets of more than USD/EUR 1000.

It is widely discussed that it will be difficult for VASPs to comply with the regulatory requirements generally applicable to traditional financial institutions. In order to comply with the Guidance and applicable (to be implemented) local legislation, VASPs will be required to transform existing infrastructure operating on a peer-to-peer basis. Blockchain-based transfers are facilitated by blockchain technology, which allows parties to transact with one another directly, without the intermediary. Moreover, blockchain’s ability to transfer additional information between VASPs might be limited. It might be easier to implement these requirements for centralized cryptoexchanges but for decentralized exchanges, it will be quite complicated.

Both VASPs (sender and recipient) must retain the required information and make it available to law enforcement authorities upon request.

Registration and Licensing

The FATF sets up the requirement that all VASPs must be registered or licensed. Under the Guidance, it is expected that a VASP to be registered in the country where it was created (as a general rule, place of incorporation) or, in the case of a natural person, in the jurisdiction where such person’s business is located. Other jurisdictions may adopt additional local licensing/registration requirements if a VASP makes its services available to residents of such jurisdiction.

Separate note: Canada

The Canadian Department of Finance published Regulations Amending Certain Regulations Made Under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, 2019 (the Regulation) applicable to dealers in virtual currency and foreign money services businesses (MSBs) offering their services to residents of Canada. The Regulation will be effective beginning June 1, 2020. The Regulation among others establishes a definition of virtual currency which is in line with the aforementioned Guidance. The interesting point that under the given definition virtual currency (amending term “funds” in the context of the Regulation) include among others a private key of a cryptographic system that enables a person or entity to have access to a fiat currency other than cash.