Estonia’s proposed new rules for companies trading virtual currencies
Here’s what has been proposed and why.
The Estonian Government has proposed new rules for Estonian companies involved in the trade of virtual currencies. That includes providers of a service for exchanging a virtual currency against a fiat currency and providers of a virtual currency wallet service.
The proposed changes are contained in a draft bill that would amend Estonia’s Money Laundering and Terrorist Financing Prevention Act to strengthen measures to protect the finance sector against risks of criminality.
The amendments would strengthen the supervisory powers of the Financial Intelligence Unit, an independent unit within the Estonian Police and Border Guard Board responsible for issuing and monitoring authorisations for companies operating in financial services, and also introduce additional rules for them to oversee regarding companies that trade in virtual currencies.
Most significantly for e-residents, this includes issuing authorisations for providing financial services only to companies that have a physical presence inside Estonia where they can be effectively monitored at the level that is appropriate for the industry. The amendments also include the provision that a person applying for the authorization has the necessary knowledge, abilities, experiences, education, and professional suitability, as well as an impeccable business reputation.
This is part of Estonia’s continuous commitment to protect its trusted business environment and prevent any possible threats for the legitimate entrepreneurs who use it — whether citizens, residents or e-residents — and also to support Estonia’s international obligations.
The bill is currently under consideration by the Riigikogu, Estonia’s Parliament, but the purpose of this article is to give e-residents a clear and comprehensive overview of what changes are being proposed and why.
Which companies are impacted by the proposed changes to the Money Laundering and Terrorist Financing Prevention Act?
Estonian companies need to apply for an authorisation or simply submit ‘a notice of economic activity’ if they offer certain products and services in certain industries. These controls are in place only where necessary to protect the required standards specific to that industry and ensure the smooth functioning of Estonia’s trusted business environment for all legitimate entrepreneurs.
However, most e-residents will have no need for either of these because they operate in fields that do not require these controls and Estonia is committed to keeping bureaucracy to an absolute minimum for all entrepreneurs. If, for example, you are a freelancer or digital nomad selling professional services online — like marketing or coding — then there is very rarely any need for an authorisation or notice of economic activity.
If you have any doubt then you should speak to your business services provider or check this list from Estonia’s Ministry of Economic Affairs and Communications about which industries may require an authorisation or notice. You can then read through the corresponding legislation on the link above to understand any additional responsibilities you may have. A list of e-Residency business services providers is available here.
For this article, we are just going to talk about one area on that list: ‘Financial services’, which require an authorisation as outlined in the corresponding legislation which is the Money Laundering and Terrorist Financing Prevention Act. More specifically, there are two areas of financial services affected by the changes, both of which relate to virtual currencies:
- Providing a virtual currency wallet service.
- Providing services of exchanging a virtual currency against a fiat currency.
This is fast evolving technology so the terminology can be a bit confusing and sometimes inconsistent, but a virtual currency is defined in law as a value that can be digitally transferred, stored or traded, and which traders accept among themselves as a medium of payment, even though it is not a legal tender of any country (which would instead be known as ‘fiat currency’). Bitcoin is the most well-known example of a virtual currency, although thousands more exist and many companies choose to create their own too. These are also often called ‘cryptocurrencies’ or ‘crypto tokens’.
The law covers both Estonian companies that offer a wallet or exchange for different types of virtual currencies created by others, as well as Estonian companies that issue their own virtual currencies for their own services (most commonly known through a process called an ‘Initial Coin Offering’ or ‘ICO’ although it is sometimes described in various other ways too.)
Last year alone, the Financial Intelligence Unit received 1,430 authorisation applications, of which 1,182 were related to the provision of virtual currencies and was split roughly evenly between the two types of services. This was a significant rise since previous years. After the applications were reviewed, approximately 95% were successfully granted.
There are now a total of 1513 companies that hold an authorisation from Estonia for the provision of services related to virtual currencies, of which around 6% were established by e-residents.
Non-Estonian companies are also able to apply for these activity licenses in Estonia, although this is not relevant for e-residents as the main benefit of the programme is to establish and manage an Estonian company.
To mitigate probable risks in the virtual currency sector, the Estonian Financial Intelligence Unit would be provided with enhanced powers of supervision and new rules, which would be continuously supervised by the Financial Action Task Force. The new rules would apply to all companies with the authorisation, including those that have already had it successfully granted.
What are the proposed changes for these companies?
The application process for an authorisation provides the Financial Intelligence Unit with the ability to assess the company’s capability to operate responsibly in their field while delivering their goals but also understanding and responding to potential risks. It also assesses the suitability and integrity of the management board itself.
This is not a one-off assessment during the application. The Financial Intelligence Unit also has the responsibility to continuously monitor companies that have been successfully granted the authorisation to ensure they are always in compliance and can revoke it when necessary.
The companies themselves also have an obligation to report in future any changes related to their application, such as a change of ownership or management board. This is why it is not advisable to attempt to bypass the authorisation application process by buying an existing company with a license. The same is true for bank accounts, which could also be revoked due to a change of ownership.
The enhanced rules would raise the standards even higher so that companies trading virtual currencies are brought into line with other financial services providers, including by ensuring that owners have an impeccable reputation. This may also mean that companies have to make appropriate improvements in a number of areas including their risk management systems, procedural rules, internal rules and potentially data protection procedures.
Most significantly for e-residents, the authorisation for all financial services including virtual currency services providers would only be issued to companies that are physically located in Estonia. This means that the company’s registered location, management board location and actual place of business must be in Estonia. Most e-residents use a ‘virtual office’, which does not require them physically to be in Estonia, but this would not be sufficient for operating financial services. The Financial Intelligence Unit would have the right to inspect the place of business if needed to confirm compliance.
In order to support these enhanced requirements, there would also be two main changes to the process of making a new application for an authorisation related to virtual currencies.
The state fee for the application would rise from €345 to €3,300 and the processing time would be lengthened from 30 days to three months which could be lengthened up to six months. This would provide the Financial Intelligence Unit with a significantly enhanced capability to assess the applications in greater detail.
This would only apply to new applicants for the authorisation, although the new requirements would still apply to everyone with the authorisation including those that have already had it issued to them. If the bill passes and becomes law, the draft proposes that companies would have until 31 December 2019 to provide evidence of their compliance with the new rules. This could include, for example, a lease for where the business activity takes place and documents with the updated internal rules.
What is the background to these changes?
The risk of money laundering and terrorist financing is an international challenge that requires countries to work together to detect and investigate money laundering, as well as to prevent it from occurring.
Estonia has consistently demonstrated and made clear that it considered this to be a high priority, both to protect itself and to honour international responsibilities.
The European Union has also taken this issue seriously, most notably in recent years by passing Directive 2018/843. This requires member states to improve co-operation between financial intelligence units, enhance transparency in business, improve checks on transactions involving high-risk countries outside the EU, and address risks that are linked to prepaid cards and virtual currencies.
The directive must be adapted into the national law of each member country by 2020.
It’s worth noting though that Estonia already performs very well in a number of these areas, which is why Estonia has been ranked as having the second lowest risk of money laundering in the world according to the latest Basel Anti-Money Laundering (AML) Index.
There are many factors involved in the design of a trusted business environment, but one key area to highlight is that Estonia has very high levels of transparency in business. Transparency is widely agreed to be one of the most important ways to combat these kinds of risks, which is why it is strongly emphasised in the EU Directive.
In Estonia’s business environment, for example, key details about all companies are publicly available, including ownership. Just as crucially, the reliability of that data is highly trusted too because Estonian company owners use their secure digital ID cards in order to confirm who they are when they operate in Estonia’s business environment, including to confirm their ownership or directorship of a company. The practice of employing a ‘shadow owner’ or ‘shadow director’ in order to conceal the beneficial owner is banned and this is thoroughly enforced.
E-Residency is also part of that system of trust, as well as being convenient for international entrepreneurs. To become an e-resident, entrepreneurs submit themselves to background checks with the Estonian Police and Border Guard Board before they are issued with a secure and trusted digital ID card to operate within Estonia’s digital infrastructure where compliance with Estonia’s business rules can be effectively monitored and their activities are highly transparent. This helps lower the risks of criminality and protects Estonia’s business environment for legitimate entrepreneurs — whether citizens, residents, or e-residents of Estonia around the world.
These issues were highlighted in more detail in the following opinion article published in the Estonian media recently.
None of this is a reason to be complacent though, of course.
You may be aware, for example, that Estonia has been in the headlines recently for serious cases of suspected money laundering involving bank accounts belonging to non-residents. This took place over a period of time that largely predates the e-Residency programme so the suspects are understood not to have been e-residents but also not to have been operating Estonian companies from abroad. It’s still an important reminder though of the threats that exist and are constantly evolving.
The Estonian government has made clear that it does not wish to stop virtual currency trading in Estonia but does intend to make the supervision more efficient in order to ensure that virtual currencies are not used for criminality.
The rise of virtual currencies has taken place at a rapid rate, as evidenced by the sharp rise in applications for the authorisations in Estonia, so the government believes that the rules must also be updated and that it is reasonable to consider their responsibilities as being equivalent to other providers of financial services.
How is the e-Residency programme affected by risks such as these?
The nature of Estonia’s business environment means that e-Residency is most popular with entrepreneurs who are unaffected by these changes, such as ‘digital nomads’, freelancers, and other small businesses selling mostly services online.
They value being able to establish a trusted company, which they can operate entirely online with minimal costs and hassle from anywhere in the world. For the vast majority of them, no authorisation is necessary.
The impact of anti-money laundering measures has already resulted in stricter rules for obtaining banking across the continent over a number of years. That’s why the e-Residency programme has been working to improve access to banking not by wanting to lower these requirements, but by opening up the market for services so there are a wider range of banking options provided by different providers that specialise in dealing with a wider range of risks for different types of companies.
Fortunately though, the groups that most benefit from e-Residency also have the lowest risk profiles for institutions that need to be concerned about the risks of criminality, such as banks. That’s because they are likely to market themselves and their business online or at least maintain an online public persona so it is relatively easy to match their financial activities with legitimate business activities. As a result, they are more likely to benefit from e-Residency in a number of ways, including by obtaining a business bank account.
That doesn’t mean that the e-Residency programme is restricted to those groups as many more people with different types of companies have found different ways to benefit from the programme. However, it has always been the case that some groups benefit more from e-Residency than others depending on their circumstances so it is the responsibility of each entrepreneur to choose their own best option globally for starting and managing a company. For many people, this would be through e-Residency, but certainly not everyone.
The impact of anti-money laundering measures is also the reason why the e-Residency programme does not recommend e-Residency to residents of countries that are labelled by the Financial Action Task Force as high-risk and non-cooperative.
The proposed changes indicate that it would not be possible to run a financial services provider, including one that is only involved with virtual currency, in an entirely location-independent way. The experience of many successful entrepreneurs in this field would seem to confirm this already, even before the law is changed, as some of them among the e-resident community have already physically located their companies to Estonia in order to develop the company.
As mentioned earlier, e-residents involved with companies licensed in Estonia to trade virtual currencies are a relatively small proportion of the e-resident community. Out of this group, it is not possible to assess at present how many will be affected by the new requirements and to what extent. However, some of them may now be considering whether to relocate to Estonia in order to continue building their companies through Estonia’s business environment or to transfer their business to a different country’s business environment.
In either case, we would always wish legitimate entrepreneurs the very best for their future and can provide guidance where possible. For example, Estonia has another government programme called Startup Estonia that helps entrepreneurs relocate here with their companies.