United Kingdom | Publication | December 2021
This is part 4 in the four part series.
This article was first published on Thomson Reuters Regulatory Intelligence on November 29, 2021.
The risk of crypto-assets being used to further criminal activity is well recognised and considered a priority by authorities and industry alike. Various efforts are underway in several jurisdictions to address these risks. These efforts are important, not only to combat financial crime, but also to support the safe development of fintech and regtech initiatives and innovation.
In this four-part series the authors look at different jurisdictions' approaches to anti-money laundering (AML) and counter-terrorist financing (CTF) in the crypto sector to include insights on a number of areas; these include:
The series is aimed at both financial institutions that are interested in the future development of crypto businesses, those aiming to operate a crypto business, and existing providers of crypto products and services to navigate and manage financial crime risks.
The crypto-asset sector has undergone exponential growth in the last few years, however it is still one of the fastest evolving financial services areas. With its many uses and ability to encourage out-of-the-box thinking, it is also one of the most controversial topics facing the financial services industry. For this sector to continue to evolve and ensure long term survival there is a requirement for some change and development. In this part, we discuss how the crypto-asset sector is driving the opportunities for change and the challenges that face its future landscape.
Since January 2020, firms carrying out specific crypto-asset activities in the UK need to comply with the amended Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) and register with the Financial Conduct Authority (FCA). The FCA carries out a deep due diligence process when assessing prospective firms seeking to register under the MLRs. As the sector evolves alongside technological advances, as will the regulation of the crypto-asset sector which is likely to expand, and with this, the challenge is to keep pace with legislative and regulatory changes.
There are a number of crypto-asset firms which remain outside the scope of the regulatory perimeter, but these firms would be well advised to keep themselves on top of regulatory developments and the general direction of travel within their specific areas since this may change.
Further, some other challenges include the ability for firms to adopt a coordinated and harmonised approach where they are operating in different jurisdictions, which is predominantly due to the disparate regulatory treatment of crypto-assets with some jurisdictions having higher or different standards than others.
In relation to opportunities, there are many which relate to the technology associated with crypto-assets. As explored by the Financial Action Task Force, crypto-asset technology can facilitate data collection, processing and analysis and help actors identify and manage money laundering / terrorist financing risks more effectively and closer to real time. Among other advantages, the sector could potentially offer faster payments and transactions, more accurate identification systems, monitoring, record keeping and information sharing between competent authorities and regulated entities.
At the national level, the new regime for German law-governed crypto-assets will be further extended. In June 2021, the German Electronic Securities Act (eWpG) fundamentally reformed the national securities legislation and introduced the option to issue bearer bonds in the form of "crypto securities" that are entered in a "crypto securities register" operated on the basis of the distributed ledger technology (DLT). Going forward, there will also be the option to issue units in investment funds in the form of "crypto fund units" entered in a "crypto securities register" based on a draft regulation (KryptoFAV). At a later stage, the scope of the eWpG will likely be further expanded to include, in particular, electronic shares.
At the European level, a proposal for a regulation on markets in crypto-assets (MiCA) intends to introduce a dedicated and harmonized framework for crypto-asset service providers in EU member states. If this proposal is agreed in trilogue it means that crypto currency exchanges (which the regulation calls "crypto asset services") have to comply with rules on consumer protection, transparency, and governance standards. In particular, there will be rules on consumer funds' protection against cyber-attacks, theft or malfunctions which are within the responsibility of the cryptocurrency exchange. The proposal is in the form of a Regulation which would mean that all rules would apply similarly in all EU member states.
Further, such service providers will also be affected by a package of legislative proposals presented by the European Commission in July 2021 that intend to strengthen the EU's AML and CTF rules. This package included measures such as a proposal for a revision of the Sixth Money Laundering Directive (AMLD6) or Funds Transfer Regulation to also include transfers of crypto-assets.
The Australian anti-money laundering regulator (AUSTRAC) has recently issued a statement highlighting the challenges digital currency exchanges are facing due to being de-banked. This has arisen as digital currency exchanges are perceived to have a higher risk profile than other bank customers, which coupled with recent enforcement action by AUSTRAC against the banks, has made these institutions more risk averse.
AUSTRAC notes that the effect of de-banking has the unintended consequence of penalising legitimate businesses. Furthermore, those that do engage in criminal activity go to underground payment methods, consequently compounding the problem.
Despite the above, there remains opportunities for innovators that adhere to their AML/CTF compliance obligations and work with other regulated entities. For example, financial institutions are beginning to consider offering customers the ability to buy, sell and hold crypto assets, directly through their systems.
The crypto landscape in Hong Kong is likely to undergo significant changes next year with the proposed introduction of a licensing regime for virtual asset exchanges. The proposed regime will restrict access to these platforms to professional investors only making it more difficult for retail customers to access the crypto markets. We note a number of exchanges have publicly indicated their intention to apply for the licence once the details are released. We also see a huge interest in the developing non-fungible tokens market in Hong Kong.
A significant challenge for crypto in the United States is that the regulatory landscape is uncertain or restrictive in many fundamental respects, including issuance, trading and custody. Moreover, the time needed to resolve the many fundamental regulatory issues as applied to crypto is likely to be measured in years and is also likely to result in a regulatory landscape that is closely aligned with a more traditional securities and commodities regulatory scheme. To the extent there is a silver lining in this regulatory uncertainty, it is that it encourages the involvement of small, more innovative firms that are willing to take on greater regulatory risk with the result that the crypto space is not yet dominated by a small number of large institutions.
In many jurisdictions there is a lot more to come for the crypto-asset sector, which poses both opportunities and challenges. Perhaps the greatest challenge is harmonising the regulatory environment and allowing firms sufficient freedom to innovate, particularly across borders, while maintaining sufficient standards so that consumers are able to use new systems and technology in a reliable and safe manner with confidence and transparency.
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