Financial crime outlook: The expansion of virtual currencies

Introduction

Senior management and boards are increasingly acknowledging the threat of financial crime as a critical risk to their business that must be addressed. This has been exacerbated in the last 12 months through the impact of the pandemic as well as rising domestic and international tensions. Our financial crime compliance practitioners, located in the UK, US, Canada, Australia and Asia, are looking ahead to 2021 to identify the incoming legislative changes, growing role of technology and the need for an effective regulatory response. This forms part of a seven-part series which will assess, among other things, the expansion of virtual currencies, the growth of the role of the money laundering reporting officer, the changing world of sanctions regimes and how the Biden Presidency could shape financial crime compliance into the future.

Part 3: The expansion of virtual currencies: Are virtual assets businesses ready for regulators?

As prices of Bitcoin and rival virtual currencies have soared to unprecedented levels, there has been a recent flurry of activity in the crypto and virtual assets space, triggering extensive news coverage and renewed public interest. This has caught the attention of regulators and other stakeholders.

Regulators across the globe, together with major inter-governmental bodies, have taken significant steps towards understanding the virtual asset market and, in particular, the associated financial crime risks. Since 2014, the Financial Action Task Force (FATF), an intergovernmental organization which set international standards for anti-money laundering and counter-terrorist financing (AML/CTF), has published reports as well as guidance on ML/TF risks and red flag indicators for identifying suspicious ML/TF activity in connection with virtual assets service providers (VASPs) and setting the minimum AML/CTF standards for the sector. Recently, FATF issued a similar report which allows affected stakeholders to use certain proposed red flag indicators of ML/TF activities, which are based on the FATF’s analysis of over 100 case studies from 2017 to 2020, as guardrails against the criminal use of virtual assets (please see here for our discussion of the report).

Furthermore, the EU’s Fifth Money Laundering Directive (5MLD) which came into force across the EU on January 10, 2020, brought various types of VASPs into AML regulatory scope, signifying a major step towards closer and more targeted supervision of this sector. What soon followed was a series of announcements to further tighten the regulatory grip, including to bring VASPs within the scope of Market Abuse Regulation or to categorize certain more types of virtual assets as financial instruments. At the same time, the use and types of virtual assets are constantly evolving, making it a challenge to adequately define and regulate this space without unintentionally hampering growth and innovation. In the UK, the AML supervisor for cryptoasset businesses, the Financial Conduct Authority (FCA), has extended the deadline under which existing cryptoasset firms require registration for AML supervision purposes. This was due to the challenges associated with understanding and thus adequately reviewing the applicant VASPs’ business activities as part of the registration process (please view our blog here).

On the other side of the globe, the Department of Finance in Canada recently released the final amending regulations that amend the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and certain regulations. The amendments introduce certain sweeping changes to the regulatory compliance regime for VASPs in Canada. Among other things, the amendments extend the ‘travel rule’ (whereby certain reporting entities are required to pass on identifying information about a customer to the next reporting entity when sending money on the customer’s behalf) to virtual assets businesses in addition to various other changes to certain client on-boarding requirements (please see here for our more detailed discussion of the amendments).

In the US, Financial Crimes Enforcement Network (FinCEN), which is the US AML agency, at the end of last year published a proposal to impose requirements for banks and money services businesses (MSBs), related to certain transactions involving convertible virtual currency (CVC) or virtual assets with legal tender status (LTDA). Specifically, FinCEN proposed reporting requirements on CVC or LTDA transactions greater than $10,000, or aggregating to greater than $10,000, that involve unhosted wallets or wallets hosted in a jurisdiction identified by FinCEN. FinCEN also proposed that banks and MSBs report certain information regarding counterparties to transactions by their hosted wallet customers, and comply with recordkeeping requirements similar to the recordkeeping and travel rule regulations (similar to the Canadian “travel rule”) pertaining to funds transfers and transfers of funds. The comment period had closed in January but now has been extended until March 29, 2021. A copy of the proposed rule and additional information can be found here.

In summary, it is evident that, across the globe, there is a heightened scrutiny by AML/CTF regulators of VASPs. In our view, as the exponential growth of the virtual assets industry continues globally, AML/CTF regulators will be more proactive in seeking enforcement of the growing AML/CTF requirements and expectations, particularly for virtual assets and currencies. Invariably, this means that firms will need to exercise a greater deal of prudence and increase their efforts to remain compliant and keep pace with regulatory changes and expectations.