FATF guidelines: Cryptocurrency or virtual asset

While somebody calls it cryptocurrency or some other name, FATF, an independent inter- governmental body has given its guidelines-2021 and let us learn from the most

authoritative source some basics on virtual asset. No popular sentiments but bare and simple guidelines to all countries/jurisdictions. A separate article of mine published earlier in taxguru.in explains the function of FATF for those uninitiated.

Yes, I shall touch its effects on India on the later part.

111 pages report narrates the following parts which are good to learn for any investor who gets excited and invests huge sum on an uncertain and sloppy territory, so far untraveled by any civilized society. For those who ventured so far, uncertainty is the only real situation.

Part 1. Introduction

Part 2. Scope of FATF Standards

Part 3. Application of FATF standards to countries and competent authorities

Part 4. Application of FATF standards to VASPs and other obliged entities that engage in or provide covered VA activities

Part 5. Country examples of risk- based- approach to virtual assets and virtual asset providers.

Part 6. Principles of information sharing and co-operation among VASP supervisors. It is time to learn more guidance from FATF.

Let us clear our cobwebs on virtual asset, a much broader term than crypto currency and virtual asset service provider. A clear expression from FATF is a must.

“Virtual asset service provider” as any natural or legal person who is not covered elsewhere under the 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:

1. Exchange between virtual assets and fiat currencies.
2. Exchange between one or more forms of virtual assets.

• Transfer of virtual assets; and

1. Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets.
2. Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset

What is a virtual asset?

The definition of VA is meant to be interpreted broadly, with jurisdictions relying on the fundamental concepts contained in it to take a functional approach that can accommodate technological advancements and innovative business models.

In simple terms, both technological and innovative business models to define a virtual asset.

In line with the overall recommendations of the FATF, these definitions aim for technology neutrality. Just because some technology is used can’t entitle any special leverage.

Further, they should be applied based on the basic characteristics of the asset or the service, not the technology it employs.

Let us elaborate more.

Firstly, VAs must be digital and must themselves be digitally traded or transferred and be capable of being used for payment or investment purposes. So, no paper transaction.

Terms like traded or transferred as per FATF carries a broad definition of VA which can be applied in various types of activities like the issuance of an asset to another person, exchanging it for something else, transferring it to someone else or on behalf of someone else, changing its ownership, or destroying it.

VAs cannot be merely digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the FATF

In choosing the terms “traded” and “transferred” the FATF intentionally created a broad, general definition of VA, which covers a wide range of activities. This could include, for example, the issuance of an asset to another person, exchanging it for something else, transferring it to someone else or on behalf of someone else, changing its ownership, or destroying it.

VAs cannot be merely digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the FATF recommendations, without an inherent ability themselves to be digitally traded or transferred and the possibility to be used for payment or investment purposes.

For this reason, a bank record maintained in digital format, for instance, which represents a person’s ownership of fiat currency is not a VA. If it functions as a mere declarative record of ownership or positions in a financial asset that is already covered by the FATF Standards, it is not a VA.

However, a digital asset that is exchangeable for another asset, such as a stablecoin which is exchangeable for a fiat currency or a VA at a stable rate, could still qualify as a VA.

The relevant question is whether the VA which has inherent value to be traded or transferred and used for payment or investment is simply a means of recording or representing ownership of something else.

It is true that assets that do not qualify as VAs should not be presumed to fall outside the scope of the FATF Standards. Instead, they may fall under other kinds of financial assets, like securities, commodities, derivatives, or fiat currency.

The FATF does not intend for an asset to be both a VA and a financial asset at the same time.

Let me explain. Can “x asset” be both financial asset as well as a VA? It depends upon the decisions of the authorities in their jurisdictions whether to consider as financial asset or otherwise?

Let us assume whether their existing regime governing financial assets or their regime for VAs can be appropriately applied to the new digital assets in question.

For example, if the asset in question is the functional digital equivalent of cash, a bearer negotiable instrument (a simple check with the inscriptions “pay—– or bearer “notation) authorities should consider how the mitigation measures in the relevant regime would apply to it.

In instances where characterization proves difficult, jurisdictions should assess their

regulatory systems and decide which designation will best mitigate and manage the risk of the product or service.

Jurisdictions should also consider the commonly accepted usage of the asset (e.g., whether it is used for payment or investment purposes) and what type of regulatory regime offers the best acceptance?

Should a jurisdiction choose to define an asset as a financial asset as opposed to a VA, existing AML/CFT (AML – Anti-Money Laundering, CFT- Countering the Financing of Terrorism) standards for financial assets would apply.

In tune with the technology-neutral approach, a blockchain-based asset that is defined as a financial asset would likely not fall under this VA-focused Guidance.

This is because the technology used is not the deciding factor in determining which FATF Recommendations apply. Elements of this Guidance may, however, still prove helpful to

jurisdictions and the private sector and should supplement other existing guidance in the

context of the RBA. (RBA-Risk based approach)

Nonetheless, every asset for payment or investment purposes should use the obligations applicable either as a VA or another type of financial asset.

Can virtual asset be transferred and if so, what type of transaction it will be? Some information from FATF clears our inquisitive minds:

Yes, it can be transferred or issued using distributed ledger or block chain technology. Let us explain a bit more. Through an event commonly referred as an ICO, an issuer or promoter offers a digital asset for sale in exchange for fiat currency or another VA.

Through a white paper, one learns about it. Promoters may tell prospective purchasers that the capital raised from the sales will be used to fund development of a digital platform, software, or other projects and that, at some point, the digital asset may itself be used to access the platform, use the software, or otherwise participate in the project. Like you, I am happy to learn the details from the most reliable website.

(Discussion from page 39)

During the offering, issuers or promoters may lead purchasers of the digital asset to expect a return on their investment or to participate in a share of the returns provided by the project.

After they are issued, the digital assets may be resold to others in a secondary market (e.g., on digital asset trading platforms or through VASPs). Any country can consider the digital asset as a security too.

Now to the domain of the responsibility of nations or jurisdictions to act and if so, what are the broad guidelines.

Page 39 to offer some information on how the countries get guidance from FATF. A very important development and crystal-clear direction.

Section III explains how the FATF Recommendations relating to

VAs and VASPs apply to countries and competent authorities and focuses on identifying and mitigating the risks associated with covered VA activities, applying preventive measures,

applying licensing and registration requirements,

implementing effective supervision on par with the supervision of related financial activities of FIs,

providing a range of effective and dissuasive sanctions and facilitating national and international co-operation.

Let us view above with the decision of RBI not to give recognition to Bitcoin but introduce steps gradually regarding virtual assets.

I do expect the government’s action to introduce a bill titled “The cryptocurrency and Regulation of Official Digital Currency Bill, 2021 in the parliament in the winter session to update the sentiments of the investors and safeguard their interests.

Particular attention is needed regarding the essential understanding of stakeholders of the money laundering and terrorist financing (ML/TF) risks associated with VA activities and to take appropriate mitigating measures to address those risks.

Every country must assess their ML/TF risks and effectively take steps to mitigate these risks.

Let us also have a Question-and-answer types of situations visualized by FATF and how they may be mitigated by the countries.

1. What is the registration or licensing requirements, particularly, related to VASPs?

VASPs must be required to be registered/licensed in the country or jurisdiction of their operation where they are created. Alternately, they can’t operate without completing these legal steps.

2. The guidance provided clearly states that it is obligatory on the part of country’s

regulatory/government authorities to identify those VASPs who operate in their countries.

3. Who will undertake VASP’s supervision? Let us take even our nation where reportedly there is no supervision and still being a nascent investment/risky activity, virtual assets are still uncontrolled and unbridled.

4. In guidance released during October 2021, FATF was clearly emphatic on 6 key What are they?

It clearly covers the definitions of VA/VASP and leaves no financial asset uncovered.

Detailed guidance on how the FATF Standards apply to stablecoins and clarified that a range of entities involved in stablecoin arrangements do qualify as VASPs under the FATF Standards.

Extra attention has been paid to give e additional guidance on the risks and the tools available to countries to address the ML/TF risks for peer-to peer transactions, which are transactions that do not involve any obliged entities.

It updated its guidelines on licensing and registration requirements.

Additional guidance for the public and private sectors on the implementation of the ‘travel rule’ was initiated.

By incorporating Principles of Information-Sharing and Co-operation Amongst VASP Supervisors, it superseded the 2019 Guidance.

To understand live examples from various countries, part 5 gives ample information.

Now, country wise details are as under. (Pages 89-101 clarify the position: though, some

information is given below for ushering in some knowledge. I have tried to quote some direct information related to acts, notifications etc., to give credence to my write up)

Italy

In Italy, Legislative Decree No. 231 of 2007, amended by Legislative Decrees No. 90 of 2017 and No. 125/2019, includes providers engaged in the five functional activities as defined by the FATF, as recipients of AML/CFT obligations.

Service providers related to Vas must get listed in a special section of the register held by

“Organismo degli Agenti e dei Mediatori” (OAM) which is a precondition for service providers related to VAs in order to carry out their activity. Obviously, enough information is collected

regarding service providers.

Finland

The Act on Virtual Currency Providers (572/2019) came into force on May 1st, 2019. VASPs are required to register (authorization) with the Finnish Financial Supervisory Authority (FIN- FSA).

The definition of VASPs includes exchanges (both fiat to VAs and between VAs as well as VAs and other goods such as gold), custodian wallet providers, and issuers of virtual currency.

Mexico

In Mexico, Federal Law for the Prevention and Identification of Operations with Resources of Illegal Proceeds was reformed in March 2018 to establish as a Vulnerable Activity the exchange of VAs made by entities other than Financial Technology Institutions and Credit Institutions.

Norway

VASPs have been subject to the Norwegian AML Act and its obligations since October 15, 2018. The relevant provision of the AML regulation appears on 96 (last updated in May 2021

– unofficial translation).

Switzerland

Switzerland had a technology-neutral approach and applied the existing AML/CFT regulatory regime to VAs and the respective VASPs from an early stage in the development of VA

related activities in the market.

Under this principle-based regime, all activities involving financial intermediation and related to virtual assets fall within the scope of the Anti-Money Laundering Act (“AMLA”).

United States Comprehensive and Technology-Neutral Framework

The United States has a comprehensive and technology-neutral regulatory and supervisory framework in place for regulating and supervising “digital assets” for AML/CFT that subjects covered providers and activities in this space to substantially the same regulation that providers of non-digital assets are subject to within the existing AML/CFT regulatory framework for FIs.

Principles of information sharing among nations are narrated on pages 102-106.

Conclusion

I am not surprised by complex coverage of virtual assets and virtual asset service providers by FATF in widest coverage possible in its 111 publication, but it essentially nails down the ultimate guidance to all nations in travelling the complex world of VA/VASP which will be

updated regularly. Yes, for an ignorant, and feigned multimillion earner as an investor, it is time to upgrade the knowledge and understand that complex and well laid rules/regulations nail anti money launderers from running away with ill gotten wealth. But the intention is not to avoid technology to show a much brighter investing target. Future offers a more complex but rewarding investing climate.

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