FATF and Digital Asset Regulation : An Imperative Recommendation to States

31/10/2019

"Whoever straddles a tiger does not descend easily" says a Chinese proverb, and it seems that the Financial Action Task Force (FATF) has chosen to mount the mount of "virtual assets" and that this ride leads them to drag all countries in its wake in an inevitable movement to regulate these "digital assets".

In June 2014¹, the Financial Action Task Force (FATF) discovered, five years after their creation, the Bitcoin/Altcoins. Its report on virtual currencies distinguished between "Virtual Currency" and "Digital Currency". The latter being the numerical representation of the former. The FATF then defined Virtual Currencies as the digital representation of a value that can be exchanged digitally, serve as a means of exchange; and/or as a unit of account; and/or as a reserve of value, but which does not have "per se" legal or discharge value in any jurisdiction.

This report placed the Institution on the back of the tiger by defining the essential terms of the debate at the time (Crypto currencies, Fiat, Bitcoin/Altcoin...), the tools (Wallet, cold & hot storage...) and the actors of this new world (Exchanges, Administrators, Minors).
On this basis, the FATF published in June 2015² a guide for the analysis of risks related to virtual currencies. This guide stressed the responsibility of States to implement effective regulation and supervision, with dissuasive sanctions, of activities related to virtual currencies. As well as their commitment to a policy of international cooperation on this subject.

Then, on 18 October 2018, the FATF amended its recommendations to not only add two new definitions to its glossary: that of "virtual assets" - defined as the digital representation of securities that can be sold, transferred or used as payment or investment - and of "virtual asset service providers"; but above all to amend its "Recommendation N°15³" to explicitly subject "virtual asset service providers" to AML/CFT obligations.

Finally, in June 2019, the FATF adopted an interpretative note to Recommendation 15 to help national authorities better understand and develop the regulation⁴ and supervision of these activities.

With this note, it can be seen that the FATF is firmly placed on the back of the tiger and that from now on, States will no longer be able to turn their attention away from digital assets. Even countries that prohibit the use of "virtual assets" on their territory will no longer be able to avoid specific regulation and the creation of an "authority dedicated" to the supervision of this part of the economy.

I. KEY PRINCIPLES FOR REGULATING DIGITAL ASSETS
The Financial Action Task Force now considers that "virtual assets" in any form (cryptomones, tokens, etc.) are essential and can no longer be ignored by public authorities. They exist in the "digital world" and by their very nature play on physical constraints. Therefore, the only way to control them - whether their use is legal or illegal in the territories under consideration - is for public authorities to structure themselves to face these new challenges and for the weight of international obligations to combat money laundering and terrorist financing (AML/CFT) to be based on the specific public authorities of each State and then on the "professionals" in the "virtual assets" sector, according to a "Door Keeper" principle.

Consequently, it will be up to States to promulgate legal norms that:

create the responsible administrative⁵ authority:
- risk identification (Recommendation 1),
- the registration or issuance of licenses for local Virtual Asset⁶ Service Providers or those who offer or make available services related to virtual assets to residents of the State concerned⁷ if domestic legislation allows the trade or use of "virtual assets".
- the identification of natural or legal persons who develop an activity related to virtual assets without authorization or illegally when the activity is specifically prohibited by law;
- the application of appropriate sanctions in the event of noncompliance.
- to seize and freeze "virtual assets" in accordance with the FATF recommendations on combating money laundering and terrorist financing;
- the State's international collaboration in the implementation of FATF standards on virtual assets

promulgate standards that establish:
- the prohibition of any activity related to virtual assets on the national territory (holding, trading, etc.);
- r the regulatory framework for such an activity.
- Which should at least indicate:
  1. the conditions for the creation of a legal entity carrying on this type of activity as well as the conditions for the control of this entity (including the presence of a "Director" and management in the territory concerned as well as specific financial conditions - Amount of share capital...) ;
  2. the conditions for the own-name practice of a resident of the country concerned,
  3. the obligation to obtain the prior agreement of the competent authorities before any major changes are made to the shareholding structure, operational structures or commercial activity of legal persons;
  4. and in any case, the sanctions applied in the event of failure to comply with such obligations or prohibitions.

II. POLITICAL ISSUES OF REGULATION
Faced with the FATF's recommendations, it would be tempting for States to adopt a minimalist position by prohibiting the use, trade and solicitation of digital assets on their territory and by transferring the obligations of risk analysis, supervision and sanctions to the financial authorities already responsible for combating money laundering and terrorist financing (AML/CFT).

However, in order to comply with the recommendations of the Financial Action Task Force, they would⁸ still need to enact a specific law and provide for sanctions for breaches. And this constraint is undoubtedly an opportunity for several reasons.

First of all, it is the opportunity to adapt the FATF's vocabulary to the domestic legal order of each country and to go beyond financial tropisms and the fight against money laundering and terrorist financing to carry out a real analysis in domestic property law of what is a "virtual asset", a "token", a digital currency (...), to establish bridges with other areas of the law: the law of obligations, company law, security law, consumer law (...) and achieve the creation of a special law capable of providing the security and stability necessary for the harmonious development of the digital economy.

Secondly, the establishment of an ad hoc supervisory and regulatory authority which should "develop a thorough knowledge of the market for virtual asset service providers, its role and structure" is the means of implementing an administrative authority which will be able to create a "plastic" regulation, likely to support the rapid development of this economic sector.

It is also an opportunity to create: new regulated professions that can assume public control service missions (e. g. VFA Agent and System Auditor in Maltese legislation⁹); regulated activities subject to AML/CFT rules (e. g. Exchange, Custodian) but also regulated operations (ICOs, STOs, IEOs...). Such a structure not only makes it possible to meet AML/CFT obligations towards the FATF, but also to secure the "general public" in its approach to the adoption of digital assets and, above all, to create an architecture that can structure the entire distributed registry technology sector.

Finally, such an incentive by the FATF is an opportunity for States to tackle the theme of the "digital society", to take stock of the "decentralization revolution" brought about by distributed registration techniques and to respond to the urgent need to create legislation on: digital personality rights (of individuals, legal entities, decentralized autonomous entities), data ownership, distributed registration technologies, digital fundraising, smartcities...

Now that the FATF has put states on the "back of the tiger", optimists will be able to see, to paraphrase Sir Winston Churchill, opportunities in the constraints that arise from the application of AML/CFT standards to virtual assets.
In any case, the tiger seems determined to continue its course, since the OECD also plans to issue its own recommendations in the coming months on the adoption by States of regulations on Distributed Registry Technology¹⁰.

For more informations, please contact Damien Concé, d.conce@rosemont.mc, or visit or webiste dedicated to DLT/Smart City

Article originaly published on Defi Economie magazine.

¹ http://www.fatf-gafi.org/publications/methodsandtrends/documents/virtual-currency-definitions-aml-cft-risk.html
² http://www.fatf-gafi.org/media/fatf/documents/reports/Guidance-RBA-Virtual-Currencies.pdf
³ https://www.fatf-gafi.org/media/fatf/documents/recommendations/RBA-VA-VASPs.pdf
⁴ The FATF recommends "initiating work to develop comprehensive regulatory and supervisory frameworks for activities related to virtual assets and virtual asset services"; N°61 Guidance for risk-based approach to virtual assets and virtual asset service provider, June 2019, FATF
⁵ N°77, Guidance for risk-based approach to virtual assets and virtual asset service provider, June 2019, FATF
⁶ N°77, Guidance for risk-based approach to virtual assets and virtual asset service provider, June 2019, FATF
⁷ N°81, Guidance for risk-based approach to virtual assets and virtual asset service provider, June 2019, FATF
⁸ N°144, Guidance for risk-based approach to virtual assets and virtual asset service provider, June 2019, FATF
⁹ http://www.justiceservices.gov.mt/DownloadDocument.aspx?app=lom&itemid=12872&l=1
¹⁰ http://www.oecd.org/finance/blockchain/