The FATF’s recommendations for the cryptocurrency industry: Summary and implications

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What is the Financial Action Task Force?

Founded in 1989, the Financial Action Task Force (FATF) is an inter-governmental policy making body established by the ministers of its 37 member countries (one of which is Canada). The FATF creates international standards for combating money laundering and terrorist financing with the purpose of “protect[ing] the integrity of the global financial system”.1 While the FATF’s guidance is not binding, per se, failure to comply with FATF recommendations may result in severe economic consequences, as the financial institutions in “non-cooperative countries or territories” are spotlighted as suspect. Consequences of non-cooperation may include political condemnation, international investigation, prosecution and sanction.2

Guidance from the FATF

On June 21, 2019, the FATF issued, “Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers” (Recommendations). The Recommendations impose anti-money laundering and counterterrorism financing rules on activities related to Virtual Assets (VA), and Virtual Asset Service Providers (VASPs). On June 28, 2019, the G20 Summit in Osaka, Japan, supported the adoption of the Recommendations, stating, “We reaffirm our commitment to applying the recently amended FATF standards to virtual assets and related providers for anti-money laundering and countering the financing of terrorism.”3

The Recommendations define VAs as:

“a digital representation of value that can be digitally traded or transferred, and can be used for payment or investment purposes. Virtual assets do not include digital representations of fiat currencies, securities, and other financial assets that are already covered elsewhere in the FATF Recommendations”.4

With this definition, the FATF is capturing cryptocurrencies like Bitcoin and Ether while excluding digital currencies that are tied to, or backed by fiat currencies. While the definition is not restricted to value that can be traded or transferred via a blockchain or distributed ledger, there is no doubt that the rise in cryptocurrencies was a major contributing factor to the development of these Recommendations.

The Recommendations define VASPs broadly, to include:

“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;
  3. Transfer of virtual assets;
  4. Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and
  5. Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset."5

Depending on the nature of the financial activities, VASPs can capture individuals, cryptocurrency exchanges and transfer services, wallet services providers, a company’s fundraising activities, including the launch of an ICO6 , STO7 or IEO8, and other possible business models.9

The Recommendations go beyond the basic “know your client” rules currently followed by entities that qualify as a VASP, as the Recommendations require VASPs to not only keep records of their own users’ identities, but also to share “required information” with other VASPs when transferring virtual assets of more than USD$1,000 or 1,000 euros.10 The requirements for entities to share a user’s information with a transferee is designed to reflect traditional AML rules, similar to those applicable to electronic fund transfers today. This particular rule is known as the “travel rule”, which mandates that when virtual assets are transferred, certain “required information”, “travel” from the transferor to the transferee.11

“Required information” as defined in the Recommendations, includes:

  1. Originator’s name (i.e., the sending customer);
  2. Originator’s account number where such an account is used to process the transaction (e.g., the VA wallet);
  3. Originator’s physical (geographical) address, national identity number or customer identification number (i.e., not a transaction number) that uniquely identifies the originator to the ordering institution, or date and place of birth;
  4. Beneficiary’s name; and
  5. Beneficiary’s account number where such an account is used to process the transaction (e.g., the VA wallet).12

Implications of imposing the “travel rule” on VASPs

It will be difficult for VASPs that facilitate transactions to establish the operational infrastructure they will be required to implement (as required by the Recommendations) due to the ‘peer-to-peer’ nature of cryptocurrency transactions. Unlike traditional transfers of fiat currency, which are facilitated by banks, blockchain-based transfers are facilitated by blockchain technology, which allows parties to transact with one another directly. In a sense, VASPs are merely platforms that help people interact with each other through the blockchain. Accordingly, it will be difficult for VASPs to comply with the same regulatory requirements as traditional financial institutions, since VASPs do not have access to the same information that financial institutions collect on a regular basis.

In practice, the Recommendations will require companies ranging from exchanges like Binance, wallet service providers like Jaxx, and traditional asset managers like GMP Securities, to collaborate with one another by sharing information about their users every time one of their users chooses to conduct a transaction. Therefore, the VASP will be responsible for identifying both the nature of a transaction and the parties to it. The VASP facilitating the virtual asset transfer will also be burdened with sharing required information with the transaction recipient or the recipient’s service provider. The Recommendations’ enforcement requirements allow countries and regulatory authorities to access all necessary documents and information held by a VASP.13 This will likely increase the complexities of complying with the Recommendations because blockchain wallet addresses are largely pseudonymous. Rarely do VASPs have a way of identifying the recipient of a transfer. The Recommendations mandate that VASPs be able to identify all parties at all times. The FATF has stated that it will give countries 12 months to adopt the guidelines, with a review set for June 2020.14

There are concerns that the regulatory costs and increased disclosure required to comply with the travel rule will push holders of cryptocurrency out of the regulated cryptocurrency space. As indicated by one London-based cryptocurrency exchange, the application of the Recommendations to virtual asset transfers would require the creation of a register that attributes all existing custodial wallet addresses to corresponding identifiable entities; or have the sender of virtual asset transfers provide their host VASP with the name of the transfer’s recipient, or the name of the VASP controlling the intended recipient’s address.15 Opponents to the Recommendations explain that such a system undermines the very purpose of blockchain, and would “become excessively onerous to manage and could drive the entire ecosystem back into the dark ages.”16

What does this mean for Canadian businesses moving forward?

Earlier this year, the Canadian Securities Administrators (CSA) and Investment Industry Regulatory Organization of Canada (IIROC) published a Joint Consultation Paper 21-402 titled, “Proposed Framework for Crypto-Asset Trading Platforms” (Consultation).17 The Consultation seeks input from the Canadian fintech community on how regulatory requirements should be tailored for crypto-asset trading platforms operating in Canada. There is little doubt that the Recommendations will greatly influence and shape the regulations that result from the Consultation.

Finally, in 2018, the Department of Finance proposed amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulations (Regulations).18 While these amendments remain to be published in final form, the Recommendations could also have an impact on how the Regulations will regulate “virtual currencies” going forward.

If you have any questions or concerns with respect to the foregoing, or would like further information, please contact Ryan Middleton or Tracy Molino.

A special thank you to Noah Walters (summer student) for his assistance with this article.

  1. FATF “Draft Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers” Guidance (2019) online: https://static.coindesk.com/wp-content/uploads/2019/06/Embargo-Virtual-Asset-Guidance.pdf at 6. [FATF Recommendations].
  2. Business Today, “Act Against Terror by October or Face Blacklisting: FATF to Pakistan” (2019) online: https://www.businesstoday.in/current/world/act-against-terror-by-october-or-face-blacklisting-fatf-to-pakistan/story/358209.html
  3. Yogita Khatri, “G20 Officially Supports FATF’s Crypto Guidelines That Require Exchanges to Share Customer Data” (2019) online: https://ca.finance.yahoo.com/news/g20-officially-supports-fatf-crypto-081134054.html
  4. FATF Recommendations supra note 1.
  5. FATF Recommendations supra note 1 at 13-14.
  6. An ICO is an “initial coin offering”; it is a fundraising mechanism that offers investors blockchain based tokens in exchange for crypto or fiat currency. ICO tokens do not grant their purchasers an equity stake in the underlying blockchain business; however, they confer various rights to participate in the blockchain application itself (Examples include: accessing a product or service, voting on technical upgrades to the project, etc).
  7. An STO is a “security token offering”; it is a fundraising mechanism that offers investors digitized shares of a company in exchange for crypto or fiat currency. Security tokens grant their purchasers an equity stake in the blockchain business; they may also confer various rights to participate in the blockchain application itself.
  8. An IEO is an “initial exchange offering”; it is the same fundraising mechanism as an ICO, except it is facilitated through a cryptocurrency exchange platform, rather than through the website of the founders facilitating the IEO. IEO’s are used to ensure that the blockchain tokens being distributed get listed on a cryptocurrency exchange immediately (to generate liquidity).
  9. Ibid at 14.
  10. FATF Recommendations supra note 1 at 25.
  11. FinCEN Advisory, “Guidance for Financial Institutions on the Transmittal of Funds “Travel” Regulations” (1997) online: https://www.sec.gov/about/offices/ocie/aml2007/fincen-advissu7.pdf
  12. FATF Recommendations supra note 1 at 29.
  13. FATF Recommendations supra note 1 at 32.
  14. Anna Baydakova, “All Global Crypto Exchanges Must Now Share Customer Data, FATF Rules” (2019) online: https://www.coindesk.com/fatf-crypto-travel-rule
  15. Serhii Mokhniev “It’s FATF’s Way or the Highway for Crypto Exchanges. That’s a Big Mistake” (2019) online: https://www.coindesk.com/its-fatfs-way-or-the-highway-for-crypto-exchanges-thats-a-big-mistake
  16. Marc Hochstein et al, “Beyond KYC: Regulators Set to Adopt Tough New Rules for Crypto Exchanges” (2019) online: https://www.coindesk.com/beyond-kyc-global-regulators-appear-set-to-adopt-tough-new-rules-for-crypto-exchanges
  17. Ontario Securities Commission, “Joint Canadian Securities Administrators/Investment Industry Regulatory Organization of Canada: Consultation Paper 21-402, Proposed Framework for Crypto-Asset Trading Platforms” (2019) online: Joint Canadian Securities Administrators/Investment Industry Regulatory Organization of Canada Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms
  18. Regulations Amending Certain Regulations Made Under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act SI/152-23 (2018) C Gaz I, online: http://www.gazette.gc.ca/rp-pr/p1/2018/2018-06-09/html/reg1-eng.html

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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