The Growing Regulatory Spotlight on Digital Assets’ Role in Funds Transfers and Payments

An obscure but powerful task force, simply known as the FATF, holds the key.

April 21, 2021

By Amy Davine Kim

Over the past two decades, the advent of the global digital banking and financial services system has revolutionized electronic funds transfers and payments and adoption of digital asset technologies. Blockchain and distributed ledger technologies will transform the way in which we buy and sell goods and services, and even the goods and services that we buy.  With this opportunity has come an increased global governmental scrutiny of implementing policies to address anti-money laundering and counter-financing of terrorism (AML/CFT) risks, and ongoing concerns about how best to put in place such policies while addressing privacy concerns.

Two years ago, the Financial Action Task Force (FATF), a powerful intergovernmental organization founded in 1989, amended its anti-money laundering Recommendations to include virtual assets and so-called Virtual Asset Service Providers (VASPs). The FATF is viewed as a crucial standards-setter for anti-money laundering and anti-terrorist financing policies; failure to adopt and enforce its Guidance is noted in the FATF’s audits, which can lead to countries being “grey-listed” and causing financial institutions to no longer do business within those countries.

The Guidance prompts countries to establish regulatory frameworks globally to address AML/CFT concerns involving virtual assets, typically including the development of compliance programs that require customer due diligence and implementation of the so-called “Travel Rule” provisions.  Now, two years later, the FATF has again proposed “updates” to its Guidance in an attempt to develop greater clarity around the requirements.

The Guidance was open to comment for 30 days by financial regulatory bodies around the world, as well as industry players, such as the Chamber of Digital Commerce. The FATF intends to release a final form of the Guidance this June.

The Chamber has long supported such standard-setting bodies and processes as undertaken by the FATF, including through its work to develop data messaging standards for the Travel Rule.  Nevertheless, this recently updated Guidance takes an overly broad, cookie-cutter approach that, for a quickly evolving industry like digital assets and blockchain technology, creates both uncertainty and unintended consequences for legitimate players in the marketplace, as well as the regulators and policy makers overseeing them.  Over the past month, since the FATF Guidance was opened up for comment, the Chamber spent countless hours evaluating the Guidance and discussing it with our Members and submitted our comments on Tuesday. We would like to highlight several points of concern that we recommend the governing body address during this consultative process.

First, the FATF’s effort to define what a Virtual Asset Service Provider is and isn’t is overly broad and seeks to capture all virtual assets as well as multiple businesses in the ecosystem – even those not typically subject to AML obligations as financial institutions.  This sweeping perspective brings all virtual assets within the purview of anti-money laundering obligations, even those not used as a “currency” or method of payment.  Not all virtual assets create the same risks nor require the same regulation at the same points, yet that nuance is absent from the Guidance.

The FATF Guidance generally treats virtual assets and peer-to-peer transactions as higher risk for illicit activities, stating in no uncertain terms that Virtual Assets or “VAs” are becoming increasingly mainstream for criminal activity more broadly” without additional evidence or support for this statement, dismissing the distinctions between different types of virtual assets, and ignoring evidence to the contrary. Further, the Guidance does not address whether current and developing controls sufficiently mitigate the risk. With higher risk typically comes the imposition of additional compliance requirements, and such regulatory hurdles often disincentivize some financial institutions from participating or innovating within the digital currency marketplace. 

Second, the Guidance expands the concept of VASP to include those that merely “facilitate” the activity of exchange, administration, and safekeeping.  For example, this includes those that develop software and engage in business development.  To be clear, we support the application of anti-money laundering compliance obligations on those financial institutions that directly provide money transfer and safekeeping services.  Yet, there are many businesses and individuals engaged in supporting these services that do not directly provide them nor are appropriate to conduct things like customer due diligence or KYC, nor should they be sharing personally identifiable information (PII) with counterparts pursuant to the Travel Rule.

Finally, updates to the Guidance concerning submission of PII between financial institutions engaged in cross-border wire transfers, colloquially known as the “Travel Rule,” expand the scope of this requirement to include not only domestic wire transfers but also transfers involving a self-hosted wallet – a unique expansion of the rule beyond what is required in the traditional fiat currency space.  While intended to address anti-money laundering challenges and help law enforcement agencies better track criminals – the expanded scope changes the goal posts at a time when industry and governments are working diligently to quickly develop a secure, global information exchange system.  The transfer of PII is a very sensitive issue, one that must be handled carefully and appropriately.  In our view, we should complete the work already underway to ensure it effectively and efficiently achieves law enforcement goals before making adjustments and additions to the requirements midstream.   

Just as important as preventing anti-money laundering violations and enabling law enforcement to better track such illegal activities, is not only understanding the scope of such threats, but also confirming the progress that all countries engaged in the digital currency marketplace have made in adopting the “Travel Rule” guidelines already adopted in 2019.  It’s important for the FATF to encourage global adoption of the current “Travel Rule” with the understanding that some States may come online with their regulations at different times than others.  This uneven progress, often called the “Sunrise Issue”, greatly impacts when a financial institution must share sensitive PII. 

The Chamber of Digital Commerce will continue its active and constructive engagement, working with all players to develop a strong understanding of this rapidly evolving space. The Financial Action Task Force’s efforts – as well as those of the many jurisdictions and regulatory bodies that are implementing them – have contributed to increased adoption and certainty in the digital asset and blockchain ecosystem. Data shows that the coordinated efforts of our industry, regulators, and law enforcement have reduced the risk of AML abuse, maintained security, and protected privacy. Data would also help track areas of increasing or decreasing risk, so that further efforts are focused on those areas of high risk in the global money laundering landscape.

While there is more to be done, the Chamber believes it is important in this highly innovative and evolving industry for the Financial Action Task Force to work collaboratively in setting Guidance that not only focuses clearly on those institutions that engage directly in the provision of financial services to customers but leverages risk-based data and the potential benefits of the underlying technologies. Our goal is to prevent illicit activity from utilizing the virtual asset system while not hindering the advancement of cutting-edge blockchain and digital assets technology that will be the cornerstones of the new age of financial services.