Financial Action Task Force Proposes Recommendations that Impact the Global Blockchain Ecosystem

Financial Action Task Force Proposes Recommendations that
Impact the Global Blockchain Ecosystem

The Financial Action Task Force is taking significant steps that could impact our industry. Here’s what you need to know.

The FATF Sets Global Anti-Money Laundering Standards.

The FATF is a multi-governmental organization that sets standards and promotes global implementation of legal, regulatory, and operational measures for combating money laundering, terrorist financing, and other related threats to the financial system.  The FATF thus develops anti-money laundering policies to bring about national legislative and regulatory reforms in its member countries.

The organization maintains a series of Recommendations that are recognized as the global anti-money laundering and counter-terrorist financing standards.

The FATF monitors the progress of its members in implementing necessary measures and publicly identifies countries that fail to meet its standards. This can have significant implications for financial institutions operating in or with those countries.

The FATF’s AML Standards Were Expanded to include Virtual Assets and Virtual Asset Service Providers.

Last fall, the FATF’s Recommendations were amended to include a set of definitions for what it calls “virtual assets” and “virtual asset service providers” (VASPs).  In February, the FATF adopted an “Interpretive Note” to explain the application of the Recommendations to virtual assets and VASPs.  In the process, it asked for public comment on how to apply existing Recommendations regarding wire transfers to VASPs.

In setting these definitions of virtual assets and virtual service providers, the FATF expanded the universe of things subject to money laundering and terrorist financing beyond typical payments and money transfers to include:

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. (emphasis added).

Virtual Asset Service Providers 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.

* In this context of virtual assets, transfer means to conduct a transaction on behalf of another natural or legal person that moves a virtual asset from one virtual asset address or account to another.

The Chamber’s Response.

Earlier this month, the Chamber submitted a letter to the FATF expressing concerns in relation to the FATF’s proposed paragraph 7(b) of its Interpretive Note to Recommendation 15 which advocates two key principles:

 

1. The Definition of Virtual Asset Is Broad, Going Beyond Typical Payments or Medium of Exchange, and Must Be Limited to Payments or Medium of Exchange When Applying AML Standards to Virtual Asset Service Providers.

The FATF AML Standards are designed for financial institutions to develop an added protective layer between ordinary commerce and financial systems.  As the FATF noted in its 2015 Guidance for a Risk-Based Approach to Virtual Currencies, it focuses on the “gateways” to the regulated financial system, such as convertible virtual currency exchangers.  The broad definitions of virtual asset and virtual asset service provider in this context makes it unclear who is captured within the requirements.

It is more common to see descriptions of regulated financial activity involving a virtual asset limited to its function as a medium of exchange (such as in the FATF’s 2015 Guidance for a Risk-Based Approach to Virtual Currencies and FinCEN’s 2013 Guidance – Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies), and more particularly in the wire transfer context.  The FATF’s own definition of a wire transfer requires that the transaction be carried out through a financial institution.

Note that the FATF’s 2015 Guidance focused on Virtual Currency Payments Products and Services (VCPPS).  In just 3 years, the FATF has changed its terminology, as well as the scope, indicating that this is a quickly evolving area requiring close study to avoid another such shift.

 

2. It Is Inappropriate to include the Broad Scope of Virtual Assets within a Wire Transfer Framework.

Considering virtual assets within a wire transfer context misunderstands the way in which virtual currency transfers work.  Transfers of virtual currency may not always involve regulated financial institutions at both ends, which is contrary to the very definition of wire transfers used by the FATF.

This interpretation would also cut off independent users from accessing regulated exchanges unless they, too, established their account at a VASP.  The requirement to obtain incoming originator information or outgoing beneficiary information would effectively block out any potential participant that does not hold its account at a VASP.  This could have a devastating effect on encouraging growth among this community within a regulated environment, potentially pushing it out.

Building a Coalition to Ensure Effective AML Compliance.

The proposed paragraph 7(b) of its Interpretive Note to Recommendation 15 will be finalized in June 2019.

The Chamber supports effective regulatory action to mitigate the risks presented by emerging technologies, including virtual currencies, but believes that more work needs to be done before a final interpretation and definitions can be issued to effect meaningful compliance.

As part of our efforts to promote sound anti-money laundering and counter terrorist financing (CTF) compliance regimes, the Chamber’s Chief Policy Officer, Amy Davine Kim, along with several Chamber members, will be attending the FATF’s public consultative meetings May 6-7, 2019 in Vienna, Austria.

While each business has its own specific perspectives on the details of these issues, the industry is unified in these broad principles.  We are coordinating a group of industry members to help present these important factors to the FATF. Let us know if you’ll be in Vienna.

New SEC Framework Signals the SEC is Open to Recognizing that Tokens Are Not Securities, But Does Little to Advance Clarity

New SEC Framework Signals the SEC is Open to Recognizing that Tokens Are Not Securities, But Does Little to Advance Clarity

 

What happened

On Wednesday, April 3, the SEC released staff guidance entitled, “Framework for ‘Investment Contract’ Analysis of Digital Assets,” to discuss its application of the Howey Test to digital assets.  Specifically, the guidance describes the various considerations for determining when a digital asset may constitute an “investment contract” under federal securities laws based on the actions of promoters, sponsors, or other third parties. The SEC also issued a No-Action Letter regarding TurnKey Jet, Inc.’s (“TurnKey Jet” or “TKJ”) plans to develop a program to use digital tokens to facilitate transactions.

The SEC staff stated that it will not recommend an enforcement action against the interstate air charter services company’s program as described because:      

1. funds from digital token sales will not be used to develop its blockchain platform, network, or app;
2. tokens will be immediately useable upon purchase;
3. the tokens will only be tradeable in the TKJ wallet and not wallets external to the platform;
4. the price of tokens will be maintained at $1 USD and can only be resold to TurnKey Jet at a discount to their face value; and
5. the marketing promotion focuses on the functionality of the token over its potential increase in market value.

Why it’s important

Both of these developments are pivotal efforts that will help define how various types of tokens will be treated by U.S. regulators. Said another way, depending on how they are defined, the SEC could assert sweeping jurisdiction (read: enforcement) over the token industry.  If within the SEC’s scope, tokens and token sponsors must comply with SEC registration and reporting requirements or qualify for an exemption.  

Our take on this development

As explained below, our overall view of these developments is that they represent a cautious, albeit imperfect, first step. Importantly, a few kernels of evolution should be noted:

• •  
  • First, the fact that the SEC (staff) has issued a document acknowledging in more detail that tokens may not be securities and provides in depth criteria for determining when that may be the case, comes a long way from Chair Clayton’s statements made in February 2018 during a U.S. Senate hearing that every ICO he’s seen is a security, as well as conversations we have had with the SEC last year.

• • Moreover, the Framework acknowledges in writing (rather than verbally in a speech) that tokens may be a security at one point in time, and then no longer maintain those characteristics of a security as the platform evolves, a policy position that William Hinman, Director of the SEC’s Division of Corporation Finance, notably enunciated regarding ether in remarks at an industry conference on June 14, 2018. 

• • Finally, the Framework also recognizes that virtual currencies may be viewed differently, albeit as a factor in the overall equation. That said, bitcoin and ether should be considered outside the scope of the securities laws given the SEC’s requirements that a currency be immediately used to make payments in a wide variety of contexts or act as a substitute for real currency, may be used to pay for goods or services without first having to convert it, and operate as a store of value that can be saved, retrieved, and exchanged for something of value at a later time.

• • Unfortunately, the good news stops there. By developing a list of over 60 criteria for analysis, the SEC staff has ensured that every token platform will trigger at least one of those criteria, if not more, thus expanding any analysis significantly. 

• • In addition, with little explanation of which factors carry more weight and which carry less, or how those are measured, participants in token systems (and legal counsel for those participants) have an even more challenging task of determining when the relevant token reasonably may be considered a security. Thus, while the insight into the various factors that may cause a token to be viewed as a security is interesting, the sheer number of those factors without meaningful guidance as to how those will be weighted and assessed, potentially creates more ambiguity, rather than less.

• • Another area of concern relates to secondary market considerations. The Framework states that if “a digital asset is transferable or traded on or through a secondary market or platform, or is expected to be in the future,” then it is more likely that there is a “reasonable expectation of profit.” This analysis is concerning. Policy makers must recognize that as the token economy evolves and all manner of assets can be tokenized, the ability to trade those assets will also increase in ways we have not previously seen.  A decentralized system requires a token that is able to be traded freely on secondary markets.  Treating tokens as securities would scuttle this ability.  Thus, the Framework seems rooted in traditional notions of securities platform trading without acknowledging this evolving reality.

• • After that assessment, it’s surprising to find that the TurnKey Jet No-Action Letter detracts even further from meaningful guidance. One can convincingly argue that the TurnKey token would not be considered a security under any circumstances.  That said, the conditions cited for coming to the conclusion that the SEC staff will not recommend an enforcement action regarding TurnKey are not just restrictive, but go even further than the criteria in the Framework would indicate.  The requirements that tokens may be “traded” only on the platform, and if redeemed, must do so at a discount, are overly constricting. 

• • Finally, because the Framework represents the views of SEC’s FinHub staff, it is not binding on the Commission.  Further, by its own terms it restates information drawn from enforcement actions, speeches, the DAO Report, and other previously made statements, thus leaving the industry searching for meaningful clarity.

All in all, we have a lot of work to do as a community to continue to demonstrate the fundamental differences among the various types and functions of tokens. Many businesses and consumers are still wary of conducting business or transactions using blockchain because of the lack of a predictable legal environment governing activities involving the technology. In the current blockchain ecosystem, the development of digital tokens that can represent numerous things, from a currency, to a commodity, a security, title to property, identity, provenance, and many others, has created the need to interpret existing laws that may no longer adequately govern the new features of this technology. As we continue to develop these technologies worldwide, we have seen that government policies have a profound effect on the development of blockchain in that location. Many countries are capitalizing on this opportunity and promoting policies that encourage adoption, while others are not as supportive. It is imperative that governments recognize publicly the benefits of this technology in order to engage businesses (and government) to enable innovation.