The Financial Action Task Force (FATF) just published the outcomes of its February 2021 plenary session. Virtual assets (VAs) and virtual asset service providers (VASPs) are firmly back on the agenda, and will be the focus of significant attention in the coming months.
The inter-governmental body, responsible for the development of standards to protect the global financial system, meets periodically to discuss strategic initiatives relating to the prevention of money laundering (ML), terrorist financing (TF) and the financing of proliferation of weapons of mass destruction.
Recommendations and guidance published by the FATF are implemented by its 39 members and nine associate members. Mutual evaluations periodically carried out by peers serve to assess each country’s compliance with and effectiveness in implementing FATF’s 40 Recommendations. They serve to encourage further reforms and, if found wanting, may result in the classification by the FATF as a jurisdiction under increased monitoring (aka "grey list") or high-risk jurisdiction ("black-list"). Countries presenting a higher risk of ML/TF often face significant difficulties in accessing the global financial system and establishing correspondent banking relationships.
The FATF brought VAs and VASPs into scope of its Recommendations in October 2018 by amending one Recommendation and adding two new definitions to its Glossary:
· Virtual Assets Digital representations of value that can be digitally traded or transferred and can be used for payment or investment purposes, including digital representations of value that function as a medium of exchange, a unit of account, and/or a store of value. Virtual assets are distinct from fiat currency (a.k.a. “real currency,” “real money,” or “national currency”), which is the money of a country that is designated as its legal tender.
· Virtual Asset Service Provider Any natural or legal person who … as a business conducts one or more of the following activities or operations for or on behalf of another natural or legal person:
i. exchange between virtual assets and fiat currencies;
ii. exchange between one or more forms of virtual assets;
iii. transfer of virtual assets;
iv. safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and
v. participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.
The FATF introduced international standards for VAs (binding on countries) by clarifying the application of its Recommendations to VASPs. Then in June 2019, FATF adopted a binding Interpretive Note and non-binding Guidance for a Risk-Based Approach to VAs and VASPs. With this important step, countries had to bring VASPs, such as exchanges and custodial wallet providers that were not already supervised under national anti-money laundering regulations, into regulatory scope.
In June 2020, VASP compliance with the Recommendations throughout 2019 and early 2020 was summarised in the FATF's first 12-Month Review of the Revised FATF Standards on Virtual Assets and Virtual Asset Service Providers. The Review revealed that, while the public and private sectors had made progress in the implementation of the Recommendations and technical solutions for compliance, a large number of jurisdictions had yet to implement regulatory regimes for VASPs. Feedback from the public and private sectors also indicated that greater implementation guidance and clarifications were needed from the FATF.
Following a number of industry consultations throughout 2020, the FATF's recent plenary announced that the 2019 Guidance for a Risk-Based Approach had been updated to include information on the application of the Recommendations to stablecoins, provide further clarity on the implementation of Recommendation 16 (aka the travel rule), as well as clarifying how to address the risks of disintermediated peer-to-peer transactions (eg swaps conducted on decentralized exchanges). The proposed revised guidance will be released for private sector consultation during March 2021.
In parallel, the FATF will continue to survey member countries' compliance with the standards and identify any further challenges, the findings of which will be published in its second 12-Month Review to be adopted at the June 2021 plenary. We can expect the 2021 review will not only identify ongoing challenges, but also those countries whose efforts towards implementation are lagging.
The draft updated Guidance is timely, given the strains felt within the industry to develop new protocols and practices for compliance. Misconceptions abound, in particular as they relate to the application of regulations to decentralised services (e.g., DeFi) and private, self-hosted wallets.
As a reminder, peer-to-peer transfers of VAs without the use or involvement of a VASP or financial institution are not explicitly subject to AML/CFT obligations under the revised FATF standards. Nevertheless, VASPs are required to identify the beneficial ownership of transacting wallets in certain jurisdictions. VASPs looking to prevent the transfer of virtual assets to other obliged entities disguised as private wallets may welcome further guidance on implementation.
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