Financial Markets

The Financial Action Task Force (FATF), which focuses on fighting financial crime, is the most advanced of the international standard setters (ISS) for creating rules governing crypto assets. Its actions so far suggest that once the other ISSs catch up, more constraints could be placed on crypto. By Justin Pugsley 

The fact that global rules on crypto are most advanced for anti-money laundering (AML) and counter-terrorist financing (CTF) is not entirely surprising. The crypto movement started as a libertarian and decentralisation project, and currencies such as Bitcoin are perceived by policy-makers as perfect conduits for laundering the proceeds of crime.    

FATF, which sets AML and CTF rules and enjoys a strong global membership, could set the tone for the global regulation of crypto assets. It launched a consultation in March with potentially far-reaching consequences. Other ISSs, such as the Bank for International Settlements (BIS), Financial Stability Board and the International Organization of Securities Commissions  are also investigating the topic, but are yet to draw firm conclusions.  

“So although [FATFs are] not fundamentally changing the rules, what they’ve done is extend in a very broad way the definition of a virtual asset and who is a virtual asset service provider,” says John Salmon, who leads Hogan Lovells’ blockchain and cryptocurrency practice. He believes this will have an important impact on other regulatory regimes, and crypto firms have been critical of FATF’s approach. 

“There’s very little overarching regulation in Europe [for crypto]. The only regulation that has European reach is AMLD [AML Directive] 5,” says Capco principal consultant Mark Profeti, which he says obligates institutional investors to check for financial crime when using crypto asset service providers and exchanges.

Role of the BIS

The AML/CTF implications of crypto are clear cut, but this is not the case when it comes to the use of blockchains and stablecoins (asset-based back crypto instruments) in wholesale finance, a likely reason why other financial ISSs have yet to formulate crypto regulatory frameworks. 

“The trading mechanisms that need to be implemented are going to take time to mature,” says Mr Profeti. He explains that it will take time to understand any discrepancies and how the treatment of crypto assets will evolve in terms of tax treatment, liquidity risk, their value as collateral instruments, understanding counterparty risk, their use across borders and so on. 

“These kinds of things will have to start to be considered quite closely. And that’s really where I see the BIS stepping in,” says Mr Profeti. “I think it’s going to be a watching brief for two to three years to see what direction innovation takes in the crypto asset market. And then they’ll start to see what the discrepancies and disparities are globally. And maybe at that point, they’ll start to formulate some standards on a global basis. I think that we are probably three to five years away from that.”

For now the BIS is heavily focused on working with central banks to develop central bank digital currencies to preserve the role of fiat currencies. Though CBDCs will challenge traditional financial business models, they may actually play a vital role in saving these firms from decentralised finance, which could disintermediate traditional firms if left unchecked. 

“It’s a deeply fractured approach at the moment. Are we ever going to create a global standard of regulation for these activities? Everyone is doing what they think is best for their particular market at the moment from what I can tell,” says George Morris, a partner in the ICT group at law firm Simmons & Simmons.

He notes that there is a mixture of smaller jurisdictions regulating crypto in an agile fashion, that are trying to put in reasonable standards and to attract business to their jurisdictions. These include the likes of Malta, Gibraltar, Liechtenstein and the Cayman Islands, but also larger jurisdictions such as Singapore and Switzerland, among the leading financial centres, took a lead with clear and predictable crypto regulatory frameworks. 

“Abu Dhabi and Gibraltar and others who are early movers in this market of regulating crypto have actually built themselves quite a good reputation as being trusted places to do business,” says Mr Morris. 

Shift in emphasis

But some see the FATF’s and even some of the EU’s rules as parts of a fundamental shift in regulatory thinking, which used to be that supervisors regulated the use of technology, but not the technology itself. This could stunt crypto’s development in mainstream financial markets. 

“What you can see is a drive by regulators to start looking at the technology itself,” says Mr Salmon, citing the EU’s Digital Operational Resilience Act and the European Commission’s latest proposals for harmonising rules on artificial intelligence. The latter, which seeks to ban the use of AI where it could cause harm, has been described by some in the industry as retrograde and heavy-handed. 

“You pull these things together, and you could see that this is the way that the regulators think they should be going,” says Mr Salmon. 

Returning to crypto, he explains that under the FATF’s proposals, states will have the power to ban non-hosted wallets, and to prevent people from either dealing with non-hosted wallet providers, or at least it being carried out in a very risk-based approach. “It’s going to really change things quite a bit,” he says. 

It remains to be seen if the ISSs can forge a global consensus on regulating crypto. Doing so would bring more certainty over the use of the technology, but would also result in it being substantially regulated and therefore absorbed into the traditional financial sector, the very thing it was partly designed to circumvent.