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The Fourth Industrial Revolution, cryptocurrency and money laundering - are you ready?

News / / Gibraltar, London

The Fourth Industrial Revolution is “characterised by a range of new technologies that are fusing the physical, digital and biological worlds, impacting all disciplines, economies and industries, and even challenging ideas about what it means to be human”.[1] This presents challenges for regulators and regulatory systems across the world, as they struggle to keep pace with rapid, complex technological innovation in all fields of life, including financial services.

With this revolution, cryptocurrencies have become a major component in the future of global finance. Research published by the Financial Conduct Authority (FCA) estimates that 2.3 million adults now hold cryptoassets (up from 1.9 million last year) and 78% of adults have now heard of cryptoassets, up from 73% in a year.[2]

Cryptocurrencies are gradually finding their place in society such as Bitcoin, Ethereum, Litecoin, Dogecoin and Polkadot among many others. Notably, a number of companies now accept virtual currencies as a form of payment and some credit providers have begun offering Bitcoin rewards to incentivise use of their facilities.[3]

In April 2021, the total market value of cryptocurrencies pushed past US$2 trillion for the first time, with Bitcoin worth more than US$1 trillion alone.[4]

Despite this, the crypto sector has largely avoided stringent regulatory oversight. The past few years, however, have seen a gradual march for cryptocurrency towards the mainstream. This is beginning to focus political and regulatory attention with the European Central Bank President, Christine Lagarde, labelling Bitcoin as a “highly speculative asset”, which has been responsible for “totally reprehensible money laundering”, and called for regulation to be applied and agreed upon “at a global level”.[5]

With momentum building, HM Treasury published a consultation paper on 7 January 2021[6] that outlines further steps the UK government proposes to take to mitigate risks to consumers. The focus for now appears to be on “stablecoins”, a type of cryptocurrency whose value is pegged to other assets (often conventional assets e.g. the US dollar or gold) in order to stabilise price volatility.

The regulation of cryptocurrency

Cryptocurrencies have garnered widespread attention and has created instant millionaires. Despite this, legitimate concerns have increasingly been raised surrounding the utility of cryptocurrencies for the purposes of laundering criminal gains, leading towards the introduction of regulations in some countries to combat this threat.

With the growing interest in cryptocurrency globally; the wider acceptance and adoption by institutions and private investors; and the inherent risks associated with digital assets because they are largely unregulated, regulators have reached a point whereby a proactive approach must be taken. This is to either foster the development of this sector to fulfil its potential for financial inclusion or, allow its growth to continue to raise concerns of financial stability and emerging vulnerabilities.

New crypto-regulation proposed by the EU Commission

On 20 July 2021, the EU Commission proposed new regulations that would make cryptoassets traceable. The proposals would firstly expand existing anti-money laundering and counter terrorist financing (AML/CTF) regulation to the entire cryptocurrency sector, and secondly place new information gathering obligations on cryptoasset service providers (CSPs) which facilitate transfers of cryptoassets.[7]

Under the proposed regulations, the CSP of the originator to a transfer (being the party from whom cryptoassets are received) would be required to identify and verify both the originator and the beneficiary of a transfer. At a high level, the proposed regulation would require an originator’s CSP to ensure the name and account number of each party accompanies a transfer. Where a transfer or series of linked transfers have a value of over EUR 1,000, the CSP would need to collect further information including the parties’ addresses or dates or places of birth. CSPs will be required to retain gathered information for a period of five years.

To become law, the proposals will need the agreement of member states and the European Parliament which could take up to two years.

Crypto regulation in the UK

Cryptocurrency businesses were brought into the scope of UK AML/CTF regulations following the implementation of the EU 5th Money Laundering Directive (5MLD).

5MLD came into effect on the 10 January 2020, whereby UK cryptoasset firms[8] must be registered with the FCA. The requirements of this new “registration authorisation”, meant that cryptoasset firms were required to apply for the right to continue their operations by 9 January, 2021. However, despite the regulations being over a year and a half in place, only a small number of cryptoasset firms are deemed to be meeting their newly acquired regulatory obligations.

A consequence of this failure to comply with the AML/CTF regulations is an unprecedented number of applications for supervision being withdrawn. A temporary licensing regime for cryptoasset businesses was in place to end on 9 July 2021. Given the industry’s delay in adapting to its new regulated status, this deadline has now been extended until 31 March 2022.[9]

The application of cryptocurrencies for the purposes of laundering money have long been a concern for national and international regulators and law enforcement agencies. This is due to the anonymous nature of transactions, which are carried out using coins or tokens. Cash remains the principle asset used by criminals to launder their illicit gains. However, cryptoassets are now being used on a wide scale and in significant quantities. This has recently been demonstrated by the London Metropolitan Police’s recent seizure of £180 million of a yet unnamed cryptocurrency held by an individual arrested on suspicion of money laundering.[10]

Currently, the UK regulatory regime differentiates between certain types of cryptoassets. While trading of cryptocurrencies is not directly regulated, offering services such as trading in cryptocurrency derivatives does require authorisation. In January 2021, the FCA banned the offering of crypto derivatives products to retail consumers.[11] An example of a ‘crypto-derivative’ would be a futures contract in relation to Bitcoin, by which Party A agrees to buy 1 Bitcoin from Party B in exchange for £30,000, but the sale won’t take place until next Monday (thus, Party A is gambling that the price won’t fall). The FCA took the view that “retail consumers can’t reliably assess the value and risks” of these products and that banning them would prevent up to £101 million worth of harm to retail investors per year. [12]

FCA crypto registration developments 

Currently, just six entities offering cryptoasset services have secured registration with the FCA.[13] Meanwhile, a number of companies sit on the list of sign-ups to the Temporary Registration Regime (TRR). The TRR was established in 2020, to allow for the continued trading of businesses who applied for supervision before 16 December 2020 whilst their credentials are under assessment by the FCA. As such, new cryptoasset businesses will be unable to join the TRR and must immediately seek full registration with the FCA. Any firms operating without a registration (temporary or full) are potentially committing a criminal offence.

The FCA will only accept businesses for permanent supervision where they can prove they have policies, controls and processes to effectively identify and prevent the use of cryptoassets for money laundering purposes.

As at the end of June 2021, it was reported that around 64 cryptoasset firms had withdrawn their applications. [14] Such businesses are required to cease regulated trading activities, and are under threat of enforcement action where they fail to do so.

The FCA maintains a Warning List of unregistered businesses which it believes continue to pursue cryptoasset activities. The FCA urges consumers to avoid dealing with firms on the Warning List and also, all financial services firms to ensure they are not dealing with firms on the Warning List. The FCA has stressed that the Warning List “should be an essential component of existing systems and controls inhibiting financial crime, creating more intrusive due diligence when such firms are seeking to set up or require professional advice or assistance, or seek banking or payment services here in the UK”.[15] In a speech delivered by the FCA CEO, Nikhil Rathi, the following point was made in respect to the registration of cryptoasset firms – “A significant number are not meeting the required standards under money laundering regulations. We have identified 111 firms operating without registration. They are listed on our website and we will take further action where appropriate. We want to support innovation and believe we can do so whilst maintaining rigorous standards on anti-money laundering controls”.[16]

In June 2021, Binance, the world’s largest cryptocurrency exchange by trading volume, was issued a warning by the FCA whereby Binance Markets Limited is not permitted to undertake any regulated activity in the UK.[17]

As noted, the FCA does not regulate cryptocurrencies, but requires exchanges to register with them. Binance has not registered with the FCA and therefore is not allowed to operate an exchange in the UK. Whilst the FCA further stated that no other entity in the wider Binance Group is permitted to conduct regulated activities in the UK, it is still possible for UK consumers to buy and sell cryptocurrencies via the exchange offered on Binance.com. This is because Binance.com is operated from outside the UK at its Cayman Islands base.

The who, how and when of FCA registration

All sectors in scope of the UK money laundering regulations including businesses operating in the crypto market are required to operate on a risk-based approach. This means that businesses can implement controls, policies and processes that are proportional to the size and nature of their business activities. This includes risk assessing their customers and applying the appropriate due diligence requirements.

Registering with the FCA for anti-money laundering supervision begins with completion of a form and payment of a registration fee. Information that the FCA will require includes details of key personnel at the applicant business so that they can be assessed as whether they are fit and proper to carry out their role. Other documentation which will be requested includes but is not necessarily limited to a business plan, marketing strategy, information on the corporate structure of the applicant, details of the key IT systems used, anti-money laundering policy and procedural documentation as well as a risk assessment for the business.

Once the FCA has received all requested documentation it may take up to three months for a final assessment of suitability and acceptance for supervision. Consequently, forward planning and efficient workflow management are recommended and some applicants will benefit from external support from legal and regulatory consultancy advisors.

Money laundering is the key to cryptocurrency-based crime. The primary goals of cybercriminals who steal cryptocurrency, or accept it as payment for illicit goods, are to obfuscate the source of their funds and convert their cryptocurrency into cash so that it can be spent or kept in a bank. 

Cryptoasset firms who want to stay out of the FCA’s cross hairs should take steps to ensure that they comply with the existing regulations, including seeking specialist legal advice where needed.

Ince is an international law and business services firm with teams in both the UK and Gibraltar who can provide expertise in helping clients navigate the complex regulatory regime established to combat money laundering and the financing of terrorism. We regularly advise both established and new entrant clients in the crypto sector and can provide guidance to your business throughout and beyond the application process.

Businesses requiring assistance on their registration with the FCA and operate in the UK in a way which complies with the relevant laws and regulations are encouraged to reach out to Annette Fong (UK) or Will Tunstall-Prince (UK/Gibraltar) for a free initial consultation.

This article, written by Annette Fong, Head of Compliance Solutions, was co-authored by Will Tunstall Prince, Trainee Solicitor.

Sources:

[8] Cryptoasset firms include: cryptoasset exchanges; cryptoasset ATMs; custodian wallet providers; issuers of new cryptoassets (for example through ICOs or IEOs); and those publishing open source software such as non-custodian wallet providers.

Annette Fong

Annette Fong Head of Compliance Solutions

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