By Wesley Pons, Associate and Elani Vogel, Candidate Attorney
1. Introduction
On 16 April 2020, the Intergovernmental Fintech Working Group (“the IFWG”) published its position paper on crypto assets, providing specific recommendations for the development of a regulatory framework for crypto assets in South Africa (“the position paper”). The IFWG is a body of several South African financial sector regulators, including National Treasury, the Financial Intelligence Centre (FIC), the Financial Sector Conduct Authority (FSCA), the National Credit Regulator (NCR), the South African Reserve Bank (SARB) and the South African Revenue Service (SARS).
The IFWG has defined a crypto asset as: “a digital representation of value that is not issued by a central bank, but is traded, transferred and stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility, and applies cryptography techniques in the underlying technology.”
This article will summarise the key points of the position paper, highlighting the risks associated with crypto assets, and the IFWG’s proposed recommendations as to the manner in which the South African financial regulatory framework can be adapted and expanded to include crypto assets and manage the associated risks.
2. The necessity for the regulation of crypto assets in South Africa
Crypto assets are a form of financial technology (“fintech”) innovation that is expected to materially affect the financial sector. It is viewed as a new form of money, or currency, potentially impacting payments, investments and capital raising. Crypto assets are borderless, and their anonymous and pseudonymous nature increases the difficulty of implementing the correct regulatory and monitoring tools. The IFWG has identified the following risks associated with crypto assets: –
i. A parallel, fragmented, non-sovereign monetary system, impacting the safety and efficiency of the financial system and financial institutions.
ii. Consumer and investor protection, including, data and cyber security risks.
iii. An undefined legal and regulatory framework as crypto assets currently operate within a regulatory void, presenting opportunities for regulatory arbitrage, the circumvention of exchange control regulations, illegitimate cross-border financial flows, money laundering and terrorist financing (“ML/TF”), and tax evasion and impermissible tax avoidance.
3. Five uses of crypto assets identified
i. The buying and/or selling of crypto assets by consumers and legal persons, the exchange of fiat currency (legal tender whose value is backed by the government that issued it) into crypto assets and vice versa, and the exchange of crypto assets into other crypto assets.
ii. The use of crypto assets as an alternative to existing payment systems to pay for goods and services, without the need for a financial institution to execute online or digital payments.
iii. Initial coin offerings (“ICO’s”) from investors to raise capital for specified projects, in exchange for digital tokens.
iv. Crypto asset funds and derivatives, whereby crypto assets could be used as the underlying asset in investment funds, such as hedge funds, private equity funds, collective investment schemes, exchange-traded funds and pension funds.
v. Ancillary crypto asset market support services such as safe custody services, digital wallet provisioning for crypto assets, and crypto asset mining.
4. Summary of IFWG recommendations
All entities providing crypto asset services, within the following categories, must be regarded as crypto-asset service providers (“CASPs”), in terms of schedule 1 of the Financial Intelligence Centre Act:
- Crypto asset trading platform (entities facilitating or providing any of the services);
- Crypto asset vending machine provider;
- Crypto asset token issuer;
- Crypto asset fund or derivative service provider;
- Crypto asset digital wallet provider; and
- Crypto asset safe custody service provider.
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CASPs will be required to register with the FIC as an accountable institution, meaning CASPs will be required to adhere to the legislative requirements aimed at anti-money laundering and combatting the financing of terrorism, including, conducting customer identification and verification and reporting to the FIC any suspicious and unusual transactions.
The IFWG recommend that crypto assets should remain without legal tender status and should not be recognised as electronic money. Crypto assets must not be allowed for the conduct of money settlements in financial market infrastructures such as the South African Multiple Option Settlement (SAMOS) system.
National Treasury’s Tax Policy Unit, alongside SARS, must consider the adoption of a uniform definition of crypto assets, as the existing definition adopted by SARS refers to ‘crypto currencies’, not to ‘crypto assets.’
Recommendations for regulating the buying and selling of crypto assets:
The buying and selling of crypto assets must be included in the definition of ‘financial services’ in the Financial Sector Regulation Act (“FSR Act”) and ‘services related to the buying and selling of crypto assets’ must be included in the licensing activities under the CoFI (Conduct of Financial Institutions) Bill.
The FSCA should become the responsible authority for the licensing of ‘services related to the buying and selling of crypto assets.’ The Financial Surveillance Department of the SARB (“FSD”) should assume the supervisory and regulatory responsibility for the monitoring of illegitimate cross-border financial flows in respect of crypto asset services.
Exchange Control Regulations should include crypto assets to prohibit any person from directly or indirectly exporting capital from South Africa (in the form of crypto assets) without Treasury permission.
The FSD should amend the Exchange Control Regulations to allow individuals to purchase crypto assets within the single discretionary allowance (SDA) and the foreign capital allowance (FCA).
The exchange control framework should be amended to allow licensed CASPs to source or buy crypto assets offshore for the purpose of selling in South Africa.
Recommendations for regulating payments using crypto assets:
The National Payment System Act should develop a framework to regulate the use of crypto assets for domestic payment purposes and/or the regulation of payment services associated with crypto assets.
Recommendations for regulating ICO’s:
The regulation of ICO issuers (for payment or exchange and utility token offerings) must be aligned, as far as possible, to that of issuers of securities or ‘over-the-counter’ financial instruments, within the Financial Markets Act.
ICO issuers should further be subject to the CoFI Bill licensing requirements and conduct standards. ICO issuers should be required to prepare a detailed prospectus, equivalent to a white paper, setting out specific requirements and details on disclosures about the company, a governance plan, any agreement(s) between the customers and ICO issuers, comprehensive independent audits, and specific reports to regulators.
Recommendations for regulating crypto asset funds and derivatives:
The pooling of crypto assets should be regarded as an alternative investment fund and, therefore, should become a licensed activity in terms of the CoFI Bill. However, a collective investment scheme should not be allowed to include crypto assets in its portfolios.
The FSCA should determine whether crypto assets should be considered as allowable assets for the asset-spreading requirements of pension funds.
The current regulatory framework should be extended to include specific requirements for crypto asset derivative instruments, including that settlement must occur in cash or fiat currency.
Recommendations for regulating crypto asset market support services:
CASPs offering custodial services and/or digital wallet provisioning should be considered as providing financial services in the FSR Act, and should, therefore, become a licensing activity under the CoFI Bill.
5. Conclusion
The IFWG’s position paper sets out the recommendations for the implementation of a regulatory framework for crypto asset activities. Implementation of the recommendations would bring about strict financial oversight and monitoring across all financial regulators. However, due to the global nature of crypto assets, financial regulators are faced with new challenges and risks to financial stability and monetary policy. In order to avoid regulatory arbitrage, regulation of crypto assets should ideally take place in line with international standards.
The IFWG has invited stakeholders and interested parties to submit their comments on the position paper, in order to facilitate a consultation process, before the IFWG provides a final position paper for the implementation of a regulatory framework for crypto assets.
Schindlers Attorneys invites any interested parties to submit their comments and/or concerns with the position paper to any of our professionals listed hereunder by no later than 10 May 2020. We will submit consolidated comments received from the public to the IFWG.
