Today, the 30th of November 2017, the MFSA issued a discussion paper on initial coin offerings (ICOs), virtual currencies and related service providers. The aim of the proposals set forth by the MFSA is to devise policies which support evolving technologies whilst ensuring that a high level of investor protection, market integrity and financial stability are maintained.
The paper, whilst referring to a statement issued by the European Securities and Markets Authority (ESMA), defines ICOs as a business or individual issuing proprietary coins or tokens, offering them to the public in exchange for fiat currencies or virtual currencies. By making references to the Financial Action Task Force’s (FATF), the paper also provides a definition of virtual currency as being a ‘digital representation of value that can be digitally traded and functions as 1) a medium of exchange and/or 2) a unit of account and/or 3) a store of value, but does not have legal tender status in any jurisdiction.’ In essence, the lack of legal tender status is the primary difference between fiat money and virtual currency.
The paper also distinguishes between virtual and digital currencies, with the latter being described as a ‘digital representation of either virtual currencies or e-money.’ Moreover, cryptocurrency is further defined as a ‘math based, de-centralised, convertible virtual currency that is represented by cryptography. Henceforth, at the very least, the discussion paper consolidates different terminology and seeks to provide guidance on differences between each concept.
The paper recognises that certain activities undertaken within the field of virtual currencies and ancillary services thereof could fall within the scope of the Investment Services Act whilst other activity may fall outside such scope. Such differentiation paves the way for the realisation that policy guidelines are needed which should eventually be transpose themselves in legislation.
The Financial Instrument test:
Of pivotal importance is the determination as to whether virtual currency is to be determined as a financial instrument. Should such be the case, MiFID provisions would most certainly apply. In an attempt to provide guidance on such, the MFSA is proposing
- A ‘Financial Instrument test’ which is currently being devised.
- A Virtual Currencies Act which shall regulate activity falling outside the scope of a financial instrument and hence outside the scope of currently enforced EU and national legislation.
In this manner, the discussion paper indicates that the MFSA is intent on having a rulebook for all kind of activity in relation to virtual currencies, irrespective of whether the virtual currency in question is classified as a financial instrument or otherwise.
Expansion of collective investment schemes investing in cryptocurrencies:
The paper moves on to prompt the possibility of providing a licensing remedy for Alternative Investment Funds and Notified Alternative Investment Funds which invest in virtual currency. This expands on the MFSA’s intention to regularise Professional Investor Funds which invest in virtual currencies. Despite the aforementioned possibility of expansion however, it is evident that no retail fund option is in the pipeline since the paper clearly states that ‘collective investment schemes investing in virtual currencies will not be allowed to be established as UCITS’.
Interesting to note is that, in relation to already existing license holders, the MFSA is proposing that activity carried out in relation to virtual currencies would have to be channelled through a specifically created subsidiary which would require a license under the to-be proposed Virtual Currencies Act.
The ‘complex instrument’ principle:
Another measure which seeks to protect investors is that any virtual currency not considered as a financial instrument, shall still be classified as a ‘complex instrument’ (as defined under MiFID) and therefore, investor protection measures as noted in MiFID shall apply to such firms. Therefore, MiFID principles shall be reverberated in the to-be-proposed Virtual Currencies Act.
When the virtual currency is classified as a financial instrument, it is to be subject to the Prospectus Directive and hence be treated and subject to obligations under currently enforced legislation.
With regards to virtual currencies which would not be classified as financial instruments, the paper denotes that these are to be subject to a license under the to-be-proposed Virtual Currencies Act which must be obtained by a specifically created subsidiary.
The paper recognises the European Banking Authority’s indication that such institutions should be discouraged from engaging in virtual currency related activity. The paper indicates that there might be the possibility that the MFSA is considering revising its position to allow credit institutions to deal in virtual currencies strictly on behalf of its clients. Again, this would need to take place through the setup of a licensed subsidiary under the to-be-proposed Virtual Currencies Act.
The paper clearly explains that financial institutions licensed under the Financial Institutions Act are not allowed to act as intermediaries of virtual currencies. The alternative to such, as suggested by the papers, would be that such institutions would need to set up a subsidiary, duly licensed under the to-be-proposed Virtual Currencies Act, which is completely segregated from the PSP’s or EMI’s regular business. The relevant license under the to-be-proposed Virtual Currencies Act would naturally be available to star-ups who do not possess a license under the Financial Institutions Act.
Initial Coin Offerings:
High level regulatory principles on transparency and merit based regulation as those applicable to standard securities which seek a listing on a regulated market would also apply to ICOs in terms of the Virtual Currencies Act. Those virtual currencies which would be classified as ‘financial instruments’ under the financial instrument test would be subject to currently applicable regimes.
All persons carrying out activities or providing services relating to virtual currencies shall be deemed to be ‘subject persons’ and hence be subject to all applicable AML and funding of terrorism laws and regulations.