Regulators on both sides of the Atlantic continue to monitor and address cryptoasset and distributed ledger technology activities. We recently posted on the guidance issued by the US Financial Crimes Enforcement Network on cryptocurrencies and in another post touched upon differences in the regulatory treatment of cryptoassets across jurisdictions. Today we report on two new developments relating to the treatment of cryptoassets by UK and US regulators.
The Joint Committee of the European Supervisory Authorities (the ESAs) issued a report on 7 January 2019 on the status of regulatory sandboxes and innovation hubs following consultations with national regulators across the European Union.
The report compares the innovation hubs and regulatory sandboxes established in 21 EU member states and three EEA states, flagging too that Hungary and Spain are in the process of establishing regulatory sandboxes.
The ongoing and accelerating pace of developments in the realm of cryptoassets in multiple jurisdictions warrants continual review and monitoring. In a report issued earlier this month on the implications of cryptoassets, the international Financial Stability Board (FSB) stated that, while cryptoassets do not currently pose a material risk to global financial stability, vigilant monitoring is needed in light of the speed of market developments. The FSB believes that due to risks such as low liquidity and the use of leverage, market risks from volatility, and operational risks, cryptoassets lack the key attributes of sovereign currencies and do not serve as a stable store of value or a mainstream unit of account. The financial stability implications of these cryptoasset characteristics include an impact on confidence in, and reputational risk to, financial institutions and regulators; risks arising from financial institutions’ exposures to cryptoassets; and risks arising if cryptoassets were to become widely used in payments and settlement. Therefore, regulators are encouraged to “keep an eye on things” as cryptoassets continue to spread throughout the world economy.
The UK Financial Conduct Authority (FCA) issued a press release on August 7 announcing that it has joined 11 other financial regulators from around the world to create the Global Financial Innovation Network (GFIN), building on its proposals earlier in the year to create a “global sandbox.” The network is intended to provide fintech firms a more efficient way to interact with regulators as they test new ideas across different markets and to create a new framework for regulators to cooperate on areas of innovation. This announcement continues a regulatory trend of being more hospitable to fintech innovation, as we have previously discussed.
Arizona has become the first state in the United States to enact a law to create a “Fintech Sandbox” – a safe zone for fintech startups to test new applications and financial services otherwise subject to state money transmitter, banking, and similar licensing requirements without having to obtain a state license. Although other countries, such as the United Kingdom, Singapore, and Australia, have created similar fintech sandboxes, similar legislation or regulations thus far have not been adopted in the United States at the federal or state level.
The Fintech Sandbox idea was promoted by the Arizona attorney general and will be administered by the Arizona Office of the Attorney General (AZ OAG). However, the Fintech Sandbox does not mean that fintech companies will be unregulated in Arizona. There will be a substantive application and oversight process.
Less than a year after the Conference of State Bank Supervisors (CSBS) announced Vision 2020, an initiative to modernize state regulation for non-bank financial companies, the CSBS revealed plans to establish a standardized licensing practice for money services businesses. Seven states have agreed to a compact whereby all participating states accept the findings of one state that has reviewed money transmitter licensing requirements, including IT, cybersecurity, business plan, background check, and compliance with the Bank Secrecy Act. The states that have joined the compact include Georgia, Illinois, Kansas, Massachusetts, Tennessee, Texas, and Washington.
As we have been reporting, cryptocurrency, as an asset class, is currently taking the world financial markets by storm. Total market capitalization of cryptocurrency is estimated to be in the hundreds of billions of dollars and new initial coin offerings (ICOs) seem to crop up every other day, while the United States and other countries' governments have been left scrambling to figure out how to best regulate this new asset class and protect market participants and end users.
The US Securities and Exchange Commission (SEC) has been a leader in taking affirmative steps toward exercising some oversight of the fragmented cryptocurrency market. On January 18, the SEC’s Division of Investment Management published a staff letter detailing some of the Commission’s concerns about how cryptocurrency-related products will comply with the Investment Company Act of 1940, including specific issues relating to valuation, liquidity, custody, arbitrage, and potential manipulation.
Recent events in the cryptocurrency markets, including the wild swings in the trading prices of bitcoin, the growing incidence of initial coin offerings (ICOs) entailing the offer and sale of unregistered securities, and the launch of bitcoin futures trading, have encouraged the federal government to ratchet up its interest in virtual currencies. Not only have the Commodity Futures Trading Commission (CFTC) and the US Securities and Exchange Commission (SEC) made public announcements about virtual currencies and taken enforcement action against virtual currency companies or initial coin offerors in recent months, but Congress now is showing increased interest in bitcoin and other virtual currencies. A few very recent signals of heightened governmental interest in virtual currency are highlighted below:
- The Senate Committee on Banking, Housing, and Urban Affairs (Senate Banking Committee) held two hearings in January during which virtual currencies were discussed in connection with strengthening anti-money laundering (AML) laws
- Reports indicate that the Senate Banking Committee will hold a hearing in February to analyze the implications of cryptocurrencies. CFTC Chairman Christopher Giancarlo and SEC Chairman Jay Clayton will likely testify at the hearing
- On January 19, Mr. Giancarlo called on the Futures and Derivatives Bar to “set the course for the future” of virtual currencies
- In a January 22 speech, Mr. Clayton again cautioned market professionals and “gatekeepers” that they need to “do better” in their handling of ICOs, and said that the SEC staff will be on “high alert” for ICOs that may be “contrary to the spirit of our securities laws.”
The Office of the Comptroller of the Currency (OCC) has released FAQs to supplement its 2013 guidance on risk management of third-party relationships. The FAQs specifically address bank relationships with fintech companies and marketplace lenders, relationships that were not necessarily an OCC focus when the 2013 guidance was issued.
As with its 2013 guidance, the FAQs focus on managing risk through a bank’s adequate due diligence and ongoing monitoring of third-party service providers such as fintech companies, and places ultimate responsibility for risk management with the bank’s management and board of directors. The FAQs recognize that the levels of due diligence and ongoing monitoring may differ based on the risk and complexity presented by specific third-party relationships.
After signaling earlier this year that it was considering delaying the effective date of the Prepaid Accounts under the Electronic Funds Transfer Act (Regulation E) and the Truth in Lending Act (Regulation Z) final rule (Prepaid Accounts Rule), the Consumer Financial Protection Bureau (CFPB) has officially delayed the effective date of the Prepaid Accounts Rule for six months to April 1, 2018. This delay comes as the CFPB has been facing significant pressure from industry, the US Congress, and consumer groups to delay or (in the case of consumer groups) retain the original effective date of the rule.