HM Treasury (HMT) recently issued a consultation paper on transposing the Fifth Money Laundering Directive (5MLD) (EU directive 2018/843) into UK law. The regulations will come into force on 10 January 2020 and will bring new firms into scope to help prevent money laundering. Taking a particular interest in Fintech organisations specialising in cryptoassets, the regulation will specifically cover firms dealing with cryptoassets.
Addressing the risks
National and international regulators have raised concerns about the risks of cryptoassets in relation to money laundering and terrorist financing, from the Basel Committee on Banking Supervision (BCBS) to European Banking Authority (EBA) to national government. In terms of the three key steps involved in money laundering, cryptoassets can be leveraged in the following ways:
§ Placement – opening crypto accounts anonymously online
§ Layering – through unregistered Initial Coin Offerings (ICO)
§ Integration – purchasing legitimate items through assets such as Bitcoin
As a result of these concerns, the 5MLD specifically addresses the risks around cryptoassets and discusses how to mitigate them. The directive puts forward the need for increased due diligence processes for crypto exchanges and custodian wallets handling certain types of cryptoassets.
So who is in scope?
HMT is currently working out how to transpose the directive into local law and it presents a much broader definition of cryptoassets than 5MLD itself. This means that more cryptoassets will fall into scope of the regulation than initially expected. The discrepancy is partly due to potential inconsistencies between with the existing FCA draft guidance on cryptoassets perimeter and the underlying provisions in Regulated Activities Order (RAO). The move may be to pre-empt potential changes to the RAO around cryptoassets, essentially future proofing the regulation, but it remains to be seen.
Under 5MLD, the definition is quite narrow and it addresses ‘virtual currencies’ as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically." This is based on both the form (ie digital) and nature (ie means) of the asset.
However, in the HMT consultation, ‘cyptoassets’ are defined as a “cryptographically secured digital representation of value or contractual rights that uses some type of distributed ledger technology and can be transferred, stored or traded electronically”. In other words, the criterion is based on the form of the asset, not the substance. Essentially it means that exchange services between fiat and virtual currencies and custodian wallet services are included in the regulation.
How this subtle, but important, difference in definition will affect the regulatory landscape remains to be seen. Some commentators have pointed out that an important difference is that 5MLD definition on virtual currencies is based on cryptoassets which are capable of facilitating a substantive business relationship. But the broad definition (as proposed by HMT) could cover scenarios in which no substantive business relationship took place, in relation to the cryptoassets. This could potentially bring in a far greater scope of cryptoassets into the 5MLD regime, which presents confusion and regulatory uncertainty.
So what should firms do now?
HMT’s consultation sets out the controls expected from a cryptoasset exchange and custodian wallet providers, in order to mitigate AML risks. We recommend businesses review the FCA perimeter guidance on cryptoassets and the HMT consultation paper to check if your organisation – and the cryptoassets you work with – are in scope. You should undertake a gap analysis to assess your current systems and controls to identify what AML measures need to be put in place to achieve compliance with 5MLD. We can help structure programmes of analysis – contact us for more information.