Crypto assets to be declared financial products

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The Financial Sector Conduct Authority (FSCA) last week issued a ”draft declaration” that will bring crypto assets such as bitcoin under its regulatory watch. The public has until 28 January 2021 to comment.

The burgeoning crypto market has been largely unregulated until now, though purchasing crypto assets does fall under several other laws, notably exchange control, Pension Funds Act (limiting the amount of “alternative assets” that may be held in a pension fund) and the Collective Investment Schemes Act.

What was missing from this arsenal of regulation is what to do about crypto assets, which have the potential to evade regulatory authorities worldwide. As economist Dawie Roodt points out in a Moneyweb Crypto podcast, “private monies” such as bitcoin are easy to hide from authorities and this means they can also be hidden from tax agencies. That potentially poses an existential threat to governments and nation states everywhere.

Regulations such as those proposed by the FSCA rely on public honesty. Crypto exchanges such as Luno and VALR are largely supportive of regulation where these provide better protection for consumers and help week out the many scams proliferating around bitcoin.

Authorities and crypto industry players have been debating for years how to define and regulate this market.

With bitcoin now sailing back towards its 2017 peak of about $20,000, it’s become clear that some form of regulation was on its way.

The draft declaration by the FSCA means crypto assets such as bitcoin and Ethereum will henceforth be classified as financial products under the Financial Advisory and Intermediary Services (Fais) Act.

Crypto operators must now give unbiased advice

This means that anyone giving advice or acting as an intermediary – such as a crypto exchange – would have to register as a financial services provider and comply with the requirements of the Fais Act.

One of the key aims of the FSCA declaration is to emphasise the high risks of investing in crypto assets, and intermediaries involved in this market -0 such as crypto exchanges – will have to do proper risk assessments and give unbiased information when advising clients.

Virtually all exchanges, anticipating that such rules were on the way, long ago implemented Know Your Customer (KYC) and Anti-Money Laundering (AML) rules (as required by the Financial Intelligence Centre Act, or FICA). This means you have to prove where your funds originated before investing in crypto assets.

What the FSCA draft declaration also means is that crypto exchanges and other crypto intermediaries will henceforth be licensed as financial services providers. The licensing and reporting requirements will allow authorities to build a richer database of information around this emerging asset class.

Crypto scam detection

Crypto intermediaries have been broadly supportive of regulation since it brings credibility to this emerging asset class and will help snuff out scams (of which there re many). A general rule of thumb for scam detection is don’t answer a too-good-to-be-true invitation that comes to you via WhatsApp.

The Intergovernmental Fintech Working Group, involving government, regulators and industry players, published a position paper in May 2020 to develop a regulatory framework for crypto assets, focusing on areas such as:

  • The implementation of an anti-money laundering and counter-terrorism financing regime,
  • A licensing and supervisory regime from a conduct of business perspective, and
  • A regulatory regime for the monitoring of cross-border financial flows.

But…there are a few problem areas

The FAIS Act imposes strict rules on how intermediaries market to clients, and the manner in which advice is given. Also covered under this Act is how client data is stored.

Responsible exchanges have invested large amounts of money in securing the crypto assets of clients using “cold storage” (disconnected from the internet) and multi-person authorisations (to prevent any one or two people in an exchange legging it with your crypto – which is, after all, nothing more than information in bits and bytes). These are the type of security questions you would need to ask an exchange before investing with them.

Farzam Ehsani, co-founder of crypto exchange VALR, notes that the FSCA declaration is not one of the 30 recommendations in the Position Paper on Crypto Assets that was published by the regulators in April 2020.

“Furthermore, all of the products in the FAIS Act have a central issuer and crypto assets such as bitcoin do not. Gold, for instance, is not classified as a financial product under the FAIS Act. We look forward to engaging fully with the FSCA during the comment period to ensure a fair, relevant and appropriate regulatory position for the benefit of all South Africans.”

Rocelo Lopes of crypto company Stratum says there are some benefits to the FSCA proposed regulation in that it would allow customers to weed out bad actors in the crypto space by establishing a hierarchy of credibility around responsible players, but the FSCA needs to take great care how it stores and secures the information it proposes gathering so as not to expose clients’ crypto portfolios to hacking or other intrusions.

“The FSCA would need to realise the enormous responsibility that comes with this appointed task and know that the crypto industry leaders will be keeping a close watch as it all unfolds,” says Lopes.

It is clear from the FSCA statement that this is the first of several regulatory steps affecting crypto assets that we can expect going forward.

What’s your view?  Is regulating crypto assets a good thing?