The crypto asset ecosystem is rapidly evolving and developments continue to challenge the application of existing legislation and regulations to emerging activities. Consumers are strongly advised to ensure that they fully understand the products and services they are getting exposed to, as well as the risks thereof.
The Financial Sector Conduct Authority (“FSCA”) has published a general notice 1350 of 2022 which can be referred to as the Declaration of a crypto asset as a financial product under the Financial Advisory and Intermediary Services Act 2022, in which it declares crypto assets as a financial product.
A “crypto asset” means “a digital representation of value that is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investments and other forms of utility; applies cryptographic techniques and uses distributed ledger technology”.
This will play a big role in making it easier for the public to distinguish between licensed and unlicensed crypto service providers, therefore helping members of the public to find a safer environment to buy and sell crypto assets.
Crypto assets remain highly volatile and inherently risky due to their decentralised and dis-intermediated value proposition. Their nature leads to the challenge of decentralised responsibility in the event of something going wrong because there is no central intermediary, issuer or ledger keeper, consumers essentially have no recourse to any authority or entity to address or resolve user errors (e.g using the wrong crypto asset address or sending Bitcoin to an Ethereum address).
The implementation of regulations in South Africa
On 20 November 2020, the FSCA published a draft Declaration of Crypto Assets as a Financial product under the FAIS Act, for public consultation. A total of 94 individual comments were received from 22 different commentators, following this public consultation process, the FSCA published the final Declaration in the Government Gazette and on the FSCA’s website. The FSCA finally declared crypto assets as a financial product under the FAIS Act, which was gazetted on 19 October 2022, this came together with increased selling of crypto assets to consumers in South Africa that was often coupled with misrepresentation and fraud. A long period of silence has finally been broken by the commissioner of the Financial Sector Conduct Authority, Unathi Kamlana.
The FSCA has also published a Policy Document supporting the Declaration. The Policy Document provides clarity on the effect of the Declaration, including transitional provisions, and the approach the FSCA is taking in establishing a regulatory and licensing framework that would be applicable to Financial Services Providers (FSPs) that provide financial services in relation to crypto assets.
In addition to the Declaration and Policy Document, the Authority also published a general exemption for persons rendering financial services (intermediary services or advice) in relation to crypto assets, in terms of section 7(1) of the FAIS Act. To facilitate the application of an appropriate regulatory framework for crypto assets , the FSCA also published a draft exemption of persons rendering Financial Services in relation to crypto assets from certain requirements. The draft exemption proposes to exempt licensed crypto asset FSPs and their key individuals and representatives from certain requirements of, amongst others, the General Code of Conduct for Authorised Financial Services Providers (General Code) and their representatives as well as the determination of Fit and Proper Requirements. Requirements contained in the General Code and Fit and Proper requirements will apply to all crypto asset FSPs once licensed, except those requirements that are exempted from, in terms of the draft General Exemption.
The South African Reserve Bank (“SARB”) issued additional guidance notes that emphasise the fact that many banks lack the requisite technical expertise to adequately assess the risks stemming from crypto assets from a legal, financial, technical and operational perspective. Although the Financial Action Task Force (“FATF”) issued an update to their recommendation 15, which reinforced the need for financial institutions to identify and assess the money laundering or terrorist financing risks related to the use of new developing technologies, and take appropriate measures to manage and mitigate the associated risks before using new or developing technologies. Banks have been encouraged to not use a “one size fits all” approach when dealing with crypto asset service providers from a risk perspective but rather apply a risk based approach. SARB advises banks to conduct risk assessments on crypto assets and crypto asset service providers (Casps) to determine the appropriate level of risk management as opposed to total avoidance, in line with the application of a risk based approach. The note (dated 15 August 2022) suggests that “if the risk posed by a particular business or customer is too great to manage successfully, the decision to de-risk should only be made after careful due diligence and consideration”.
Intergovernmental Fintech Working Group
The crypto assets industry has been the subject matter of much debate given the advances made in technology and the breakneck speed in which people have placed their trust within this industry. The FSCA Declaration demonstrates that South Africa’s regulators aim to keep pace with international technological advancement within the financial services sector and adapting current regulatory frameworks where applicable.
The regulatory intervention has been a long time coming and was informed, initially by work completed by the Intergovernmental Fintech Working Group (IFWG) in 2016, and more recently by the Crypto Assets Regulatory Working Group (CARWG). The IFWG was established in 2016 to understand the growing role of fintechs and innovation in the South African financial sector and explore how regulators can more proactively assess emerging risks and opportunities in the market. The IFWG includes participation from the National Treasury, the Financial Intelligence Centre, the Financial Sector Conduct Authority, the National Credit Regulator, the South African Reserve Bank, the South African Revenue Service and the Competition Commission.
The classification of crypto as a financial product, which has long been anticipated following the publication of the Intergovernmental Fintech Working Group (IFWG) initial position paper, will help provide regulatory clarity to both crypto asset service providers as well as investors. The licensing requirements that will flow from this classification will drive high standards in the industry, particularly in relation to consumer protection, with potential investors easily able to identify those providers that satisfy regulatory requirements.
The Intergovernmental Fintech Working Group (IFWG) is also excited to provide feedback on its inaugural regulatory sandbox (RSB) initiative, a framework used by regulators across the world to foster innovation in the financial services sector, while keeping oversight of emerging risks. The regulatory sandbox (RSB) provides innovators in the financial sector with an opportunity to test their new products and services that push the boundaries of existing legislation and regulation responsibly, all under the supervision of relevant regulators. The RSB is a controlled environment that enables the testing of innovative products and services against regulation or legislation within predefined parameters and timeframes. The RSB first opened for applications during April 2020, following a cohort-based approach, that is, repeatedly opening the RSB for a period, allowing a new group of participants to test each time. At the same time, the IFWG went through a ‘retrospective’ review to consider how to improve on its approach and processes to serve both applicants and the regulators more effectively through the RSB. The Intergovernmental Fintech Working Group announced the opening of its regulatory sandbox, following an adjusted rolling-based approach, which means that it will remain open for the foreseeable future in October 2022.
Best practices
The key best practices for good cryptocurrency compliance starts with understanding various typologies allowing you to implement effective controls. Integration of compliance technology within your cryptocurrency compliance process remains vital as your cryptocurrency compliance program will only be as good as the employees that oversee it. Bearing that in mind, it is important to ensure that you appoint compliance employees with the ability and expertise to identify AML/CFT threats. The Financial Action Task Force (FATF) recommends that financial institutions take a risk-based approach to AML/CFT compliance – and this guidance extends to cryptocurrency service providers. Risk-based compliance requires firms to deploy compliance measures in proportion to the compliance risk that their customers present. This latest step towards “crypto acceptance” might be likely preceded by ushering in regulatory modalities for crypto exchanges in South Africa with the main focus on asset listing, such as Know Your Customer (KYC) & Anti-Money Laundering (AML).
Kuben Naidoo, the current deputy governor of the SARB and a member of the Monetary Policy Committee, said “We are not intent on regulating it as a currency as you can’t walk into a shop and use it to buy something. Instead, our view has changed to regulating (cryptocurrencies) as financial assets. There is a need to regulate it and bring it into the mainstream, but in a way that balances the hype and with the investor protection that needs to be there.”
Conclusion
Legitimate crypto asset service providers will no longer be painted with the same brush as those using these technologies irresponsibly – or worse – for malicious intentions. This also greatly lowers the barriers to entry for cryptocurrency platforms seeking banking and other commercial relationships as they are currently being treated with prejudice, regardless of their legitimacy. Compliance will be a key concern for crypto investors over the next few months leading to the introduction of monitoring and control regulatory mechanisms by the various South African regulators.
Should you require assistance in understanding the implications of this regulatory development on your crypto asset operations or require advice, guidance and assistance on the licensing process that is now applicable to persons rendering financial services in respect of crypto assets, please contact the FluidRock Compliance, Risk & Ethics team on hello@fluidrockgovernance.com.
Author: Thembi Makhado