The Malta Financial Services Authority (the “MFSA”) published a discussion paper to present to the public a proposed policy to be adopted by the MFSA for the regulation of the Initial Coin Offerings (“ICOs”), virtual currencies (“VCs”) and service providers involved in such activities. The aim behind the proposed policy is to support innovation and new technologies for financial services in the area of VCs whilst ensuring effective investor protection, financial market integrity and financial stability. The major issues intended to be regulated through this proposed policy are the following;
Definitions and classifications
The first issue addressed by the MFSA in the discussion paper is defining the terms of ICOs and VCs. ICOs were defined as ‘’an innovative method of raising funds from the investing public, using so-called ‘coins’ or ‘tokens’.’’ These coins or tokens serve to access the service or product that the issuer develops using the proceed of the ICO, or provide voting rights or share in the future revenues of the issuing venture. On the other hand, for VCs the MFSA accepts the definition assigned to VCs by the Financial Action Task Force (the “FATF”), and explains how digital currencies encompass both electronic money and VCs, with cryptocurrencies being a sub-category of the latter. Further to sub-dividing VCs into coins and tokens, the MFSA proposes to further sub-categorise VCs into securitised and utility tokens.
Introduction of the ‘Virtual Currencies Act’
The discussion paper acknowledges how certain VCs and activities related to VCs could fall within the scope of existing financial services legislation while other VCs and related activities could fall out of the scope of the existing framework and thus remain to be unregulated. In this regard, the MFSA is proposing to adopt a new legislative framework specifically regulating the carrying on of business associated with VCs falling outside the scope of the existing national and EU financial services legislation. To this end, the MFSA is proposing the drafting of a new ‘Virtual Currencies Act’ (the “Act”), where it should apply a principles-based approach and then supplemented by MFSA guidelines, rather than a rules-based approach, in order not to stifle technological innovation. The discussion paper is also inviting the major stakeholders to submit their views on whether certain types of utility tokens should be exempted or not from the proposed Virtual Currencies Act.
Financial Instrument test
Based on the above, the discussion paper puts a lot of importance on whether the features of the VC constitute a financial instrument under MiFID and other relevant existing legislation, specifically in the forms of: i) transferable securities; ii) units in collective investment schemes; iii) commodities; and iv) their respective financial derivatives contracts. The discussion paper calls this test as the ‘Financial Instrument test’ and should form part of the proposed Virtual Currencies Act.
Fit and proper test
The discussion paper also emphasises on the overarching principle that persons involved in activities concerning VCs are required to be ‘fit and proper’. The fit and proper test shall be satisfied based on sufficient competence, experience, knowledge and expertise of the person in the field of the IT, the VCs and their underlying technologies, including the Distributed Ledger Technology (“DLT”).Issuers of ICOThe Discussion paper also emphasises the fact that issuers of ICOs must carefully consider whether their activities constitute regulated activities or not, based on the ‘Financial Instrument Test’. If the test indicates that a VC issued through an ICO does not qualify as a financial instrument, then the proposed Virtual Currencies Act would apply. This Act should contain similar high level regulatory principles on transparency and merit-based regulation as those currently applicable to securities seeking a listing on a regulated market.
Collective Investment schemes
For collective investment schemes investing in VCs, the MFSA is considering the possibility to see the proposed framework for PIFs investing in VCs, to which the consultation document proposing it was published by the MFSA on the 23rd October, to be extended also for AIFs and NAIFs investing in VCs. However, the discussion paper makes it clear that collective investment schemes investing in VCs will not be allowed to be established as UCITS.
Investment Services License Holders
Investment services licence holders wishing to provide an investment service in relation to a VC will also have to conduct the ‘Financial Instrument test’ on the relevant VC and if it does not qualify as a financial instrument the existing licence holder would have to obtain a separate licence under the Virtual Currencies Act. Existing investment service licence holders would be required to set up a subsidiary solely for the purpose of providing services and activities in relation to VCs that do not qualify as financial instruments. A VC that does not qualify as a financial instrument should automatically be classified as a complex instrument as defined under MiFID.
Commercial trading in VCs is mostly done via unregulated platforms, often called exchanges. If a VC intends to apply for admission to trading on secondary market, it depends whether that VC is qualified as a financial instrument or not. If the VC if not qualified as a financial instrument, the existing legislation shall not apply, and the Act would apply. The Act would provide for a framework for the regulation of the issuer and the exchange platform. MiFID trading platform would have to set up a subsidiary solely for the purpose of listing and trading VCs which do not qualify as financial instruments.
The MFSA is also considering whether it should revise its position to allow credit institutions to deal in VCs that do not qualify as financial instruments, solely on behalf of their clients, subject to the proposed requirement of setting up a subsidiary which ensures complete segregation from the credit institution’s regular business. The relevant subsidiary would be required to obtain a specific licence under the Virtual Currencies Act.
In the discussion paper, the MFSA, reiterates that any person making use of VCs as an instrument of payment for goods or services must be aware that the Financial Instruments Act does not cater for risks associated with VCs. Therefore, the MFSA is proposing that financial institution shall only be allowed to provide payment services in relation to VCs solely on behalf of their clients, subject to the proposed requirement of setting up a subsidiary, which such subsidiary would be required to obtain a specific licence under the proposed Act.
Insurance companies and retirement pension schemes
The discussion paper is proposing to prohibit insurance companies and retirement pension schemes from dealing in VCs for their clients or their own account.
Anti-Money laundering provisions
The MFSA is proposing that any person carrying out an activity or service in relation to VCs whether the VC is deemed as a financial instrument or not, shall be considered as a subject person under the Prevention of Money Laundering and Funding of Terrorism framework and thus has to comply with it.
The MFSA is inviting the major stakeholders to submit their feedback on any issues present in the field of VCs and ICOs, and on the proposed legal framework as outlined in the discussion paper, until the 11th January 2018.
Please feel free to contact us should you require more information on this discussion paper and the proposed legal framework disclosed in such discussion paper, or on Virtual Currencies and Initial Coin Offerings.