Regulating the Future Crypto Economy
Malta is often being touted as the “Blockchain Island” and as being crypto-friendly, attracting a lot of interest from the DLT and Cryptocurrencies sphere for its proposed legislation and rules. Blockchain is hailed as revolutionary in the way business is conducted and Malta’s ambitious plan is to be a leader in this new modern era.
The proposed Virtual Financial Assets Act (VFAA), which has been approved by the Maltese Parliament will regulate cryptocurrencies qualifying as Virtual Financial Assets (VFA) and related VFA services. The Act aims to establish a solid legal framework which is not only intended to attract legitimate operators seeking accreditation and transparency, but also to create stability in a sector which has in the past months been marked by hype and in certain instances, abuse.
Virtual Financial Assets
The concept of a VFA under Maltese law refers to any form of digital medium recordation used as a digital medium of exchange, unit of account or store of value that excludes electronic money, financial instruments and virtual tokens. In order to determine the legal framework applicable to a coin or token, the MFSA has proposed a Financial Instrument Test to establish whether a DLT Asset would be considered as a financial instrument and thus falling under current financial services legislation, a virtual token which falls outside the scope of the VFAA (and financial services) or a VFA which is regulated under this new Act.
The concept of a virtual token, more commonly referred to as a utility token, is limited in its nature under the VFAA, as it refers to a DLT Asset which has no utility, value or application outside of the DLT Platform on which it was issued. On the other hand, coins and tokens are considered to be financial instruments if they qualify under the definition provided by MiFID which includes: (1) transferable securities; (2) money market instruments; (3) units in collective investment schemes; (4) financial derivative instruments, which include a number of financial instruments; and (5) emission allowances consisting of units recognised for compliance with the requirements of Directive 2003/87/EC (Emissions Trading Scheme). In order to supplement the VFAA, over the next few months the MFSA will also be issuing additional rules and guidelines on its implementation.
Initial Virtual Financial Asset Offerings
One primary element of the Maltese regulation is the regulation of ICOs which are termed as Initial Virtual Financial Asset Offerings. The lack of regulation worldwide has allowed the market to be infiltrated by fraudulent platforms allowing seemingly legitimate entrepreneurs seeking crowdfunding to accumulate millions of investor funds only to then disappear with that money and leaving bona fide investors in the dark.
The VFAA is intended to address this need for regulation and investor protection. It sets out the requirements when offering VFAs to the public, including obligations when presenting advertisements, as well as the ensuing liability should any statements used be misleading, inaccurate or inconsistent. The Act also sets out specific information that must be included in the Whitepaper which must be registered with the MFSA. The role of the Whitepaper can be compared to that of a prospectus in a traditional IPO1. The requirements in the Act aim to enhance the Whitepaper’s objective of offering clarity to potential investors on the proposed project, while instilling trust and legitimacy in the minds of investors to fund it.
The provision of services related to VFAs is also regulated under the Act. Brokers, wallet providers, asset managers, custodians, investment advisors and market makers offering services related to VFAs all require a licence to be issued by the MFSA as the competent regulatory authority.
Crypto-exchanges, referred to as VFA exchanges, have also been classified as a VFA service and are thus deemed to be a licensable activity. This will therefore regulate those exchanges converting fiat money (such as the Euro, USD, GBP etc) to cryptocurrencies qualifying as VFAs and vice-versa, as well as those exchanges converting one type of cryptocurrency to another.
The MFSA’s Consultation Paper on the VFA Regulations sets out a number of exemptions from the requirement to obtain a licence under the Act. Persons who are trading in VFAs on their own account are not required to obtain a VFA Services Licence if they are solely conducting that activity and they are neither market makers nor dealing on own account when executing client orders. This exemption however is not automatically operative and is subject to the MFSA’s written determination as to the applicability of that exemption.
The proposed VFA Regulations also exempt custodians of collective investment schemes from the requirement of a VFA Services Licence solely for the purposes of providing the custody of VFAs to a collective investment scheme. A similar exemption applies to investment managers of collective investment schemes with regards to offering portfolio management and investment advice under the VFAA in this limited case. These service providers are required to notify the MFSA prior to acting on the basis of this exemption.
The Regulations also set out the Licence Categories for VFA Services. These are modelled very similarly to the licensing categories set out in the Investment Services Act, and under the VFAA, services are classified under four different categories. Operators of a VFA Exchange, including the holding of VFAs and private cryptographic keys require a Class 4 licence by the authority.
The role of the VFA Agent
Issuers of VFAs and applicants for VFA Services Licences are required to appoint a VFA Agent to advise them on their responsibilities and obligations under the Act and to act as a liaison between them and the MFSA. The VFA Agent’s role is an onerous one as it must ensure that the applicant has satisfied all the requirements specified by the Act as well as those set out in the MFSA’s rules, while also ensuring that the applicant is a fit and proper person. These obligations have been set out more clearly in the recently issued MFSA Consultation Document on the VFA Rules for VFA Agents. VFA Agents are required to be authorised by the MFSA and must abide by the ongoing obligations as set out in the proposed rules. Failure to abide by these rules can lead to liability on the part of the Agent.
The law also provides a transitory provision for persons who are already operating when the Act comes into force in the coming months. This means that persons that are set up and trading in or from within Malta may benefit from a grandfathering provision, allowing them to continue to act within the remit of the VFAA, provided that they apply for the licence or authorisation from the MFSA within the specified period of time.
These are exciting times for Malta as we are embracing the proliferation of new and emerging technologies to turn the island into a hub for digital technological innovation. As the MFSA rolls out additional rules and guidelines to supplement the new Act, and once the VFAA comes into force, it is hoped that authorities and service providers, on all levels, adopt a pragmatic and not overly prescriptive approach to enable, and not stifle, technological innovation.
- 1Initial Public Offering