Regulation of Crypto Assets
The IFWG on regulation of crypto-assets
A new era for Cryptocurrency?
Cryptocurrencies have, since their first introduction to the market in South Africa, enjoyed relative freedom from regulatory oversight. Cryptocurrencies were not included in the definition of financial products overseen by the Financial Sector Conduct Authority and neither were they regulated by the South African Reserve Bank.
However, since it has become abundantly clear that cryptos were here to stay, the National Treasury (along with the South African Reserve Bank, the Financial Services Board, the South African Revenue Service, and the Financial Intelligence Centre) issued a statement warning the public about the risks of transactions and investments in crypto assets, at the time referred to as virtual currency (VC). In December 2014, the South African Reserve Bank (SARB), published a position paper highlighting various risks associated with virtual currencies.
In 2016, South Africa established an intergovernmental Fintech Working Group (IFWG) consisting of representatives from the National Treasury, the SARB, the SARS, the Financial Sector Conduct Authority (previously known as the Financial Services Board), the NCR and the Financial Intelligence Centre. The IFWG was established to shed light on the role of financial technology, known as "Fintech", to enable policymakers and regulators to better manage risk and enable innovation and innovation in the South African financial sector. On the 14th of April 2020, a new framework for Fintech was published by the IFWG for public participation.
How does Fintech contribute to the financial sector?
Fintech is technology-enabled financial innovation which aims to reduce costs and frictions, increase efficiency and competition, broaden access and to be an enabler for financial inclusion by leveraging technology. The FSCA described Fintech as "technology applied to financial services, resulting in new business models, applications, processes, products and services with an associated disruptive effect on financial markets and institutions".
Crypto assets are a form of fintech innovation that steadily impacts the financial sector of the country. Subsequently, the need has arisen to develop a regulatory and policy response to crypto asset activities in South Africa.
What are some of the challenges faced by regulators?
Due to the transportable nature of crypto assets, regulators are challenged on a global level as these assets can be classified under numerous economic functions. Should regulation tread across different jurisdictions it could potentially result in a fractioned approach where countries respond with varying measures of stringency. In light of the aforementioned, crypto-asset activity would potentially defect to jurisdictions that are less harshly regulated.
How does the IFWG suggest crypto assets be regulated?
The IFWG recommends that entities providing crypto-asset services be classified as Crypto Asset Service Providers (CASPs), including but not limited to, trading facilitators or platforms, intermediary services and crypto-asset funds or derivatives. CASPs will be required to register as an Accountable Institution with the FIC and will subsequently be required to adhere to the legislative obligations aimed at anti-money laundering/combating the financing of terrorism (AML/CFT). A Risk Management and Compliance Framework (RMCP) will have to be developed and implemented ensuring compliance with the FIC Act.
The proposed regulation suggests that the beneficiary CASP should obtain and hold accurate originator information as well as beneficiary information of the crypto asset transaction, and make this information available to the appropriate regulatory and/or law enforcement authorities if and when requested to do so.
The regulation suggests that crypto assets will remain without legal tender status and not be recognised as electronic money. However, the existing tax structure within the Income Tax Act and the Value-Added Tax Act is supported whereby SARS applies normal income tax rules to cryptocurrencies and will expect affected taxpayers to declare cryptocurrency gains or losses as part of their taxable income. The onus, therefore, remains on taxpayers to declare all cryptocurrency-related taxable income in the tax year in which it is received or accrued.
It is further recommended that services rendered in respect to crypto assets will be included in the definition of "financial services" in the Financial Sector Regulation Act. This means that the FSCA will become the responsible authority for the licensing of "services related to the buying and selling of crypto assets" and will be given the mandate to develop specific conduct standards for these services.
It is important to note that the pooling of crypto assets will be regarded as constituting an alternative investment fund. However, a collective investment scheme would not be allowed to include crypto assets in its portfolios. Furthermore, it will be required of the FSCA to make a determination on whether crypto-assets should be considered as allowable assets for the asset spreading requirements of pension funds.
The way forward?
Considering the proliferation of crypto assets it is surely inevitable that cryptocurrency markets will become more tightly regulated. However, it is too early to predict whether that regulators will succeed to effectively prevent the exploitation of crypto assets for money laundering and terrorist financing purposes without frustrating innovation, growth and access in this new emerging market.