FATF Guidance on Virtual Currencies

John Collins, Partner

The Financial Action Task Force (FATF) is little known among many but plays a powerful role in protecting the global financial system.  Founded over 30 years ago by the members of the G7, the group was intended to bring the most advanced economies in the world together to explore and share how they were each addressing money laundering.  From there, they could develop and adopt shared standards to combat all forms of financial crime. Much has changed in financial services in the past 30 years but what was observed then - the globalization of financial services and ability to arbitrage regulatory regimes - has only accelerated.

The advent of cryptocurrencies and global, peer-to-peer blockchain networks, non-existent until only 10 years ago, were obviously not on the G7’s radar in 1988.  That said, these networks are, in reality, global financial networks unbridled from the central intermediaries (banks and other financial institutions) upon which much of FATF’s work has been based. Financial intermediaries have been the lever upon which nations across the world have leaned upon to protect and monitor the financial system from money laundering, terrorist financing support, and other crimes.

That leads us to FATF’s recently issued guidance regarding virtual currencies. (Note: I’m cognizant of the fact that many do not prefer the term ‘virtual currencies’ and instead insist upon digital currencies or assets or any number of other terms of art.  For the purposes of this article, however, and because FATF themselves have chosen virtual currencies as their preferred nomenclature, I’ll stick to it.)  Specifically, their recent proposed “Interpretive Note” to Recommendation 15, set for final adoption this week.  For some context, shortly after FATF’s founding, the group issued a set of Forty Recommendations “intended to provide a comprehensive plan of action needed to fight against money laundering.” 

Recommendation 15 focuses on new technologies and calls for countries and financial institutions to keep a look out for emerging technologies, products, and business lines and apply appropriate controls based on a risk assessment.  

You can read the FATF’s new guidance here but the bottom line is the document makes explicit and public what has been communicated to members of the virtual currency industry for years.  Namely, what we in the United States know as the funds transfer rule, better known as the “Travel Rule”, must be complied with by applicable industry players.  These players are namely virtual currency exchangers and custodial wallet providers, newly deemed by the guidance as “Virtual Asset Service Providers” (VASPs).

A lot has been written on the application of the Travel Rule to virtual currency networks and, in particular, companies that provide custodial wallet services for these tokens, assets, currencies, etc.  I’d invite you read some of Yaya Fanusie’s articles on this topic, as well as Chainalysis’ letter to FATF.  This work lays out succinctly the challenges and opportunities this new guidance will present for the industry.

The funds transfer rule was created in the late 70’s via legislation from the U.S. Congress.  The problem at the time were wire transfers stripped of information such as the sender or the beneficiary.  This was done to obfuscate the money trail and better facilitate money laundering.

Cryptocurrency transactions are not wire transfers.  They are not funds being sent from bank to bank. However, in some cases, they look a lot like that.  For example, when it sent from one custodial wallet that is managed by Company X and sent to another custodial wallet Company Y.  These are two financial institutions where funds are going from one account to another.  

These rules are principles-based and thus neutral to technology and the exact form of compliance.  These open blockchain networks operate fundamentally differently than wire transfers, and FinCEN, FATF, and others, understand that.  But, just because they run on blockchains and not bank wires, doesn’t mean these rules don’t apply. In fact, due to increased regulatory scrutiny and relatively high risk associated with the cryptocurrency sector, they apply all the more.  That said, as a Senior Treasury Official recently stated: companies “need to know with whom they are dealing.” It’s as simple as that.  

It will take some thoughtful, coordinated, and honest thinking from the industry as to how to satisfy compliance with the Travel Rule and FATF’s guidance as a whole.  To date, this hasn’t happened. Industry leaders should consider using their exceptional technical talent to find ways that might better facilitate compliance with the principles-based guidance issued by FATF and to communicate this work to policymakers not only at FinCEN, but leaders on both sides of Pennsylvania Avenue.  We have spent the past several years working on the problems listed above and working with policymakers around the world to communicate their concerns to industry.  We believe the time is ripe to rise to the occasion.

Takeaways

  • The newly released FATF guidance should not come as a surprise to virtual currency companies.

  • Regulators around the world are eager to see compliance by applicable players in the industry.

  • There’s likely an opportunity for education, as well as creative problem solving and innovative technologies, to help reach compliance and build the current gaps.

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