While the world is advancing massively from the concept of physical assets to virtual assets, it is witnessing government scrutiny in terms of how these assets would be regulated. Virtual assets have many potential benefits in terms of making payments easier, faster and cheaper. It allows swift transfer of value around the world but without appropriate regulation it also poses risk of misuse. One such regulation to curb misuse in this fintech model has been enacted in the British overseas territory of Cayman Islands which is called the Virtual Assets (Service Providers) Law, 2020 (“VASP Law”) to stimulate the fintech development. The VASP Law was passed by the Cayman Island on May 20, 2020 but shall only come into force upon issue of commencement order which is still pending.
To enable regulation of the virtual assets regime in entirety, Cayman Islands government has come out with not just VASP Law but a package of regulation which also includes the Monetary Authority (Amendment) (No.2) Law, 2020, the Securities Investment Business (Amendment) Law, 2020, the Mutual funds (Amendment No.2) Law, 2020, and the Stock Exchange Company (Amendment) Law, 2020 (collectively referred to as “VASP Regime”). The VASP Regime enables the conduct of virtual asset business in the Cayman Islands along with the registration and licensing of the persons providing the services. For the VASP Law framework to be meaningful there was a need to amend the other legislations in the VASP Regime.
The origin of VASP Law traces back to recommendations made by the Financial Action Task Force (“FATF”). FATF suggested that there is a need to regulate businesses involved with virtual asset transactions and for the registration and licensing of persons who are providing “virtual asset services”. Moreover the definition indicated in the VASP Regime is pulled out from the FATF approach to virtual assets.
Various concepts of VASP Law
In order to understand the ambit of virtual assets under the VASP Regime in Cayman Islands, it is quintessential to look at the definition of the “virtual assets” which is defined as the digital representation of value that can be digitally traded or transferred can be used for payment or investment but does not include a digital representation of fiat currencies. This specific description would likely encompass all tradable or transferable cryptocurrencies, security tokens, utility tokens or other digital assets, with the exception of digital fiat currencies which essentially are currencies issued by the entities concerned in a country or are government approved as a legal tender in that country of issuance, inter alia by government decree or law.
Similarly “services in virtual assets” implies issuing virtual assets or providing one or more of the following services or operations for or on behalf of a natural person or legal entity or legal arrangement:
With the exception of virtual asset issuances, the VASP Law will only affect persons that carry out virtual asset services as a business or in the course of a business for or on behalf of other persons. It does not appear to affect persons that carry out those functions only for themselves. With regards to virtual asset issuances, this distinction does not apply. This means that most issuers of virtual assets for their own benefit will be subject to the VASP Law.
The performance of virtual asset service comes with a condition precedent of registering oneself as the virtual asset service provider (“VASP”) who as a licensee provides virtual asset services as a business or in the course of business to clients within or outside Cayman Islands. The definition of VASP rules out natural person and is applicable only to legal persons thus prohibiting any individual to carry on virtual asset services as a business or in the course of business.
Eligibility for functioning as VASP
The following has to be adhered to in order be eligible to function as VASP:
Additionally VASPs are required to ensure that the senior officers, trustees and beneficial owners are fit and proper. A notification to the Cayman Island Monetary Authority (the “Authority”) has to be provided in case of registration in another jurisdiction. Lastly they are also required to provide any other information that may be required by the Authority to enable it to perform any of its function.
Factors to be considered before granting license
The Authority before granting license would take into account several factors like size, scope and complexity, technology, method delivery of the virtual asset service. In order to be considered, an applicant’s knowledge, expertise and experience would be looked into. Whether the applicant has the procedure of combating money laundering in place would also be assessed. There must be a fair assessment of risk to the financial system. The financial background of the entity is also assessed that is net worth and the capital reserve to ascertain stability.
Regulatory compliances to be adhered to by the VASP
In addition to the above VASPs are subjected to regulatory requirements from the Authority which include the following aspects:
1. Registered Person: A legal person carrying on virtual asset service has to be registered with the Authority under the VASP Law. Such persons are known as the registered persons. This registration is not required for persons who want to provide asset custody service or asset trading platform services. The registration enables issuance of virtual assets to public under a certain threshold and needs approval of the Authority. Performance of activities without such registration would attract a penalty of US$ 24390
2. Licenses: Virtual asset service licenses are required for persons providing services:
· Virtual asset trading platform (for instance- cryptocurrency exchange)
· Virtual asset custody services (for instance wallet services)
· Issuance of newly created virtual asset directly to public (for instance initial coin offering)
3. Existing Licenses: In case businesses were granted licenses prior to the VASP by the Authority under any other previously existing law, such businesses would still be required to furnish a notice to the Authority in case of continuance of service. The Authority would decide whether the entity be conferred with the licensing or registration.
4. Sandbox Licenses: The other salient introduction in the VASP Law is the grant of sandbox licenses which would be accorded by the Authority where it considers that a virtual asset service represents an innovative use of technology that requires supervision not offered by a license or registration under the VASP Law. The Authority would issue a sandbox license to serve the best interest of public by virtue of restricting the financial market for that entity.
In other words to impose restrictions upon the business and trim down disruption in the fintech sector, the Authority shall issue sandbox licenses which would also enable easy revocation of such permissions to mitigate material risk for the welfare of public and stability of financial services. These licenses are granted for a period of 1 (one) year which is subject to review by the Authority.
However, vide FAQs published by the Cayman Islands Ministry of Finance it is now settled that registration or license is not required under VASP Law if virtual asset are used strictly for personal use.
Enforcement of VASP Law
For every regulation to be enforceable there has to be provisions which would have deterrence on the defaulters. Thus the VASP Law ensures that in case of non-compliance, the Authority would have the ability to revoke license, cancel registration and impose conditions on the licensee and lastly it also reserves rights with the Authority to move the court to protect interest of clients and creditors.
Any conduct of virtual asset service business without a registration or waiver from the Authority would attract a penalty of CI$ 25,000 (US$ 30,488) along with 1 (one) year of imprisonment and post the conviction a daily fine for any default of CI$ 10000 (US$12,195). Moreover on carrying of business of custody of virtual asset custody or trading platform without valid licenses, a summary conviction would be attracted with a fine of CI$ 10000 (US$12,195) along with 1 (one) year of imprisonment and post the conviction a daily fine for any default of CI$ 10000 (US$12,195).
To bring a greater sense of responsibility, vicarious liability has also been introduced in a sense that if any body-corporate commits any offence, the senior officer who had the knowledge of the incident and neglected the same shall also be held equally liable. Finally on any contravention of the provision of VASP Law for which a penalty is not prescribed, the penalty amounts to US$4878.
Changes made to other regulations in the VASP Regime
One of key change in AML has been the mandatory Due Diligence requirement for all one-off transactions, regardless of value and provide transaction information for every virtual asset transfer as if it were a wire transfer of funds.
The definition of “security” has been amended to include virtual assets that “represent, are derivatives of, or can be converted into securities under Schedule 1”. This ensures that virtual assets are put at par with securities which eliminates regulatory uncertainty. Thus virtual assets that are securities would be distinguished from one that are not (for instance- stablecoins)
The funds regime has amended the definition of “equity interest” and now mutual fund includes any other representation of interest that carries an entitlement to participate in the profits of the company. This arrangement will try to reap benefit from the innovative technologies and that the fund may now use virtual assets form of conveying equity interest.
Stock Exchange Company (Amendment) Law, 2020
This amendment allows virtual assets securities exchanges to be licensed and operate under the framework. This implies that stock exchanges in the country will not have the sole right to list virtual assets as securities.
Although the law is not yet in force as it not notified by the government there is a need to start fulfilling the mandates by the entities willing to perform such services. While there are certain clarification which are still sought by businesses which includes the threshold in excess of which registered entities cannot issue virtual assets to public. The VASP Regime in entirety is a welcome move as it eliminates any regulatory doubts and leaves space for innovation in fields of traditional securities exchange and mutual funds
The goal of the Cayman Island Government was to provide for appropriate regulation without stifling creativity. The VASP Regime will help preserve the role of Cayman Island as a desirable location for legitimate virtual asset businesses. Owing to its quaint location and minimal tax policies these policies would be lucrative return for investors and now that Cayman Islands have extended these favourable conditions to virtual assets which are often shunned elsewhere, it is safe to say that territory would witness a splurge in investments.
The article is authored by Ayush Chowdhury, Co-head, BlockSuits.
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