Huzaima Bukhari, Dr. Ikramul Haq & Abdul Rauf Shakoori
The technological landscape has changed massively in the last few years and this has also transformed the financial sector around the world. New phenomena of digital currencies have emerged which are growing at a rapid pace and posing a threat to conventional financial mechanisms. These are being seen as substitutes and disruptive to conventional banking. Initially, due to lack of knowledge, these virtual assets (VA) and digital currencies were viewed with a lot of ambiguities, however, with more understanding about the operations and evolution of function of VAs and Virtual Assets Service Providers (VASP), now countries have started to regulate them. Various countries as well as regions, have introduced a comprehensive regulatory framework for the regularization of this sector.
Financial Action Task Force (FATF), being an effective international body to formulate policies and standards to combat money laundering and financing of terrorism, first amended its recommendation 15 to regulate VASPs for Anti-Money Laundering (AML) and Combatting the Financing of Terrorism (CFT) by imposing the condition of obtaining a license or registration under the comprehensive system of its monitoring. The interpretive note of recommendation 15 explains the applicability of FATF requirements on VAs and VASPs and implementation of the risk-based approach on their activities and operations. The interpretive note requires that in addition to licensing and registration of VASPs, preventive measures, such as customer due diligence, recordkeeping, and suspicious transaction reporting, like sanctions and other enforcement measures; and international cooperation should be made part of proper monitoring.
In addition, recommendation 16 deals with domestic and cross-border wire transfers and sets high bars on all types of businesses to prevent access to terrorists and other criminals for the movement of their illegally generated funds. The FATF amended its regulations for travel rule by extending it to VAs and VAPS which was initially applicable to Banks only and in the recent G20 conference, the President of FATF urged members states to implement FATF Standards, including travel rule requirements, as soon as possible. The travel rule requires that VAPS should provide customer information which includes senders’/recipients’ identification information such as names, addresses and account details in case they trade up to a specific threshold. United States (USA) has taken a lead role by enacting the regulation based on Banking Secrecy Act which is a USA law that is equally applicable to VAPs as well.
European Union introduced the 5th Anti-Money Laundering Directive (5AMLD) which was implemented in January 2020. Though the directive is not comprehensive as per the FATF rule, however, it requires similar information such as maintaining the record of customers’ activities and performing ‘know your customers’ requirements. Other countries like the United Kingdom (UK) earlier being part of the European Union, were initially following the same directive but as the FATF travel rule is effective now, the UK Financial Conduct Authority (FCA) requires concerned sectors to implement the travel rule in true letter and spirit. Similarly, other jurisdictions in Europe and Asia are also observing this rule. Switzerland lowered the threshold limit to $1,000 from $5000 whereas Singapore has introduced the Payment Service Act, 2019 which sets clear directions for the industry to comply with AML requirements.
Since Pakistan has not legalized this sector, therefore, no such efforts have been undertaken to frame regulations. Government institutions have only issued caveats and notices about the consequences of investing in cryptocurrency but the regulatory framework is yet to be finalized. Central Bank believes that due to a high degree of anonymity these virtual currencies can be used for illegal activities and the communiqué by the State Bank of Pakistan (SBP) (ERD/M&PRD/PR/01/2018-31 & FE Circular No. 03 of 2018) explicitly bars from trading and even promoting Virtual Currencies, whereas Securities and Exchange Commission of Pakistan (SECP) issued a Position Paper on November 06, 2020 for Regulation of Digital Currencies. This consultation paper focuses exclusively on non-government or non-central-bank-issued crypto assets and not on central bank digital currencies though it contains basic guidelines in the light of FATF recommendations and contains some basic definitions, concepts, and inner workings of the Digital Assets universe. It also indicates the approach adopted by regulators towards digital assets globally, including a definition for digital assets in Pakistan and its mechanism for operation/regulation of digital assets. It explains the way forward for designing and developing a robust regulatory regime at par with the world for regulating Digital Assets and highlights the present policy proposals to industry participants and stakeholders. However, no effective regulations could be introduced to monitor this sector.
As per the Chainalysis adoption index for the market share of the investment in VAs, Pakistan is ranked as third in row after Vietnam and India. Similarly, the Times of India also reported that Pakistan’s crypto market grew the most at 711%, and Central and South Asia and Oceania gained a valuation of $572.5 billion in 12 months up to June 2021. The Chainalysis report also indicated that Pakistan received an excess of $1.5 billion in crypto-cash last year. Despite having a huge market share with millions of people engaged in this sector in Pakistan, no serious efforts are made to deal with its administrative and legal aspects and there is even no determination exhibited by the relevant ministries to take onboard relevant institutions and law enforcement agencies including the SBP, SECP, Financial Monitoring Unit, Federal Investigation Agency, Federal Board of Revenue, and other stakeholders directly or indirectly involved with trading related matters. Hence, no comprehensive study at the national level has been presented so far by the ministries as well as the relevant institutions to assess the risks posed by this sector, their mitigation, and their impact on our economy.
As reported in the media, while hearing the petition challenging the legality of the crypto ban imposed in 2018, the Sindh High Court directed the government to come up with modalities for cryptocurrency regulation within three months in consultation with the Minister for Information and Technology. So far, no concrete framework has been introduced either by the SBP or the SECP. This undue delay in regulating is, on the one hand impacting our revenue-generating activity and on the other, is providing criminals access to the financial sector. Now that the FATF has updated its travel rule and issued updated guidance for a risk-based approach for VAs and VASPs, Pakistan can introduce a comprehensive framework on same lines. The requirements of recommendations 15 and 16 can be easily met by using the existing licensing requirements mentioned for formation of companies, applying the model of investment or security, trading companies as per the model compatible with the functions of our regulatory bodies. In the USA cryptocurrencies have to be registered as commodities trading advisors and commodity pool operators along with regulatory requirements mentioned in the Investment Company Act, 1940 and Investment Advisor Act 1940 along with relevant state’s investment laws. UK treats cryptocurrency as a property, and licensing requirements depend on the regulated activities in terms of Financial Services and Market Act, 2000 and Payment System Regulators requirements, etc.
Similarly, VASPs should be made liable to maintain an Anti-Money Laundering program and include written policies and procedures. VASPs should also maintain internal controls with reasonable assurance of continued compliance by designating an officer for this purpose, training of the concerned staff in reporting suspicious activity, and independent review to assess the adequacy of the program. Similarly, no one should be allowed to access the system to be listed on the sanction list maintained by the Government, UN, or OFAC sanction list. The UK introduced the Anti-Money Laundering and Countering Terrorist Financing supervisor for companies carrying out cryptocurrency ventures. Both USA and UK require the companies to perform ‘know your customer’ and customer diligence checks for those dealing in crypto, verifying their basic information such as their legal names, proof of residence, government-issued identity documents, etc. Pakistan already has a mechanism to regulate money service businesses under the Money Laundering Act, 2010, that can be applied to regulate cryptocurrency as well.
Regularization of this sector will not only generate economic activity in the country but will also help the government to enhance its revenue by claiming a fair share of taxes. This sector is growing and major countries in the world have either started their risk assessment or issued regulations. It is a good time for us to bring this sector into the regulatory framework to encourage virtual currency-based innovations and efficiencies in finance and business. Our regulatory framework should also protect investors to ensure larger financial inclusion without any disadvantage to individuals, corporations, and governments.
Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions