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Investor protection and market integrity - Silvio Schembri

Malta is moving into crypto-asset regulation at a very fast pace. The government has pushed this area of financial services within the context of the future evolution of fintech, which we believe can provide Malta with the opportunity to be a thought leader in that space and as a result, the jurisdiction of choice.

I am acutely aware that there are concerns in certain quarters regarding the potential risks to financial market integrity which Malta is facing as a result of the government’s decision to enter the crypto-asset space. I am conscious of the possibility that some of the already announced blockchain companies may not pass our robust tests and will not get the necessary licences to operate to or from Malta.

I am also aware of the various local and international media articles which provide contrasting views regarding the risks and opportunities relating to crypto-assets. Together with the MFSA, I have been pushing for a robust regulatory regime which achieves the high-level objectives of financial regulation, as set out by international standard-setting bodies.

In this regard, the framework being implemented under the Virtual Financial Assets Act seeks to safeguard market integrity, ensure financial soundness and achieve a high level of investor protection.

The two main challenges faced by financial supervisors with regards to the regulation of crypto-assets are the high rate of failure of entities issuing ICOs and the risk of fraudulent activity connected therewith, and the use of crypto-assets and exchanges for money laundering.

In this article I briefly describe how these risks are being addressed in Malta through the implementation of the VFA framework.

The Virtual Financial Assets Act stipulates measures aimed at addressing the risk that the financial system is abused, thereby causing investor detriment. Apart from setting out the information which must be included in a White Paper (offering document), the Act specifies that an issuer of coins or tokens must appoint a VFA agent, who is required, prior to on-boarding an issuer as its client, to assess its fitness and properness. A VFA agent is a subject person under the anti-money-laundering legislation and is required to carry out due diligence also for that purpose.

The government has decided to go beyond EU law, as ensuring market integrity is high on our agenda

Chapter two of the proposed VFA rulebook – the Virtual Financial Assets Rules for Issuers of Virtual Financial Assets – issued by the MFSA for consultation on July 30, 2018, provides more detailed and granular rules, inter alia with respect to the appointment of a number of functionaries by the issuer, including a systems auditor and a custodian, and requirements relating to cybersecurity, record keeping, transparency and the admission to trading on a DLT exchange.

These requirements, along with additional rules currently being drafted by the MFSA, seek to ensure that operators in this field are honest, competent and financially sound, and that they are subject to a high measure of initial and ongoing checks. This should mitigate the risk of market malpractice and investor detriment. 

The Virtual Financial Assets Act explicitly stipulates that VFA agents, issuers and licence holders (including exchanges and wallet providers), are to be considered subject persons for anti-money-laundering purposes. This goes beyond what is required by the EU fifth anti-money-laundering directive, which requires the regulation of exchanges and wallet providers for this purpose.

In this regard, the government has decided to go beyond EU law, as ensuring market integrity is high on our agenda. In this regard, the designation of both the issuer and the VFA agent as subject persons becomes a sine qua non to ensure a clean market. While the issuer is the person undertaking the ICO – or rather, as it appears in the Act, an Initial Virtual Financial Asset Offering – the VFA agent, given his role as a first line of defence in the field, is considered to be in a good position to monitor compliance with AML obligations.

To further strengthen our AML regime, the FIAU, the MFSA and the IFSP are currently working together on sector-specific implementing procedures to cover specifically the crypto-asset sphere.

The action taken so far by the government and the MFSA to mitigate the risk to market integrity and investor protection are a start. We plan to continue strengthening the regulatory framework to ensure that the system remains clean – and several new initiatives should be expected in this respect.

For example, the Act provides for the power to make regulations to establish data repositories for the collection of customer due diligence information and documentation being retrieved by licence holders in Malta. A data repository would strengthen our intelligence regime and allow licensed entities to benefit from an additional source of information for their AML due diligence. This and other initiatives are currently being discussed to ensure proper market integrity.

While no regulator in the world can guarantee a risk-free environment, I am confident the MFSA will apply its high standards of monitoring also to the field of crypto-assets. A zero-tolerance policy to market malpractice, particularly instances of financial crime, is the only way to go for sustainable growth in this field.

Silvio Schembri is Parliamentary Secretary for Financial Services, Digital Economy and Innovation.

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