Introduction
VASP Law
Mutual Funds (Amendment) (No 2) Law 2020
Securities Investment Business (Amendment) Law 2020
PCL (2020 Revision) and AML (Amendment) (No 2) Regulations 2020
Comment
On 20 May 2020 the Cayman Islands introduced a new framework for regulating virtual asset businesses.
The Virtual Assets (Service Providers) (VASP) Law 2020 will come into force on the issue of a commencement order. The VASP Law derives from recommendations made by the Financial Action Task Force and provides for the regulation of virtual asset businesses and the registration and licensing of persons which provide virtual asset services.
In addition to the VASP Law, the government has amended a number of existing laws to extend to virtual assets, including the Mutual Funds Law (Revised) and the Securities Investment Business (SIB) Law (Revised). These amendments are expected to come into force at the same time as the VASP Law.
This article provides a high-level summary of the VASP Law and the amended legislation above. It also provides a brief overview of recent and related amendments to the Proceeds of Crime Law (Revised) (PCL) and the Anti-money Laundering (AML) Regulations (Revised) that are already in effect.
What are virtual assets?
The VASP Law defines 'virtual assets' as "a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes but does not include a digital representation of fiat currencies".
This wide definition will likely capture all cryptocurrencies, security tokens, utility tokens and other digital assets that are tradeable or transferable, with the exception of digital fiat currencies. While the term 'digital expression of fiat currencies' is not defined, this is likely to apply only to government-issued virtual currencies as opposed to, for example, Tether and Gemini dollars.
What are virtual asset services?
The VASP Law applies to any person which provides 'virtual asset services' – defined as the issuance of virtual assets or the business of providing one or more of the following services or operations for or on behalf of a natural or legal person or legal arrangement:
- exchange between virtual assets and fiat currencies;
- exchange between one or more other forms of convertible virtual assets;
- transfer of virtual assets;
- virtual asset custody service; or
- participation in, and provision of, financial services relating to a virtual asset issuance or the sale of a virtual asset.
With the exception of virtual asset issuances, the VASP Law will affect only 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 regard 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 VASP Law also addresses persons that promote themselves as carrying on virtual asset services, even though they may not technically be performing a virtual asset service (as defined under the VASP Law). In addition, natural persons are prohibited from carrying on virtual asset services as a business or in the course of business in or from within the Cayman Islands.
Issuance of virtual assets
The 'issuance of virtual assets' means the sale of newly created virtual assets to the public in or from within the Cayman Islands in exchange for fiat currency, other virtual assets or other consideration. It does not include the sale of virtual service tokens. For these purposes, a 'virtual service token' means a digital representation of value which is not transferrable or exchangeable with a third party at any time and includes digital tokens whose sole function is to provide access to an application or service or to provide a service or function directly to their owner.
The term 'public' is not defined and therefore should be interpreted with caution and given a broad meaning. However, limited private sales to owners, affiliates and employees are unlikely to be within the scope of 'virtual asset issuance'. Further, as the definition is limited to sales for consideration, airdrops and bonus issues should also be excluded.
Persons that wish to issue virtual assets from the Cayman Islands must first register with the Cayman Islands Monetary Authority (CIMA), as discussed further below. Once registered, and prior to issuance, they must submit a request to CIMA for the approval of a virtual asset issuance. The issuance must not exceed a prescribed threshold, which will be an amount in fiat currency that can be raised by an issuer within a given timeframe. Such threshold has yet to be announced. Issuers that intend to raise funds over the prescribed threshold will have to conduct the sale in the fashion of an initial exchange offering through a licensed virtual asset trading platform (VATP) (as defined below).
Exchange and transfer of virtual assets
The VASP Law does not regulate businesses that exchange, trade or transfer virtual assets for and on behalf of themselves for their own benefit.
However, it does capture service providers and other intermediaries. In particular, VATPs will require a licence under the VASP Law. Broadly, a 'VATP' is any digital platform that facilitates the exchange of virtual assets for a benefit (eg, a fee or commission) and:
- holds custody of or controls virtual assets on behalf of its clients to facilitate an exchange; or
- matches bids and sales.
The definition does not include platforms that only provide a forum where sellers and buyers may post bids and offers or where parties trade in a separate platform or in a peer-to-peer manner.
Persons that do not operate a VATP but carry out exchanges or transfers of virtual assets for or on behalf of others will not require a licence if there is no custody of the assets. However, they will have to register under the VASP Law.
Custody
'Virtual asset custody services' are defined as the business of safekeeping or administration of virtual assets or the instruments that enable the holder to exercise control over virtual assets. These service providers will also require a licence under the VASP Law. This definition will likely capture all persons (including virtual wallet providers) that hold or have access to, for or on behalf of other persons, the private keys or similar attributes that can control a virtual asset. This will directly affect custodians and administrators that operate in this space from within the Cayman Islands.
Financial services relating to virtual asset issuances or sales
While the term 'financial services' is not defined under the VASP Law, until such time that regulatory guidance on the point is issued, businesses which consider themselves to be financial service providers should apply for registration or for a waiver from CIMA (as briefly described below) before providing services for virtual asset issuances or sales.
Registration or licensing?
Businesses which provide custodial services of virtual assets and businesses that operate or intend to operate a VATP will require a licence. All other persons carrying on or intending to carry on virtual asset services will require registration. Depending on the extent of the activities, CIMA may require an applicant for registration to apply for a licence instead.
Existing licence holders under other regulatory laws (eg, the Mutual Funds Law, the SIB Law or the Companies Management Law (Revised)) must notify CIMA if they wish to carry on virtual asset services and may request a waiver from registration or licensing under the VASP Law. CIMA will apply the same considerations to a waiver as to the grant of registration or a licence under the VASP Law.
Applications for registration or licensing are subject to an assessment fee payable at the time of application. An application fee (and annual renewal fee) will also be charged in such amounts that will be notified to an applicant once CIMA has notified the applicant of the successful outcome of its application for registration or licence, as the case may be. All such fees will be limited by a prescribed range yet to be announced by CIMA.
CIMA considerations
CIMA will consider, among other matters:
- the size, scope and complexity of the virtual asset service, underlying technology, method of service delivery and virtual asset utilised;
- the applicant's knowledge, expertise and experience;
- the AML procedures and data protection safeguards in place for the applicant;
- the similarity of the virtual asset service to activities under the SIB Law or any other regulatory laws;
- the risks that the virtual asset service may pose to existing clients, future clients, other licensees or the Cayman financial system;
- the applicant's net worth, capital reserves and financial stability;
- the applicant's ability to comply with the VASP Law and the relevant requirements of the AML Regulations; and
- whether the applicant's senior officers and ultimate beneficial owners are fit and proper persons.
Additional considerations will also apply to virtual asset issuances.
Ongoing requirements
Persons registered or licensed under the VASP Law will be subject to ongoing requirements. These include the registrant or licensee:
- undertaking audits of their AML systems and procedures at the request of CIMA;
- preparing audited accounts and submitting them to CIMA annually;
- ensuring that their senior officers and beneficial owners are fit and proper persons;
- obtaining prior approval from CIMA to appoint senior officers or AML compliance officers;
- providing certain notices to CIMA confirming their compliance with the AML Regulations and data protection laws and ensuring that all communications relating to the virtual asset service are accurate;
- designating an employee as the officer responsible for the procedures for combating money laundering, terrorist financing and proliferation financing; and
- obtaining prior approval from CIMA before issuing or transferring shares or other equity interests totalling 10% or more of the registrant or licensee.
Further requirements apply for custody providers and operators of VATPs.
Sandbox licence
The VASP Law also introduces the concept of a sandbox licence that provides CIMA with the flexibility to regulate relevant businesses that utilise innovative technologies and activities by imposing additional requirements to, or allowing certain exemptions from, the standard requirements within the VASP Law. A sandbox licence is meant to operate for a limited timeframe so that CIMA can assess how best to regulate a sandbox licence applicant and whether legislative changes may be required to further promote the development of the particular innovative technologies or activity that is subject to the sandbox licence.
Mutual Funds (Amendment) (No 2) Law 2020
The definition of 'equity interest' under the Mutual Funds Law has been amended to include "any other representation of an interest". This amendment is broad enough to capture digital tokens or other virtual assets. Therefore, open-ended funds issuing redeemable tokens instead of shares or other equity interests are now covered by the Mutual Funds Law and must be registered or licensed thereunder.
Securities Investment Business (Amendment) Law 2020
The SIB Law has also been amended to extend to virtual assets. In particular, the definition of 'securities' now includes virtual assets which can be sold, traded or exchanged immediately or at any time in the future and:
- represent or can be converted into any of the securities listed in Schedule 1 of the SIB Law; or
- represent a derivative of any of the securities listed in Schedule 1 of the SIB Law.
The securities listed in Schedule 1 of the SIB Law are traditional securities including equity interests, debt instruments, options and futures.
Therefore, persons dealing in, arranging deals in, managing or advising on virtual assets that are securities will have to register or be licensed under the SIB Law. To avoid regulatory overlap, CIMA may exempt an applicant from registration or licensing under the SIB Law or the VASP Law. However, an applicant must first apply under either law before having this exemption granted.
One significant exclusion applies for private issuers of virtual assets that are securities under the SIB Law. Where a private issuer issues, redeems or repurchases its own virtual assets that represent shares, limited partnership interests, units in a unit trust, debt or warrants of the private issuer, such activity is an excluded activity. This means that private issuers of certain types of security token will not have to register or be licensed under the SIB Law (although they may still have to be registered under the VASP Law).
PCL (2020 Revision) and AML (Amendment) (No 2) Regulations 2020
Relevant financial businesses, as defined under the PCL, must comply with the AML Regulations. The definition of a 'relevant financial business' includes the provision of virtual asset services. The PCL was the first Cayman law to contemplate virtual assets and the definitions used differ slightly to those used in the VASP Law. In particular, the definition of 'virtual asset services' does not explicitly include virtual asset issuances. However, the VASP Law requires virtual asset issuers (as well as all persons which carry on virtual asset services) to comply with the AML Regulations.
CIMA has issued specific AML-related guidance to virtual asset service providers and the standards of compliance that it expects when carrying on virtual asset services.
Further, under the most recent amendments, new regulatory requirements have been implemented to ensure that sufficient information is being obtained relating to transfers of virtual assets by intermediaries. Businesses which operate virtual asset transfer or exchange services must now comply with these higher standards.
The VASP Law provides a coherent framework that will add a welcome degree of certainty for businesses which intend to issue virtual assets and businesses which carry on or intend to carry on virtual asset services. The government's intention has been to provide for appropriate regulation without stifling innovation. The VASP Law should help to maintain Cayman's position as an attractive domicile for legitimate virtual asset businesses.
For further information on this topic please contact Bradley Kruger or Michael Robinson at Ogier by telephone (+1 345 949 9876) or email ([email protected] or [email protected]). The Ogier website can be accessed at www.ogier.com.
