The unprecedented interest, investment, and participation in crypto assets, as well as the risks that have been identified with the use thereof, has spurred regulators across the world into establishing an appropriate regulatory framework for crypto assets.1 While there has certainly been an increased global focus on crypto regulation in the last 12 months, the approach taken by regulatory bodies has not been uniform. Very few countries have officially adopted crypto assets as legal tender (El Salvador and the Central African Republic have made Bitcoin legal tender), some countries have or appear to have plans to outright prohibit crypto assets (China and India), while most countries have taken a more cautious "wait and see" approach and hinting at developing new crypto regulation while also trying to fit crypto assets into the existing financial regulatory landscape.
In South Africa, regulators have come a long way from the initial public statement concerning virtual currencies in 20142 which focused on highlighting the risks of virtual currencies. Since then, there has been a dedicated intergovernmental approach that seeks to research, monitor, evaluate, and ultimately bring crypto assets within the South African regulatory purview, with a focus on responsible innovation and consumer protection.
In 2019, the Crypto Assets Regulatory Working Group (CAR WG)3 published a consultation paper aimed at outlining the prominent policy proposals and regulatory approaches to industry stakeholders.4 This was followed by a position paper on crypto assets in 20215 (position paper) which, in addition to making various policy and regulatory recommendations for capturing crypto assets within the existing regulatory framework by regulating crypto asset service providers (CASPs), also included a high-level analysis of the jurisdictional approaches to crypto regulation in other countries. The position paper shows that whilst the international regulatory community is actively engaged in discussions around regulating crypto assets, the approaches adopted by each jurisdiction are varied.
The position paper also draws heavily on guidance from the Financial Action Task Force (FATF), an independent international inter-governmental body established to protect the global financial system against money laundering and terrorist financing, which has specifically recommended the regulation of virtual asset service providers (VASPs) for anti-money laundering and counterterrorist financing (AML/CFT) purposes.6 The FATF has suggested that each jurisdiction assess the risks emerging from the crypto asset sector and establish a regulatory regime that aligns with that country's risk assessment.7 This appears to be the approach adopted by most global regulators, however, there is concern that this de-synchronised global approach may provide opportunities for regulatory arbitrage and result in increased regulatory uncertainty and a higher compliance burden for the inherently borderless crypto world.
Whilst the FATF's recommendations are not legally binding, they serve as a strong motivation and guideline for formulating and implementing a crypto asset regulatory framework, especially with the vulnerabilities that an unregulated crypto environment can pose to financial stability and participants. Of the members of the IFWG, the South African Reserve Bank (SARB) has already begun issuing guidance and directives on the regulation of crypto assets, most of which has been prefaced on the FATF's recommendations.
Impending regulation of crypto assets and CASPs
Speaking recently at a virtual webinar in July 2022, the Deputy Governor of the SARB confirmed that the regulators are preparing to introduce various regulations directed at the crypto asset sector, taking a phased approach over the next 12 to 18 months.8 The two most pertinent statements made by the Deputy Governor relate to the confirmation that (i) the Financial Sector Conduct Authority (FSCA) intends to declare crypto assets as a "financial product" for the purposes of the Financial Advisory and Intermediary Services Act, 37 of 2002 (FAIS Act) (see Recommendation 9.1 of the position paper), and (ii) CASPs be included in the list of accountable institutions in Schedule 1 of the Financial Intelligence Centre Act, 38 of 2001 (FICA) (see Recommendation 2 of the position paper).
i. Declaring crypto assets as a financial product
What are crypto assets?
According to the IFWG, crypto assets are defined as "a digital representation of value that is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility, and applies cryptographic techniques and uses distributed ledger technology ".9 This is an intentionally broad definition which is intended to act as an umbrella term for different crypto asset tokens, and includes exchange or payment tokens, security tokens and utility tokens. Crypto assets therefore include cryptocurrencies, non-fungible tokens (NFTs), and stablecoins, although excludes central bank digital currencies (CBDCs).
What are the implications of the designation as a financial product?
In 2020, the FSCA published a proposed declaration notice proposing the declaration of crypto assets as a financial product in accordance with section 1(h) of the FAIS Act.
According to the FSCA, crypto assets are materially similar to some of the other financial products already listed in the definition found in the FAIS Act.10 While some crypto assets may behave as a commodity or form of payment, others are more akin to securities and foreign denominated investment instruments. The effect of this declaration will be that some of the immediate risks posed to consumers will be mitigated given that:
- any person furnishing advice or rendering intermediary services in relation to crypto assets will need to be authorised as a financial services provider (FSP) under the FAIS Act; and
- by virtue of their authorisation as a FSP, such person would need to comply with the relevant requirements imposed under the FAIS Act, including the requirements found in the General Code of Conduct for Authorised FSPs and Representatives, 2003 and the Determination of Fit and Proper Requirements, 2017. These requirements include the disclosure, reporting, continuous professional development, and fit and proper obligations imposed on an FSP, as well as its key individuals and representatives.
As an interim measure intended to address the existing vulnerability of consumers that participate in the crypto environment, the position paper indicates that the intention behind this recommendation is to provide the FSCA with the requisite legal powers to "clamp down" on consumers being abused by financial advisors and intermediaries offering financial advice on crypto assets. According to the FSCA's Regulatory Plan, the timeline for the declaration of crypto assets as a financial product under the FAIS Act is uncertain. Similarly, the timeline for the enactment of the Conduct of Financial Institutions (COFI) Bill (which will ultimately replace the FAIS Act and therefore replace the provisions governing crypto asset related financial advice and intermediary services) is also unclear.
The FSCA has indicated that it intends to introduce further policy developments that capture the full spectrum of CASP activities in a phased manner and has expressed that it is likely to do so through the COFI Bill, as the intended central overarching piece of legislation regulating the conduct of financial institutions.
ii. Recognising CASPs as accountable institutions
Who and what is a CASP?
It has been recommended that CASPs be included as accountable institutions for the purposes of Section 1 of FICA. The crypto market in South Africa, therefore, needs to become familiar with who and what constitutes a CASP. The position paper indicates 6 categories of CASPs (which are identified by the nature of the function or service provided rather than the underlying technology used), namely: (i) crypto asset trading platforms, (ii) crypto asset vending machine operators, (iii) crypto asset token issuers, (iv) crypto asset fund or derivative service providers, (v) crypto asset digital wallet providers, and (vi) crypto asset safe custody service providers. The position paper also helpfully provides further explanations of the services offered by each such category and an indication of which regulatory authority/ies the CASP would likely need to register with.
That said, the categories of CASPs as well as the licensing and registration frameworks will still need to be further developed and finalised in terms of the proposed regulatory updates.
What does it mean to be an accountable institution?
The Financial Intelligence Centre issued its proposed amendments to schedules 1, 2 and 3 of FICA on 19 June 2020. One of the proposed amendments is the inclusion of CASPs on the list of accountable institutions found in Schedule 1 of FICA.
FICA imposes numerous obligations on accountable institutions that are intended to combat anti-money laundering / combatting the financing of terrorism risks. These include an obligation on accountable institutions to develop and implement a Risk Management and Compliance Programme (RMCP) and perform customer due diligence for each transaction or business relationship entered with a client on an ongoing basis.
The expectation is that the inclusion of CASPs in the FICA regime will mitigate against the risks of anonymity associated with the use crypto assets. While many CASPs have historically endeavoured to implement their own AML/CFT compliance out of an abundance of caution, this recommendation will likely increase the compliance burden of most CASPs. It is also worth noting that, despite their transparent nature, rigorously monitoring customer behaviour on public blockchains through smart contracts is not a simple task, and in some circumstances, this may require substantial investment by CASPs in blockchain analytic capabilities.
Additionally, the Prudential Authority (PA) has specifically tasked banks with monitoring client transactions and business relationships, especially where a direct or indirect link to crypto assets or CASPs has been noted, and to report on any suspicious or unusual activity as mandated by FICA.11 In this regard, banks play an important role in instances where they act as conduits for transactions involving crypto assets or where funds are linked to CASP activity.
Activities in the South African market
Turning to activities within the South Africa crypto market, we note the establishment of the Crypto Asset Association of South Africa (CAASA). CAASA is an industry association representing the interests of South African CASPs. The CAASA aims to promote ethical and accountable self-governance for CASPs, working within the fit-for-purpose regulatory framework, enabling the industry to realise its bounds potential to transform South Africa through both economic and socio-economic benefits.
Unlike other jurisdictions that are contemplating new pieces of legislation for the regulation of crypto assets, South Africa seems to be incorporating crypto regulation into the existing legislative framework. The final look of South Africa's crypto assets regulatory framework is still unclear, however, taken at face value the recent announcement by the Deputy Governor of the SARB appears to indicate the initial areas of focus of the impending crypto regulation. The FAIS Act and FICA are detailed pieces of legislation which cover a broad range of regulatory topics from governance, consumer protection, licensing, and data retention to name a few. Examples of some regulatory topics which require more discussion regarding the route South Africa will take are the regulation of cross border transactions, tax, as well as the prudential concerns.
Given the approach adopted by our regulators, in particular the intention to regulate crypto assets under existing legislation, we eagerly await the amendments that will unfold over the upcoming months and how these will affect the various industry players.