Financial Action Task Force releases updated guidance

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The Financial Action Task Force (FATF), a global anti-money laundering watchdog, has released updated guidance on digital assets and digital asset service providers. The release portrays renewed commitment to stay current with rapidly evolving technology and business practices in the industry, emphasizing the need for regulators to remain agile as well as addressing specific new developments within the industry.

The revised guidance comes following a 12-month review of the initial release, which found that some jurisdictions’ anti-money laundering (AML) and combating the financing of terrorist (CFT) regimes with respect to digital assets were still underdeveloped or not developed at all.

It is important to remember that while FATF guidance is not law, FATF recommendations will be influential in (and often form the basis for) new regulation in member countries. Therefore, the guidance is likely to be highly indicative of where domestic regulatory approaches toward digital assets are likely to go.

FATF: guidance for a risk-based approach to virtual assets and VASPs

The changes make some important clarifications and appear to be aimed at closing gaps by better defining the boundaries of FATF’s remit with regard to digital assets. For example, the guidance highlights six focus areas for the updated guidance, the first of which is to “clarify the definitions of virtual assets and virtual asset service providers to make clear that these definitions are expansive and there should not be a case where a relevant financial asset is not covered by the FATF Standards.”

There is also a focus on the rise in crime associated with digital assets and how these might be facilitated by new innovations within the industry. For example, the background to the guidance has been updated to make specific reference to the risks posed by digital assets, saying that both new and emerging risks should be monitored and guide the allocation of resources in FATF member countries and businesses:

The FATF has observed that VAs (virtual assets) are becoming increasingly mainstream for criminal activity more broadly. The majority of VA-related offenses focused on predicate or [money laundering] offences. Notwithstanding, criminals did make use of VAs to evade financial sanctions and to raise funds to support terrorism.

The FATF’s definition of digital asset (referred to as ‘virtual asset’ in the guidance) has been overhauled, and emphasizes that their definitions should be “interpreted broadly, with jurisdictions relying on the fundamental concepts contained in it to take a functional approach that can accommodate technological advancements and innovative business models.”

Similarly, the definition for service providers has been developed. This is important, because FATF recommends that service providers in this space be made to adhere to the same AML/CTF requirements as traditional financial institutions. While the original guidance was clear that almost any digital asset exchange is caught by this definition, the new guidance explicitly says that decentralized exchanges and platforms are considered virtual asset service providers for the purpose of the guidance and therefore are subject to the FATF standards.

Interestingly, much of the updated guidance is concerned with separating marketing obfuscation from reality in assessing digital asset service providers. Regulators are urged to treat all providers the same where they provide fundamentally similar services, regardless of business model. That this is appended to a section which recommends that each member country strive to bring itself in line with global regimes in order to avoid jurisdiction shopping is illustrative, suggesting renewed focus and suspicion on underhanded practices which might not be illegal in and of themselves but yet still undermine regulatory efforts.

For example, the guidance now refers specifically to the growing interest in non-fungible tokens, warning that despite claiming otherwise, some NFTs may constitute digital assets for the purposes of the FATF and pose money-laundering and terrorist financing risks owing to their secondary markets.

Specific guidance is also given on ‘stablecoins’, including offering a definition of the term and some consideration toward their unique risk factors and highlighting that rate-of-adoption will be instructive in assessing risk:

Some proposed so-called stablecoins have been sponsored by large technology, communications or financial firms and seem to have the potential for rapid scaling and mass-adoption. In the same way as any other large-scale value transfer system, this propensity for mass-adoption significantly increases the risk of criminal abuse for ML/TF purposes.

In numerous places, the updated guidance that those dealing in stablecoins should be subject to the same regulatory supervision as those dealing in typical digital assets and traditional financial assets.

The guidance also clarifies that for the purposes of FATF, central bank-issued digital currencies (CBDCs) are not considered digital assets, though still makes the point that they are categorically considered fiat currency and thus still fall within the FATF responsibility.

The updates are comprehensive. Other updates include (but are by no means limited to):

• Countries which have not implemented the ‘travel rule’ are to be considered of high AML/CFT risk;
• Highlighting the importance of cross-border information sharing between regulators and authorities, due to the cross-border nature of digital asset movement;
• Every country must have an authority specifically supervising digital asset service providers for AML/CFT purposes

FATF makes clear that there are no unregulated digital asset businesses

Perhaps the biggest takeaway is that the FATF makes a point of reiterating throughout the guidance that there are no loopholes in the FATF regime: digital assets and digital asset service providers fit within and are subject to the existing regime regardless of whether or not they come packaged as a new business model. This attitude is salient throughout the update, but is also addressed specifically at several points:

The expansiveness of these definitions represents a conscious choice by the FATF. Despite changing terminology and innovative business models developed in this sector, the FATF envisions very few VA (virtual asset) arrangements will form and operate without a VASP (virtual asset service provider) involved at some stage.

Though the guidance doesn’t say so explicitly, it can be inferred from this emphasis that the FATF is addressing the apparently common belief that a good enough marketing spin is all that is needed to be able to do business entirely without regulation. The FATF puts a pin in that misconception: there is scarcely a digital asset that can be contemplated which wouldn’t fit within existing regulatory definitions as prescribed by FATF. If you weren’t already suspicious of products and companies claiming (implicitly or otherwise) to be free from regulation—particularly where they do not implement AML and KYC controls—then the FATF’s attitude should be treated as an invitation to scrutinize these business practices and take your business elsewhere. 

The guidance is still to be finalized, with private consultation now beginning and due to conclude by April 20.

See also: CoinGeek Live panel, Digital Currency & Global Compliance: Tools & Tips for Exchanges, Wallets & Other Service Providers