Knowledge

Donald Rumsfeld once said that there are known knowns, there are things we know that we know.  There are also known unknowns, there are things we know that we don't know. 

On 9 September 2022, the BVI Financial Services Commission (the "FSC") circulated the draft Virtual Assets Service Providers Act, 2022 (the "VASP Act") for consultation.  With the circulation of the VASP Act, the market is now confronted with known knowns and known unknowns in the regulation of virtual assets.

We know there will be legislation, and we know what it looks like.  But we don't know what the full scope of the law will be.  There is still uncertainty as to what services, assets and persons will ultimately fall within the legislation.

This briefing aims to illustrate what is known, and what is still unknown, about the new legislation, in order that market participants can better prepare for the forthcoming regulatory changes.

What we know

The VASP Act is designed to incorporate the principles outlined by the Financial Action Task Force in its Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (the "FATF Guidance").  The purpose of the FATF Guidance and the VASP Act is to extend regulatory oversight to service providers and ensure consumer protection in the virtual assets space. 

The current draft of the VASP Act regulates certain types of activity, in line with the FATF Guidance, and covers the following activities:

• virtual assets service providers;
• virtual assets custody services; and
• virtual assets exchanges.

The definition of virtual assets service providers ("VASPs") is wide in scope and will include any person engaged in the business of any VASP activity on behalf of another person.  The types of activity included in the definition of virtual assets service include:

• hosting wallets or maintaining custody or control over another person's virtual asset, wallet or private key;
• providing financial services relating to the issuance, offer or sale of a virtual asset;
• providing kiosks for the purposes of facilitating virtual assets activities; or
• engaging in other activities that, under guidelines to be issued, constitutes a virtual assets service, issuing virtual assets, or being involved in virtual assets activity.

This is supplemented by further types of activities in the definition of VASP which include conducting, on behalf of another person:

• exchange between virtual assets and fiat currencies;
• exchange between one or more forms of virtual assets;
• transfer of virtual assets, where the transfer relates to conducting a transaction on behalf of another person that moves a virtual asset from one virtual asset address or account to another;
• safekeeping or administration of virtual assets or instruments enabling control over virtual assets;
• participation in, and provision of, financial services related to an issuer's offer or sale of a virtual asset; or
• such other activity or operation as may be specified in the Act or regulations made thereunder.

Where a person falls within the scope of the VASP Act, they will be required to apply for registration and comply with certain continuing obligations. 

The registration requirements and continuing obligations are designed to ensure that service providers in the BVI operate in a prudent manner, that service providers comply with international anti-money laundering standards, and that virtual assets service providers are subject to regulatory oversight.

What we don't know

The consultation period for the draft VASP Act closed on 23 September 2022.  Following our review of the draft legislation (and submissions to the FSC), we consider that there are a number of points that require further clarification.  Key considerations include: 

• Clarification of what types of virtual asset are covered.

The current draft VASP Act provides that virtual assets are "a digital representation of value that can be digitally traded or transferred, and can be used for payment or investment purposes", although digital representations of fiat currencies and bank accounts are excluded.  There is provision for excluded digital tokens, although there is currently no guidance on what tokens are actually excluded.

We note that the position taken under the VASP Act concurs with the approach taken by the FATF, but differs from approaches taken in other jurisdictions, such as Singapore, where the Financial Services and Markets Act 2022 ("FSMA") provides that a digital token is either "a digital payment token" or "a digital representation of a capital markets product" and excludes certain types of token.

We expect that the VASP Act will exclude certain types of token, but it is difficult to determine what may be excluded at this time.  It is possible that excluded tokens could include forms of utility token, service token, non-fungible token ("NFT") and limited purpose payment token.

There is evidence for this approach elsewhere.  For instance, utility tokens are expressly excluded from the scope of the FSC's Guidance on Regulation of Virtual Assets, and NFTs are generally deemed out of scope in the FATF Guidance.  If we look to other jurisdictions, we note that Singapore excludes limited purpose payment tokens from FSMA and Cayman excludes virtual service tokens from its virtual assets legislation. 

As such, it is likely that there will be carve-outs for various types of token, but we will need to await the revised draft legislation before the position is clear. 

• Clarification of whether issuers are included.

The draft VASP Act unusually includes issuing virtual assets in the definition of virtual assets services, which departs from the FATF Guidance.  The inclusion of issuing assets is peculiar, given that the purpose of VASP legislation is to regulate service providers not issuers.  We also note that Singapore does not include issuances in the definition of digital token services under FSMA.

As such, there is some ambiguity in the current draft legislation and it goes beyond the FATF Guidance.  Further clarification is required as to the intended meaning and effect of this drafting, or whether the language will be amended or removed in the final version of the legislation. 

• Clarification of what types of persons will be excluded.

The VASP Act provides that generic categories of service provider (such as cloud service providers) will fall outside the definition of service provider.  The draft legislation also makes provision for excluded persons, which will be set out in subsequent regulations.  It is currently unclear as to what types of excluded person will be included or when any such regulations will be brought into force.

Our view is that the market needs clarity on which classes of person may be excluded.  We note that Singapore provides for the exclusion of lawyers, liquidators and receivers where services are incidental.  Should the FSC take a similar approach, we consider that it would also be prudent to include executors, administrators and trustees. 

Given the wide scope of virtual assets services, it is also possible to foresee other classes of person inadvertently falling within the legislation.  We envision scenarios where this could potentially occur under the law of agency, bailment, security, partnership law, or pursuant to the order of a Court.  We consider that clarity is required in this respect and that best practice would be to consider exclusions. 

We will, however, need to await the revised legislation before understanding what safe harbors are available.

• Clarification regarding the interplay of the VASP Act with other financial services legislation.

The VASP Act is part of a wider suite of financial services regulation and we would expect the VASP Act to align with similar legislation.  For instance, the Guidance on Regulation of Virtual Assets already provides guidance on the treatment of tokens in the context of securities and money services legislation.  It remains to be seen whether the VASP Act will align with such guidance, or whether the guidance itself may require updating to ensure equivalence in regulatory standards.  Similarly, more clarity is required as to registration requirements where activities may fall under the VASP Act and other financial services legislation.

A further issue is that the VASP Act appears to introduce new regulatory requirements.  Specifically, there is a requirement to have two individual directors and, in certain heightened risk scenarios, a requirement that one director is resident in the BVI.  This requirement appears to go beyond FATF principles on equal regulatory treatment, and is not aligned with the approach taken in relation to similar types of BVI regulated entities.  As such, it is to be determined whether this provision will remain in the final legislation, or whether this is indicative of a wider change in regulatory approach.

In summary, there are several points which still require clarification, and it is not possible to confirm with certainty what the final legislation will look like.  We do, however, have a good understanding about what we do not know, and what market participants will need to know.