FATF releases targeted update on virtual asset and virtual asset service providers: implementation of standards

Background: FATF recommendations and guidance

In February 2012, FATF published its recommendations in ‘International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation’ (Standards). The Standards require all member jurisdictions to impose anti-money laundering and counter-terrorism financing (AML/CTF) obligations on financial institutions and designated non-financial businesses and professions. The Standards were extended to financial activities involving VAs and VASPs in October 2018. To date, over 200 jurisdictions have committed to implement the Standards.

In June 2019, FATF adopted guidance on the application of the risk-based approach to VAs and VASPs. FATF has periodically released updates to its guidance. We published a previous article in April 2021 on an earlier version of the draft guidance.

FATF has also published two 12-month implementation reviews. You can read the first and second review on the FATF website. These reviews identified that member jurisdictions had made limited progress in implementing the travel rule.

Virtual assets and virtual asset service providers

A ‘virtual asset’ is defined in the Standards as a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes. VAs do not include digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the Standards.

A ‘virtual asset service provider’ means any natural or legal person who is not covered elsewhere under the Standards, and – as a business – conducts one or more of the following activities or operations for or on behalf of another natural or legal person:

• exchange between VAs and fiat currencies;
• exchange between one or more forms of VA;
• transfer of VAs;
• safekeeping and/or administration of VAs or instruments enabling control over VAs; and
• participation in and provision of financial services related to an issuer’s offer and/or sale of a VA.

Findings from the Report

The Report builds on the previous 12-month reviews conducted in 2020 and 2021. The Report focuses on the implementation of FATF’s travel rule, which imposes obligations on ‘wire transfer’ transactions. The rule requires member jurisdictions to ensure their financial institutions obtain and share originator (sender) and beneficiary (recipient) information during the transfer, and to take appropriate measures (including freezing orders) where information is lacking.

In the Report, FATF indicates an urgent need for countries to better understand money laundering/terrorism financing risks associated with VAs and VASPs, as well as the need for widespread accelerated implementation and enforcement of the travel rule to limit the misuse of VAs and VASPs. This stems from findings of continued slow uptake of the travel rule by member jurisdictions over the past year. The key reasons for implementation delays include:

• the fact that the country is still developing a licencing and registration regime for VAs and VASPs; and/or
• a lack of domestic expertise to supervise and enforce compliance with the travel rule.

VASPs continue to encounter challenges to implementation (known as the ‘sunrise issue’) due to the variability in uptake across jurisdictions caused by slow implementation of the travel rule or nuances in travel rule regulations across jurisdictions.

The Report confirms that there are technological solutions to support compliance with the travel rule, but encourages further innovations from the private sector to develop globally operable technological tools which can accommodate cross-jurisdictional nuances.

The Report further identifies emerging risk areas in the VA sector as including decentralised finance, use of non-fungible tokens for illicit financial activities such as money laundering and the use of unhosted wallets to evade the Standards. FATF has committed to monitor market trends for material developments requiring further consideration, including the application of the Standards to decentralised finance and non-fungible tokens.

FATF will conduct a further implementation review by June 2023.

Application in Australia

The travel rule is yet to be implemented in Australia. Members of the blockchain industry have expressed concerns that strict enforcement of the travel rule in Australia would give rise to competitive disadvantage and inhibit innovation in the VA sector.

The Select Committee on Australia as a Technology and Financial Centre recommended in its final report dated October 2021 that AUSTRAC strike a balance by appropriately managing risks without implementing the travel rule in a punitive manner.