The Intergovernmental Fintech Working Group (IFWG), through the Crypto Assets Regulatory Working Group (CAR WG), recently published a position paper on crypto assets. The paper is confirmation that crypto assets will be brought into the South African regulatory purview in a phased and structured manner.
The paper essentially provides a roadmap for putting in place a framework for regulating crypto assets, through the regulation of crypto asset service providers (CASPs), in South Africa. It also serves to initiate the process for the individual financial sector regulators to implement the recommendations contained therein.
Crypto assets remain highly volatile and inherently risky given their decentralised and disintermediated value proposition (i.e. crypto assets offer a direct, peer-to-peer transactional capability that does not require a financial intermediary, such as a bank). Their decentralised nature leads to the challenge of decentralised responsibility in the event of something going wrong: because there is no central intermediary, issuer or ledger keeper, consumers essentially have no recourse to any authority or entity to address or resolve user errors (e.g. using the wrong crypto asset address, or sending Bitcoin to an Ethereum address).
As crypto asset-related activities are likely to increase, inaction by the South African financial regulators may potentially accelerate the creation of unregulated parallel systems. This could continue to prevent authorities from having ‘line of sight’ of crypto asset-related activities and developments. By gradually bringing crypto assets into the South African regulatory purview, the most pertinent and immediate risks that have been identified around AML/CFT, cross-border financial flows and consumer protection will be addressed. The position paper makes 25 recommendations on how to bring crypto assets into the South African regulatory remit in a phased and structured approach across three main areas namely:
Anti-money laundering and combating the financing of terrorism (AML/CFT)
The Financial Action Task Force (FATF) has revised Recommendation 15 in respect of new technologies. This revised standard now explicitly requires jurisdictions to regulate crypto assets and crypto asset service providers (CASPs) for AML/CFT purposes.
Cross-border financial flows
From an exchange control perspective, the current Exchange Control Regulations do not explicitly cater for crypto assets, with the implication that the SARB’s Financial Surveillance Department (FinSurv) does not have explicit powers to require South African crypto asset trading platforms to report transactions involving crypto assets. Daily crypto asset trading values in South Africa exceeded R2 billion for the first time in January 2021, providing some anecdotal evidence that there may be significant value moving into crypto assets without FinSurv having oversight over such flows, or the requisite powers to direct market behaviour as appropriate for South Africa.
Application of financial sector laws
Given the increased retail interest in crypto assets, growing instances of consumer abuse, fraud and market misconduct have been noted both internationally and in South Africa. Recent schemes highlighted in the media further emphasise the need for the South African authorities, predominantly through the FSCA, to take action against the growing tendency for market abuse under the guise of crypto assets.
South Africa aims to mitigate the risks posed by crypto assets around money laundering, the financing of terrorism and consumer protection, while not shutting out the potential benefits such financial innovations can bring. Thus, South African regulators aim to enable responsible innovation by regulating CASPs through an appropriate regulatory framework that proportionately balances the potential benefits against the risks that may be introduced into the financial system, while ensuring a level playing field is maintained by not unduly advantaging or disadvantaging either the incumbent role players or new fintech entrants.
To this end, the members of the IFWG agree on the following six principles that will guide the approach on regulating CASPs in South Africa:
Principle 1 - Crypto assets must be regulated appropriately.
Principle 2 - An activities-based perspective must be maintained, and the principle of ‘same activity, same risk, same regulations must continue to apply and inform the regulatory approach.
Principle 3 - Proportionate regulations that are commensurate with the risks posed must apply (i.e. a risked-based approach to crypto asset regulation must apply).
Principle 4 - A truly collaborative and joint approach to crypto asset regulation by the IFWG must be maintained.
Principle 5 - The dynamic development of the crypto market must continue to be proactively monitored, including maintaining knowledge on emerging international best practices (through standard-setting bodies, etc.).
Principle 6 - Digital literacy and digital financial literacy levels must be increased amongst consumers and potential consumers of crypto assets.
The paper represents a policy position that is based on the identification and definition of use cases at the time of drafting the position paper. The need for continuous refinements, amendments and additions is expected within the context of the evolutionary nature of the subject matter and the broader ecosystem. Once finalised and published, the paper will serve as a mandate to the individual financial sector regulators and other relevant regulators to implement the recommendations.