Virtual Assets are commonly associated with criminal activity, typically as a consequence of their anonymous nature. Over the last few years significant efforts have been made to tackle the use of digital assets in the laundering of illicit funds. But do the changes go far enough?
FATF Guidance and Money Laundering Regulations
The Financial Action Task Force ("FATF") (the intergovernmental anti-money laundering watchdog) initially identified the following risks associated with virtual assets, including:
Their use in facilitating payments and payment services to populations that do not have access to (or have limited access to) bank regular banking services;
The anonymity provided by the trade in virtual currencies on the internet
The limited identification and verification of participants
The lack of clarity regarding the responsibility for AML/CFT compliance, supervision and enforcement for these transactions that are segmented across several countries
The lack of a central oversight body
Consequently, the FATF adopted changes to its Recommendations to explicitly clarify that they apply to financial activities involving virtual assets. They introduced two new definitions in the AML sphere, “virtual asset” and “virtual asset service provider” (VASP), and it recommended that VASPs be regulated for anti-money laundering and counter terrorist financing purposes.
In June 2019, the FATF issued guidance on the application of the risk-based approach to virtual assets and VASPs intended to help national authorities in understanding and developing regulatory and supervisory responses to virtual asset activities and VASPs. It is also intended to help private sector entities seeking to engage in virtual asset activities to understand their anti-money laundering or counter terrorist financing obligations and how they can effectively comply with these requirements.
The FAFT Recommendations were subsequently adopted as part of the EU's 5th Anti-Money Laundering Directive that was implemented into UK law via the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 ("MLR 2019"). Consequently, since 10 January 2020, cryptoasset exchange providers and custodian wallet providers in the UK need to be compliant with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 ("MLR 2017").
Subsequently, on 20 June 2020 the Joint Money Laundering Steering Group published a revised version of their guide for the Prevention of Money Laundering/Combating Terrorist Financing that included sectorial guidance for cryptoasset exchange providers and custodian wallet providers.
Current Issues
It is arguable that Japan has set the standard for regulation of virtual assets and exchanges. Japan was the first country to legally define virtual assets, and it has adopted strict rules to combat illegal activity to protect customers and exchanges. Some countries take a different approach. Only a few weeks ago China told banks and payments platforms to stop supporting digital currency transactions altogether. However, there are a significant number of countries permitting cryptocurrency transactions whilst lagging behind when it comes to regulation.
Speaking at its annual review of progress on crypto regulation on 25 June 2021, the FATF announced that only 58 out of 128 countries that report to it have implemented its revised Recommendations. Of those, 52 are regulating virtual asset service providers (VASPs), and six are prohibiting the operation of VASPs altogether.
The gaps in implementation mean there are no global safeguards to prevent the misuse of VASPs for money laundering or terrorist financing, leading to “jurisdictional arbitrage.”
What is also concerning is that even countries who have implemented the FATF Recommendations, are struggling to ensure that the cryptocurrency firms they regulate are meeting the required standards. In the UK, the FCA initially set a deadline of 9 July 2021 for companies to register with them. However, firms are struggling to comply with UK anti-money laundering legislation and as a result, the FCA extended the deadline to 31 March 2022. In fact, only 5 companies have successfully registered with the FCA, with a further 90 given temporary registration, permitting them to trade whilst their application is assessed.
Comment
As transactions are recorded in a public ledger, by their very nature virtual assets should be transparent and it should be possible to identify who is behind the virtual assets. In theory this should mean that this is an ineffective tool for money laundering.
However, whilst VASPs in regulated countries like the UK present a lower risk for money laundering, the concern is the ease at which virtual assets can be purchased in non-regulated jurisdictions. This provides a relatively easy route for criminals to purchase virtual assets without the need to comply with stringent AML checks.
Furthermore, many criminals often purchase virtual assets with the assistance of over-the-counter brokers. OTC brokers are agents or firms that facilitate trades between buyers and sellers who do not want to (or cannot) transact on a cryptocurrency exchange.
Additionally, IP anonymity provided by networks including The Onion Router (or the dark web) or Invisible Internet Project allow individuals to muddy internet activities and obscure transactions, frustrating anti-money laundering measures.
These risk factors do little to incentivise further investment in the necessary technology solutions and compliance infrastructure required to protect investors on a global scale. VASPs and investors alike will be looking at governments and regulators to step up their efforts and get a head of the game. Sadly, they are currently behind the technology.
The FATF recently consulted on proposed updates for their AML Guidance, the result of which are due to be announced soon. This will be an interesting read however, until there is world-wide conformity in the application of anti-money laundering controls for virtual assets, its use in money laundering will remain a significant risk. Until effective measures are adopted on a global scale, links between money laundering and virtual assets will continue to cause concern in the marketplace.
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