The EMA s position on the proposed inclusion of custodian wallet providers in the scope of the 4 th Money Laundering Directive

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1 The EMA s position on the proposed inclusion of providers in the scope of the 4 th Money Laundering Directive This paper addresses the proposals for an amendment Directive ( 5MLD ) to the 4 th Money Laundering Directive ( ) put forward by the European Commission in July 2016 and the subsequently issued Presidency compromise proposals on this text. Amongst other changes, 5MLD proposes to include providers within the scope of the AML/CTF regime of. This is reflected by the proposal to include a new point (h) under article 2(1)(3) that refers to wallet custodial services of credentials necessary to access virtual currencies." Under an amended article 47(1), member states will furthermore need to ensure that providers of exchanging fiat currencies, providers [and others]... are licensed or registered.... This inclusion of providers within the scope of is justified by the following reasoning set out at recital 6 5MLD: to say currencies declared to be legal tender) as well as providers are under no obligation to identify suspicious activity. Terrorist groups are thus able to transfer money into the Union's financial system or within networks by concealing transfers or by benefiting from a certain degree of anonymity on those platforms. It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include exchange providers. Competent authorities should be able to monitor the use of virtual currencies. This would provide a balanced and proportional approach, safeguarding technical advances and the high degree of transparency attained in the field of alternative finance and social entrepreneurship. The EMA believes that the provisions for providers are drawn excessively broadly and capture services that do not merit inclusion within the regulatory framework. In what follows below, we explain our reasoning and set proposed amendments that would provide for a more proportionate outcome. 1) There is little evidence that services present significant risks of money laundering or terrorist finance. Whether the wallet and customer credentials are stored on a customer s own device or on the provider s server, there is little evidence that wallet providers are subject to a significant risk of money laundering or terrorist financing. Many wallet services offer software overlays (like a web browser) or facilitate non-financial, token transfers (like a cloud database) and are therefore more akin to software services than to a financial services providers. It is therefore disproportionate and very disruptive to the development of many new blockchain technologies to include custodian wallet providers within the regime. Virtual currencies are an innovative sector with a high growth potential, so the approach taken should be proportionate to the risks posed. Our preferred option is therefore to adopt text which will focus 5MLD enhancements on exchange activity, which has been identified by a number of authorities who have investigated this issue 1, as 1 See, e.g., FinCEN Guidance FIN-2013_G001, Application of FinCEN s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies, March 18, 2013 (exchangers and administrators of virtual currencies obligated under U.S. AML laws; no reference to custodial wallets); FATF s Guidance for a Risk-Based Approach to Virtual Currencies, June 2015 ( countries should consider applying the Page 1 of 8

2 posing a risk of money laundering. In particular, we propose to delete all references to custodian wallet providers. We have proposed changes to the Directive text at the section marked PROPOSAL 1 below. 2) Even where customer credentials are stored with a custodian, the real risk is the loss of customers funds; this is not a money laundering risk and is better addressed in the future through prudential regulation There may be a financial risk to customers arising from their use of a when their private keys or credentials are stored on the provider s server, but this risk arises from potential attack of the service provider s system and would thus be better addressed as part of a regime of prudential and IT systems regulation. 3) Many custodian wallet providers do not hold customer credentials that enable access to virtual currencies; they only provide software overlay services Many providers do not hold private keys for their customers. Rather, they provide wallet software through which customers can access their private keys that may be stored locally with the customer or may be distributed to a number of other locations. These providers have no control over customers assets, and an attack on their servers would not expose customers to the risk of loss of their assets. We do not believe that such software service providers should be included within the scope of AML regulation nor do they merit prudential regulation should this be considered. As a minimum, therefore, we propose the definition of provider in the Directive ensures that only providers of services who hold users private keys or fragments of such keys should fall within scope. We proposed possible amendments to the definition and consequent changes to the Directive text at PROPOSAL 2 below. 4) Virtual currencies must be distinguished from loyalty points, in-game value and electronic money The definition of virtual currencies should not only distinguish e-money from virtual currencies (we welcome the Presidency s amendments in this respect), but also between currencies that function as a general means of payment and stores of value such as loyalty points and in-game value that may only be used within a particular product offering. We have made suggested revisions to the definition of virtual currencies in PROPOSAL 1 and PROPOSAL 2 below. PROPOSAL 1 Removal of providers from scope relevant AML/CFT requirements specified by the international [FATF] standards to convertible [] exchangers, and any other types of institution that act as nodes where convertible [] activities intersect with the regulated fiat currency financial system ); HM Treasury, Digital Currencies: Response to the Call for Information, March 2015 ( the [UK] government intends to apply anti-money laundering regulation to digital currency exchanges, to support innovation and prevent criminal use (italics added)); Monetary Authority of Singapore, press release, March 13, 2014 (MAS to introduce regulations to require intermediaries that buy, sell or facilitate the exchange of virtual currencies for real currencies ). Page 2 of 8

3 Proposed 5MLD Presidency compromise of 18 Sep 2016 EMA proposed text Recita l 6 5MLD Recita l 7 5MLD to say currencies declared to be legal tender) as well as providers for virtual currencies are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include virtual currency exchange virtual exchange providers will not entirely address the issue of anonymity attached to virtual currency transactions, to say currencies declared to be coin and banknotes of a country that is designated as a legal tender and is accepted as a medium of exchange in the issuing country) as well as are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include virtual currency exchange exchange, or holding, storing and. [ ] virtual exchange exchange,or holding, storing and to say coin and banknotes of a country that is designated as a legal tender and is accepted as a medium of exchange in the issuing country) as well as for virtual currencies are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include providers for virtual currencies. [ ] exchange,or holding, storing and transferring services for virtual currencies will not entirely address the issue of anonymity attached to virtual Page 3 of 8

4 art. 2(1)(3) (g) and (h) art. 3(18) as a large part of the environment will remain anonymous because users can also transact without exchange platforms or primarily and professionally in exchange services currencies; (h) wallet providers offering custodial services of credentials necessary to access virtual currencies. (18) 'virtual currencies' means a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically. will not entirely address the issue of anonymity attached to transactions, as a large part of the virtual currency environment will remain anonymous because users can also transact without exchange platforms or custodian wallet these providers. [ ] primarily and professionally in exchange services currencies; (h) wallet providers offering custodial of credentials necessary to acess virtual currencies. (18) virtual currencies means a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically can be digitally transferred, stored or traded and functions as a medium of exchange, and/or a currency transactions, as a large part of the environment will remain anonymous because users can also transact without these in exchange services currencies;. (h) of virtual currencies. (18) virtual currencies means a digital representation of value that can be digitally transferred, stored or traded and functions as a medium of exchange, and/or a unit of account; and/or a store of value, which is not the legally established currency of a country and which is not funds as defined in point (15) of Article 4 of the Directive 2007/64/EC nor monetary value as referred to in Art. 1 (4) and (5) of Directive Page 4 of 8

5 unit of account; and/or a store of value, which is not the legally established currency of a country and which is not funds as defined in point (15) of Article 4 of the Directive 2007/64/EC nor monetary value as referred to in Art. 1 (4) and (5) of Directive 2009/110/EC. ensure that providers of exchanging services currencies, custodian wallet providers, are registered, that service providers are licensed or registered, and that providers of gambling services are 2009/110/EC. For the avoidance of doubt does not include air miles and similar products, nor in-game and similar currencies. Art. 47(1) Member States shall provide that currency exchange and cheque cashing offices and trust or company service providers be licensed or registered and providers of gambling services be provide ensure that providers of exchanging services currencies, custodian wallet providers, service providers be are licensed or registered, and that providers of gambling services be are ensure that providers for virtual currencies are registered, that service providers are licensed or registered, and that providers of gambling services are PROPOSAL 2 Distinction of custodial from non-custodial wallet providers Proposed 5MLD Presidency compromise of 18 Sep 2016 EMA proposed text Recita l 6 5MLD to say currencies declared to be legal tender) as well as to say currencies declared to be coin and banknotes of a to say coin and banknotes of a country that is designated as a Page 5 of 8

6 Recita l 7 5MLD providers for virtual currencies are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include virtual currency exchange virtual exchange providers will not entirely address the issue of anonymity attached to virtual currency transactions, as a large part of the environment will remain anonymous because users can also transact without exchange platforms or country that is designated as a legal tender and is accepted as a medium of exchange in the issuing country) as well as are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include virtual currency exchange exchange, or holding, storing and. [ ] virtual exchange exchange,or holding, storing and will not entirely address the issue of anonymity attached to transactions, as a large part of the virtual currency environment will remain anonymous because users can also transact without exchange legal tender and is accepted as a medium of exchange in the issuing country) as well as for virtual currencies providers are under no obligation to identify suspicious activity. [ ] It is therefore essential to extend the scope of Directive (EU) 2015/849 so as to include providers for exchange,or holding, storing and transferring services for virtual currencies and providers will not entirely address the issue of anonymity attached to virtual currency transactions, as a large part of the environment will remain anonymous because users can also transact without these Page 6 of 8

7 art. 2(1)(3) (g) and (h) art. 3(18) primarily and professionally in exchange services currencies; (h) wallet providers offering custodial services of credentials necessary to access virtual currencies. (18) 'virtual currencies' means a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically. platforms or custodian wallet these providers. [ ] primarily and professionally in exchange services currencies; (h) wallet providers offering custodial of credentials necessary to acess virtual currencies. (18) virtual currencies means a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically can be digitally transferred, stored or traded and functions as a medium of exchange, and/or a unit of account; and/or a store of value, which is not the legally established currency of a country and which is not funds as defined in point (15) of Article 4 of the Directive 2007/64/EC nor monetary value as referred to in Art. 1 in exchange services currencies;. (h) of virtual currencies. (18) virtual currencies means a digital representation of value that can be digitally transferred, stored or traded and functions as a medium of exchange, and/or a unit of account; and/or a store of value, which is not the legally established currency of a country and which is not funds as defined in point (15) of Article 4 of the Directive 2007/64/EC nor monetary value as referred to in Art. 1 (4) and (5) of Directive 2009/110/EC. For the avoidance of doubt does not include air miles and similar products, nor in-game and similar currencies. Page 7 of 8

8 Art. 3(19) Art. 47(1) (4) and (5) of Directive 2009/110/EC. (19) provider means a professional provider of a wallet or a means of storing customer credentials that would enable access to virtual currency Member States shall provide that currency exchange and cheque cashing offices and trust or company service providers be licensed or registered and providers of gambling services be provide ensure that providers of exchanging services currencies, custodian wallet providers, service providers be are licensed or registered, and that providers of gambling services be are ensure that providers of exchanging services currencies, custodian wallet providers, are registered, that service providers are licensed or registered, and that providers of gambling services are ensure that providers for virtual currencies services and custodian wallet providers are registered, that service providers are licensed or registered, and that providers of gambling services are Page 8 of 8