Introduction
During the past few months Malta has made significant efforts to be the first jurisdiction to create a detailed framework which regulates virtual currencies and Distributed Ledger technology (DLT) which resulted into the fruition of the newly established Malta Digital Innovation Authority (MDIA), the Innovative Technology and Services Act (ITAS) and the Virtual Financial Assets Act (VFAA), confirming Malta as the ‘Blockchain island’. This process of regulating blockchain, including virtual currencies is being followed by regulators and the industry players all over the world and is creating a lot of interest, as in fact a large number of already established blockchain and crypto business are setting up operations in Malta due to these developments.
The Malta Digital Innovation Authority will process the registration for innovative arrangements or services as required by the Innovative Technology Arrangements and Services Act (ITAS). The latter regulates the regime for technology services providers and certification of the said Innovative Technology Arrangements or Services. The Virtual Financial Assets Act (VFAA) is the new framework that regulates cryptocurrencies, Initial coin offerings and other Virtual Financial Assets (VFA) services offered. The aim of the legislation, regulations and rules is to safeguard financial stability, promote market integrity and ensure investor protection. An introductory explanation of the VFA framework is detailed below.
Virtual Financial Assets
The Maltese framework defines a virtual financial asset (VFA) to any form of digital medium recordation that is used as a digital medium of exchange, that is accepted by all parties for trade of goods or services, unit of account, that is a nominal monetary unit of measure or currency to represent the real value or store of value, which refers to an asset that maintains value without depreciating and is not electronic money, a financial instrument or a virtual token. In order to have proper classification, The Malta Financial Services Authority (MFSA) has produced the Financial Instrument (FI) test to classify such DLT assets. Whilst Virtual Financial Assets are regulated by the VFAA, those DLT assets classified by such FI test as Financial Instruments and Electronic virtual tokens are regulated by the respective financial services legislation and those DLT assets classified as virtual tokens are not regulated.
The test is divided into different stages. It first determines whether a DLT asset qualifies as a Virtual Token (VT) if not, the test moves to the next stage. DLT assets shall be considered as VT under VFAA if the assets have utility and value only within the context of a DLT platform and may not be exchanged for funds on the platform or within the issuer. Therefore, DLT assets which cannot be exchanged directly against legal tender, bank credit or another DLT asset will not fall within the VFA Act.
The test then determines if the DLT asset is e-money and also whether DLT qualifies as a financial instrument under MiFID which encompasses the following assets:
- Transferable securities
- Money Market Instruments
- Units in Collective Investment schemes
- Financial Derivatives ,
- emission allowances consisting of units recognised for compliance with the requirements of Directive 2003/87/EC (Emissions Trading Scheme).
If a DLT asset is determined as a Virtual Token, electronic money or other financial instrument, the DLT assets will not qualify under the VFA Act.
Initial VFA Offering
The newly enacted Virtual Financial Assets Act in Malta recognizes the possibility for the issuance of Initial Virtual Financial Asset Offering (‘Initial VFA Offering’), more commonly known as Initial Coin Offering (ICO’s). with the main purpose of ensuring investor protection, promote Market integrity and safeguarding financial stability.
The VFAA defines the Initial VFA offering as “a method of raising funds whereby an issuer is issuing virtual financial assets and is offering them in exchange for funds”. This concept can be compared to crowdfunding methods that have been long established and used as a platform for new business to gather the necessary funds to initiate or develop their ideas.
The law establishes that an issuer of any type of ‘Initial VFA Offering’ shall seek the services of a registered VFA agent, who, provided that the issuer meets all the legal criteria, would register the whitepaper on his behalf. The publishing of a whitepaper, which is the equivalent to that of a Prospectus in a traditional Initial Public Offering is not new to the Virtual Financial Assets world; however, the new legislation means that issuers when producing such a whitepaper should ensure that it is consistent with the number of specific requirements established by the VFAA and is duly registered with the competent authority. This aids in creating a regulatory framework allowing transparency to potential investors on the proposed project, stability and security of the industry.
VFA Services and Service Providers
The VFAA defines a VFA Service to be any of the following services which is provided in relation to a DLT asset which has been determined to be a virtual financial asset
- Reception and Transmission of Orders
- Execution of orders on behalf of other persons
- Dealing on own account
- Portfolio Management
- Custodian or Nominee Services
- Investment Advice
- Placing of virtual financial assets
- The operation of a VFA exchange
The rules set ongoing obligations that such VFA Service Providers must adhere to including: [i] organisational requirements; [ii] prudential requirements; [iii] conduct of business obligations; as well as [iv] record keeping, reporting and disclosure requirements and also set out the supplementary conditions for VFA Exchanges.
It is being proposed to have four different licence classes, the requirement to appoint a VFA Agent, the possibility of the Competent Authority to require the appointment of a Systems Auditor. The criteria taken into consideration by the MFSA prior to granting a licence, include fitness and properness, as well as initial capital requirements which will range from €25,000 to €730,000 and that the VFA Service Provider’s business shall be effectively directed or managed by at least two individuals in satisfaction of the ‘dual control’ principle.
The VFAA also requires appointing a Board of Administration that shall monitor and periodically assess the adequacy and implementation of the Licence Holder’s strategic objectives in the provision of VFA services, the effectiveness of the Licence Holder’s governance arrangements and the adequacy of the policies relating to the provision of services to clients and take appropriate steps to address any deficiencies.
License holders shall also be considered as subject persons and shall comply with the Prevention of Money Laundering Act
The VFA Agent and his responsibilities
The VFAA has made it mandatory for all issuers and other service licence holders to appoint a VFA agent. Such a VFA Agent needs to be authorised and must be either an advocate, accountant or auditor or a firm of such professionals, or Corporate service providers or otherwise a legal organisation which is wholly owned and controlled by such persons mentioned before.
The VFA Agent will have great responsibility to ensure thorough Due Diligence of clients prior to accepting to offer its services to any Client, by ensuring that such person is a fit and proper person, that is that the Client is of sufficient good standing and repute, has sufficient financial resources and that its board of administration has collectively sufficient knowledge, experience and expertise in the field of information technology, DLT and DLT assets, at all times.
Besides processing the license application to all applicants, a VGA agent appointed by an issuer must also:
- Advise and guide the issuer on its responsibilities and obligations required by the VFAA and to guide the issuer on matters relating to trading on DLT exchanges,
- Submission of documents and information to the competent authority,
- The VFA agent shall be independent from the issuer and shall confirm its independence through writing,
- Act as an intermediary between the issuer and the competent authority in connection with registration of whitepaper registration and other matters,
- Submit to competent authority on annual basis a certificate of compliance,
- The VFA Agent alongside with the issuer shall determine whether a DLT asset falls within the definition of the VFAA using the FI test described in the following section.
The Competent authority shall establish a public and online register listing all registered VFA Agents
Conclusion
Whilst the Act has been approved by Parliament last July, the proposed rulebook should be finalised by mid-October so that the entire framework is being suggested to be effective from 1st November. Finally, it has to be noted that the purpose of all this regulation is to have a robust framework which safeguards financial stability, promotes market integrity and ensures investor protection.
Daniel Camilleri