What is the travel rule?
The Financial Action Task Force (FATF), the influential intergovernmental agency dedicated to combatting anti-money laundering (AML) and counter-terrorism financing (CTF), has recently updated its guidance to Recommendation 16, also known as the 'travel rule'. This will have a profound impact on businesses operating in the cryptoasset space.
The travel rule provides that countries should ensure that financial institutions, in order to satisfy their anti-money laundering (AML) and counter-terrorist financing (CTF) obligations:
- require that the wire transfers it facilitates be accompanied by accurate information in relation to its wire transfers' sender(s) and receiver(s) (including beneficial receiver(s)), and that such information remain with the wire transfer throughout the payment chain;
- monitor wire transfers to detect those that are not accompanied by the required accurate information; and
- take freezing action and prohibit the conducting of transactions which are the subject of a UN Security Council resolutions relating to the prevention and suppression of terrorism and terrorist financing.
FAFT's guidance to the travel rule has now been expanded to include virtual assets and virtual asset service providers (VASPs), with effect from June 2020. In practice, this means that entities that conduct the exchange, transfer or safekeeping of virtual assets (as well as activities in connection with the issuing or underwriting of virtual assets) above a certain threshold will be required to satisfy the travel rule in the same manner as traditional financial service providers.
The end of pseudonymity?
The ability to pseudonymously transact using cryptoassets, in particular bitcoin and privacy-preserving cryptoassets such as Monero, has been a key feature and attraction of the asset class since its inception. This expanded travel rule will clearly have an impact on such pseudonymity, as exchanges will be required to collect, store and potentially share certain information with other VASPs.
Notably however, the expanded travel rule does not capture peer-to-peer transfers of virtual assets which do not involve a VASP or financial institution, i.e. so-called over-the-counter (OTC) trades. Omitting these transactions from the guidance was "deliberate", says the FATF, as Recommendation 16 is aimed at “placing AML/CFT obligations on intermediaries between individuals and the financial system". Whether this omission undermines the AML/CTF efficacy of the travel rule remains to be seen, given than unhosted wallets (i.e. wallets held independently of a VASP) are believed to account for much of the illicit activity conducted using cryptoassets.
In preparation for the travel rule going into effect, VASPs have been moving to implement the necessary procedures to satisfy their obligations. In some instances, this has been challenging owing to the lack of native real-world identity ownership attribution on most major platforms, and the need to balance disclosure obligations with data protection and privacy laws and regulations.
In June 2020, the FATF completed a twelve month review of the implementation of its revised guidance. Overall, the FATF found that jurisdictions had made progress, and that “35 out of 54 reporting jurisdictions advised that they have now implemented the revised FATF Standards". While 19 jurisdictions have not yet implemented the revised standards in their national law, FATF noted that "there is evidence of progress. In particular, there has been progress in the development of technological solutions to enable the implementation of the ‘travel rule’ for VASPs, even though there remain issues to be addressed by the public and private sectors.”
Work remains to be done to develop and implement infrastructure that will enable the seamless sharing of travel rule information between VASPs, many of whom operate using divergent systems, platforms and programming languages. FATF noted that it “is not aware yet that that there are sufficient holistic technological solutions for global travel rule implementation that have been established and widely adopted”, and that “the FATF calls upon the VASP sector to redouble its efforts towards the swift development of holistic technological solutions encompassing all aspects of the travel rule." We continue to monitor this situation closely and work with clients seeking to bridge the technology gap identified by FATF.
FAFT has noted that the “fast-moving and technologically dynamic” virtual asset sector requires “continued monitoring and engagement”. Therefore, it has committed to, among other things, “continue its enhanced monitoring of virtual assets and VASPs and undertake a second 12-month review of the implementation of the revised FATF Standards on virtual assets and VASPs by June 2021 and consider whether further updates are necessary”. Furthermore, FATF has promised to “release updated Guidance on virtual assets and VASPs, addressing issues including…anonymous peer-to-peer transactions and travel rule implementation”, and “continue to promote the understanding of money laundering and terrorist financing risks involved in transactions using virtual assets…”.
The updated FATF guidance coincides with an ongoing consultation by HM Treasury on legislation that would seek to expand its regulatory authority to include cryptoassets, with a view to bringing further cryptoasset service providers with the scope of the UK's AML and CTF regimes. We would expect the FCA and the Prudential Regulatory Authority to review their own positions following the conclusion of HM Treasury's consultation.
Watch this space for updates and commentary as this fast-moving regulatory landscape unfolds.