Critical questions of the supervisory authority concerning cryptocurrencies

Date: 19 June 2018

We previously wrote about the qualification of cryptocurrencies and the manner in which the legislator and supervisory authorities are currently approaching this development. In brief, a European (or even international) regulatory framework is being awaited. This means that supervisory authorities can currently only make use of the current regulatory framework.
Last Thursday the Dutch Authority for the Financial Markets ("AFM") published a new notice concerning cryptocurrencies. This time the notice is addressed to new or(currently) exempted managers of investment institutions that invest in cryptocurrencies, with the existing regulatory framework being the Alternative Investment Fund Managers Directive ("AIFMD"). Nevertheless, the notice also includes a general message for everyone who is active in the financial markets in the cryptocurrency field: as long as the risks concerning the cryptocurrencies are present, the AFM takes a highly critical approach to financial products or services that are based on cryptocurrencies that fall or may fall under its supervision.

The AFM is very much worried about whether or not managers of investment institutions that invest in cryptocurrencies are able to comply with the full licensing requirements. Currently there already is a significant threshold under the legislation and regulations for compliance with the licensing requirements of a manager of an investment institution. The nature and characteristics of cryptocurrencies are hard to fit into an existing (AIFMD) framework, so thorough knowledge of the applicable legislation and regulations is required. The AFM therefore worries that the above-mentioned parties currently lack the thorough knowledge of the applicable legislation and regulations.

In the situation that either a new or an existing exempted manager of an investment institution that invests in cryptocurrencies must apply for a licence, the licensing requirements that apply pursuant to the legislation and regulations must be complied with (the significant threshold described above). The AFM has drawn up additional questions concerning cryptocurrencies that it wants to be answered to its satisfaction before a licence is granted. These questions pertain to various aspects of the licensing requirements. For instance, one of the questions that is asked is in which manner a manager of an investment institution assesses the liquidity of investments, with subquestions being how the manner of price volatility and the trading volume of cryptocurrencies is taken into account in this assessment and how this volatility of cryptocurrencies is handled between the time of a withdrawal request by an investor and the actual time of withdrawal. The manager is also asked to explain how and which valuation policy will be drawn up and how this valuation policy will be implemented using appropriate, transparent and consistent procedures, so that the assets can be valued accurately and at a fair value.
The AFM also forces market participants to carefully consider their business model and to put the interests of the customer/investor centre stage in doing so. The product development process will have to reflect the complexity of investments in cryptocurrencies.

The AFM also draws attention to the role of the depositary. The duties and responsibilities of the depositary have been significantly expanded since AIFMD, as a result of which the depositary has been given a more important role to play. For instance, the question is asked whether the cryptocurrencies that qualify as financial instruments, are held in a financial instruments account and, if this is the case, how delegation of custody tasks to third parties is handled. The AFM also asks for the manner of verification that the investment institution or the legal owner is the (exclusive) owner of the cryptocurrencies and whether or not a depositary can make sure that there are procedures that ensure that cryptocurrencies cannot be transferred, traded or supplied without the depositary being informed of this. 

We have only included some of the questions above by way of illustration. For a complete list of the questions, please refer to the letter that the AFM sent to the exempted managers of investment institutions that invest in cryptocurrencies.

In addition to this, the AFM states that it wants to be informed early about any desired expansion of the (existing) product range with cryptocurrencies by the new or the (currently) exempted manager, because - according to the AFM - this entails significant additional management risks. Attention is also drawn to the fact that both exempted managers and managers with a licence of investment institutions must comply with the requirements of the Money Laundering and Terrorist Financing (Prevention) Act. 

The above makes it clear that the AFM takes a critical approach to the developments in the cryptocurrency field. It also shows that the AFM - in the absence of a regulatory framework - makes use of its powers in such a way that an (informal) framework is more or less created within which parties can apply for a licence if they manage an investment institution that invests in cryptocurrencies or can act as depositary of such an investment institution. 

This is a Legal Update from Nellemarie Staal and Danielle Martens. Click here for pdf. 

For more information:

Nellemarie Staal                        Danielle Martens
+31 30 259 5652                       +31 30 259 5652