• Tue. Sep 20th, 2022

Cullen Commission explores issue of money laundering through virtual assets – FinTech

ByChad J. Johnson

Aug 17, 2022

In June 2022, the final report of the Commission of Inquiry into Money Laundering in British Columbia was released. As we have already pointed out in Cullen Commission Releases Final Report on Money Laundering in British Columbia — Key Takeaways, the Commission’s report, led by B.C. Supreme Court Justice Austin Cullen, examines the nature and extent of money laundering activity in B.C. and examines the multiple issues that have contributed to his meteoric rise. The 1,800-page long report includes an analysis of the role of virtual assets, including cryptocurrencies, in money laundering and other crimes, as well as investigative methods. The report provides a useful and comprehensive overview of the current regulatory landscape relating to cryptocurrencies and other virtual assets in Canada, and addresses the challenges and opportunities that lie ahead for both regulators and private players.

While the report notes that illicit activity is becoming a smaller and smaller share of the overall virtual asset market, the report also observes that significant challenges continue to arise both in terms of prevention and enforcement. In particular, the Commission found that federal regulatory efforts have thus far been hampered by a failure to adequately consider the unique nature of virtual assets and the inherent difficulties in preventing their misuse.

While exploring what the Commission perceives as gaps in federal regulatory efforts in the virtual asset space, the report also highlights the important role that the provincial legislature and regulators can play in addressing regulatory gaps. At present, the Commission considers that the patchwork of efforts to regulate digital assets present significant opportunities for illicit financial activity. The report further notes that the incomplete regulatory framework poses systemic risks to the investing public, as evidenced by the collapse of QuadrigaCX and other recent debacles in the industry. The Commission considers that improved provincial regulation, likely with the cooperation of provincial securities regulators, is essential both to protect the investing public and to grant virtual asset service providers a more consistent and predictable regime. in which to operate.

As the report indicates, federal and provincial governments are paying increasing attention to the virtual asset sector to bring a greater degree of certainty and predictability to space for service providers and the public. . As the regulatory landscape relating to cryptocurrencies and other virtual assets continues to develop, it will be imperative for relevant stakeholders to understand the legal landscape and ensure they remain compliant with this evolving area of ​​law. fast. The Commissioner was encouraged that securities regulators are developing frameworks for virtual assets and providing guidance to companies on the circumstances in which they will be subject to securities regulation.

Below, we discuss several key points from the Virtual Assets chapter (Chapter 35) of the report:

The PCMLTFA travel rule

The report explores the impact of Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) on the virtual asset space and discusses the effectiveness of requiring compliance with the “move rule”. The Travel Rule requires certain financial entities and “money services businesses” to keep detailed records of accounts and transactions related to the transfer of virtual currency, particularly when receiving such transfers. The information to be collected from the transferring party and the recipient includes the relevant account numbers and all names and addresses attached thereto. The travel rule also requires these entities to implement risk-based policies to determine whether and when to reject such transfers if they do not contain prescribed information.

However, the report finds that the travel rule has suffered from difficulties in implementing it in practice. For example, there is no single, uniformly accepted technology solution for implementing the travel rule and despite attempts to harmonize customer due diligence approaches and processes, the industry continues to use widely disparate methods to identify and track their users’ transactions. The PCMLTFA Travel Rule is also limited in scope as it only applies to transfers between service providers of virtual assets, not between a provider and a given user’s private virtual wallet. The Commission also observed that the inclusion of virtual assets in the definition of “money services businesses” in the PCMLTFA ignores the fact that many virtual asset service providers are highly sophisticated trading platforms that engage in activities such as fast trading and rapid movement of funds. As the Commission noted, such activities can raise significant red flags for traditional money services businesses, but are common in the virtual asset space. Virtual asset service providers therefore face reporting requirements that are fundamentally inconsistent with the realities surrounding their business. As the report indicates, federal regulatory efforts have placed virtual asset service providers in an often inadequate legal regime that consistently fails to consider prevailing business realities.

Provincial regulations

While overall the Commission views the inclusion of virtual assets in the PCMLTFA favorably despite some shortcomings, it asserts that provincial involvement will likely be key to establishing an effective regulatory regime for virtual assets. As noted by the Commission, the PCMLTFA does not address issues such as the internal operations of virtual asset service providers, nor does it provide rules regarding the protection of investors and consumers or the regulation of payment processors. third. The report recommends that a BC provincial level regulator be appointed from existing bodies or newly created bodies to address these issues in consultation with regulators and stakeholders, including the Anti-Money Laundering Commissioner, the British Columbia Financial Services Authority and the British Columbia Securities Commission.

Availability of audit services

According to the report, another significant barrier to effective regulation of the virtual asset industry is the availability and effectiveness of auditing services. The Commission has found it difficult for non-traditional digital asset service providers to find auditors with the skills and experience to operate effectively in the virtual asset industry. Additionally, auditing standards require further clarification from regulators in order to be applied to virtual asset service providers in a sensible and effective manner. In addition, these audit services can be prohibitively expensive for new suppliers. In response to these questions, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada have jointly prepared a joint consultation document which aims to provide a regulatory framework for virtual asset trading platforms. The report views these developments favorably and indicates that the virtual asset space will likely continue to see other levels of oversight established in the future.

Cryptocurrency and crime

The report also discusses the extent to which virtual assets are involved in criminal activities. The report references an annual report from Chainalysis, a leading cryptocurrency data platform, which states that the percentage of cryptocurrency transactions involving illicit activity over the past few years has been “low.” . Chainalysis reported that in 2019, only 2.1% of the total analyzed cryptocurrency transaction volume was illicit, with that number dropping to 0.34% in 2020. It is important to note, however, that the volume of money involved in these “low” percentages is still significant, totaling US$2.4 billion in 2019 and US$10 billion in 2020. We note that the 2022 Crime Report from Chainalysis indicated that approximately US$14 billion dollars worth of virtual assets went to illicit addresses in 2021. Despite these large amounts and rising amounts, the commissioner noted that Chainalysis paints a generally bullish picture of the cryptocurrency space as it relates to containment of illicit activity, stating that this illegal activity is steadily decreasing as a percentage of the overall cryptocurrency market.

Conclusion

The inclusion of the virtual assets chapter in the report highlights the rise of digital assets, the growing government surveillance of the sector, and the practical obstacles to combating money laundering and other crimes in space. As noted by the Commission, it is encouraging that regulatory frameworks for virtual assets are being further developed and refined, as this will provide better guidance for companies operating in the sector and better protection for the investing public.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.