The Malta Financial Services Authority (‘MFSA’) published a new set of rules regulating collective investment schemes using virtual currencies.
On 22 January 2018, The Malta Financial Services Authority (MFSA) issued a feedback statement on industry responses to its own consultation on the proposed regulation of collective investment schemes in virtual currencies. The consultation document was launched on 23 October 2017, with the consultation process closing on 10 November 2017.
The consultation document proposed a standalone rulebook applicable to Professional Investment Funds (PIFs) that have investment in virtual currencies (VCs) as their investment objective. Building on existing rules applicable to PIFs, the MFSA added further rules specifically intended to mitigate the potential risks of investing in VCs. The main proposals, aiming to safeguard the interest of investors and the integrity of the financial market in the context of virtual currencies, require the PIF and, in some instances, its service providers to ensure competence, include risk warnings, guarantee quality assessment, implement risk management and carry out valuation of investment in VCs.
The MFSA invited interested individuals to submit their feedback on the consultation document over the three weeks succeeding its launch. The product of this publication is a 19-page feedback statement published on 22 January. This statement summarises the responses received by the MFSA and outlines the MFSA’s response and position to these responses. Hereunder follows a summary of the MFSA’s position following the requested feedback from the public.
In response to a significant number of comments on the matter, the MFSA revised its position on the publication of a standalone rulebook applicable to PIFs investing in VCs and will now insert additional requirements pertaining to such PIFs as supplementary licence conditions applicable to such collective investment schemes. The idea of the standalone rulebook was consequently dropped.
The framework will be applicable to collective investment schemes investing in VCs irrespective of their exposure. The framework will also be applicable to those PIFs investing in VCs either directly or indirectly through trading companies or special purpose vehicles. Any other type of indirect investment including investment in units of a collective investment scheme that itself invests in VS will be understood to fall outside the scope of this framework. However, all investments in units of collective investment schemes created through Initial Coin Offerings (ICOs) will be construed as “direct” investments in VCs.
A number of respondents suggested that PIFs investing in VCs should be allowed to convert to Alternative Investment Funds (AIFs) whose assets under management exceed the thresholds prescribed under Article 3(2) of the Alternative Investment Fund Manager Directive (AIFMD). The MFSA is inclined to extend to scope to further encompass AIFs and Notified AIFs but this issue will remain under consideration until the conclusion of the consultation process on the Discussion Paper on Initial Coin Offerings, Virtual Currencies and Related Service Providers, in particular with respect to Question 11 of that discussion paper.
The MFSA reiterates the definition of cryptocurrency as a “math-based, decentralised virtual currency that is protected by cryptography”. Cryptocurrencies are thus considered a sub-category of VCs. Likewise, ICOs are now considered another such sub-category of VCs. Furthermore, the MFSA has proposed a Financial Instrument Test to determine under which circumstances a VC would be classified as a financial instrument in accordance with the general principles of the European Securities and Market Authority (ESMA).
The MFSA was of the view that the legal structure for PIFS making such investments should be limited to SICAV and INVCO structures. These are required to have a board of directors responsible for the overall conduct of business of the collective investment scheme. Limited Partnerships and Unit Trust Structures were also considered to meet the safeguards of additional governance oversight and the decision was taken to extend the regime to these limited partnerships and unit trusts. Moreover, PIFS wishing to invest in VCs may be additionally established as Incorporated Cell Companies (ICCs) or Incorporated Cells (ICs) of either a SICAV ICC or a Recognised Incorporated Cell Company (RICC)
The MFSA has decided that the proposed regime be available only to Qualifying Investors. However the MFSA is considering whether credit and financial institutions should be allowed to deal in VCs, subject to the conditions stipulated therein, solely on behalf of their clients whereas (re)insurance companies and retirement pension schemes are still prohibited from dealing in VCs, either on their own account or for their clients. Final determination on this matter is pending.
The MFSA emphasised its expectation that the governing body of PIFs should have a suitable mix of skillsets encompassing financial services, the field of VCs and their underlying technologies. This requirement also applies to the governing bodies of existing PIFs launching sub-funds investing in PIFs. The Compliance Officer is expected to have an understanding of the field of VCs and the technologies underpinning them while the MLRO is further expected to remain up-to-date with various money-laundering and funding of terrorism typologies adopted with the Digital Ledger Technology (DLT) ecosystem.
This requirement ensures that the appointed investment manager carries out appropriate research to assess the quality of the VCs being invested in. Assessment should be carried out prior to investing in the VC. Thereafter the offered scheme should ensure that the VC investment remains in accordance with investment objectives, policy and restrictions described in the scheme’s offering documentation.
On the basis of the feedback received, the authority has decided to maintain the regulatory status quo that currently exists under the existing PIF regime and conformity with the principle of risk spreading shall also remain optional for PIFs investing in VCs.
Safekeeping and Custody
PIFs investing in VCs are expected to adopt a combination of cold and hot storage. For cold storage, multi-signature wallets, requiring the input of two out of two signatories to access the wallet and carry out transactions, are required. The investment manager (or the investment committee and/or portfolio manager where the PIF is self-managed) is expected to be the first signatory, and the custodian the second signatory. Subsequently, these individuals may transfer the VCs from the multi-signature (cold) wallet to the sole-signature (hot) wallet to which the investment manager (investment committee and/or portfolio manager) will have sole access. The authority will assess, on a case-by-case basis, the adequacy of safekeeping and custody arrangements applicable to PIFs investing in VCs.
Service Providers and Governing Body
It is necessary for service providers wishing to act as such to PIFS investing in VCs to have sufficient financial resources and liquidity to enable them to conduct their business, as well as such business organisations, systems, and experience deemed necessary by the MFSA for them to act in this role. Collective Investment Schemes are required to ensure that proposed service providers meet these requirements. Competence in the area of VCs of the relevant service providers will be assessed by the MFSA on a case-by-case basis.
Although the features of DLT permit real-time financial auditing, the MFSA still considers periodic audit cycles to be neither irrelevant nor obsolete. It also expects auditors engaged by PIFs investing in VCs to have necessary knowledge and expertise in this area.
An investment manager authorised in an EU/EEA State or Recognised Jurisdiction does not need prior approval of the in-house investment committee members by the MFSA.
The MFSA retains that the additional requirements introduced by the framework are commensurate to the associated risks and are deemed necessary for members of a collective investment scheme’s governing body to be in a position to discharge their duties in a diligent manner.
The manner in which the investment manager (or investment committee and/or portfolio manager) performs Risk Management, including stress testing procedures, is a business decision that should be undertaken by the aforementioned individual. The MFSA will issue guidance and other rules based on industry best practices.
PIFs investing in VCs should ensure that the appointed investment manager employs an appropriate liquidity management policy, monitors the liquidity risk of the scheme and ensures the liquidity profile of the investments of the scheme complies with its underlying obligations. The MFSA is of the view that not all VCs can be considered as liquid and thus should not be termed “highly liquid assets”. As such, the investment manager should employ appropriate liquidity tools.
The MFSA clarifies that the valuation policies and procedures applicable to the other asset classes should also be adopted to the valuation of VCs exposures and the calculation of the net asset value of the scheme. PIFs are expected to use appropriate and consistent procedures to ensure proper and independent valuation of assets. The MFSA will issue guidance and other rules as deemed necessary.
Listing on a regulated market shall also be available to PIFs investing in VCs. This possibility shall not encompass those units that have been created through an ICO until the until the conclusion of the consultation process on the Discussion Paper on Initial Coin Offerings, Virtual Currencies and Related Service Providers and the regulatory framework ensuing in implemented.
The MFSA is currently considering the matter of the manner in which PIFs investing in VCs will discharge their reporting obligations in terms of Article 3(3)(d) of the AIFMD, and it will issue further guidance in due course.
Zeta’ Advisory team has extensive know how in this area. Zeta offers a extensive range of advisory, administration and management services, which include company formation, MFSA applications for various structures as well as ongoing administration for all companies, including book keeping and payroll services.
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