Virtual currency regulation in Jersey

Virtual currency trading value and volume is soaring globally, but regulating virtual currencies and those who provide virtual currency exchange services (Exchangers) is challenging. 

Exchangers operate at the interface between the physical and the virtual value chains, exchanging virtual money, such as Bitcoin, into tangible, so-called "fiat" money, or vice versa.

The Proceeds of Crime (Miscellaneous Amendments) (Jersey) Regulations 2016 (the Regulations), which came into effect on 26 September 2016, have brought Exchangers within the ambit of Jersey's anti-money laundering legislation. Like other financial services businesses, Exchangers must comply with the island's laws, regulations, policies and procedures aimed at preventing and detecting money laundering and terrorist financing.

The Regulations, which were prompted by consultations from the Government of Jersey, made virtual currency exchange a supervised business and require Exchangers to register with, and fall under the supervision of, the Jersey Financial Services Commission (JFSC) solely for the purpose of anti-money laundering and countering of terrorist financing (AML/CFT).

But in a nod to the island's burgeoning Fintech sector and inclination of the industry to take appropriate measures to the fast-developing digital sector, an innovative regulatory sandbox was created, allowing Exchangers with turnover of less than £150,000 per calendar year to test virtual currency exchange delivery mechanisms in a live environment without the normal registration requirements and associated costs.

As such, the Regulations offered a measured approach to risk, created further opportunities for the Fintech community and placed Jersey at the forefront of regulatory development in this sector.

The measures that were taken in 2016, as implemented by the Regulations, responded to a "first step" approach, leaving room for further development and regulations in that sector. The goal was to start applying the industry's biggest stakeholders (i.e. JFSC, Digital Jersey, Jersey Finance…) to the task of instigating a regulatory framework for virtual currency businesses, which started with an anti-money laundering and countering of terrorist financing supervisory regime.

As planned, the JFSC has now suggested progression in that area and offered in a consultation paper issued in December 2019 a pro-active regulatory framework not restricted to money laundering threats. In this briefing, we will discuss the current state of the regulation for Exchangers and the recent propositions made by the JFSC.

Background to virtual currencies

Fiat currency is paper based currency that a government, State or collection of countries (such as the European Union) has declared to be legal tender, but which is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Most modern paper/plastic currencies are fiat currencies; they have no intrinsic value and are used solely as a means of payment.

Virtual currencies, on the other hand, have no physical presence. They are, as the name implies, virtual and exist only on a digital distributed decentralised network called a blockchain.

In essence, each virtual currency is a collection of concepts and technologies that form the basis of a digital money ecosystem. Each unit of virtual currency (such as Bitcoin, Ether or Ripple, for example) is used to store and transmit value among participants in a particular blockchain.

Virtual currencies use cryptography for security, making them incredibly difficult to counterfeit or hack. Importantly, virtual currencies are not issued by any central authority, although this is likely to change in the future.

Interest in virtual currency continues to grow and virtual currency trading value and volume has rocketed in recent years.

A shift in the debate between currency or commodity – a parallel with securities

The nature of virtual currencies is complex and presents challenges to regulatory systems. Regulation is needed to ensure virtual currencies are not used to facilitate money laundering and terrorism activities and to give regulators associated monitoring, investigatory and preventative powers. As we explained, this has already been introduced in Jersey by the Regulations, however, the challenge now consists of whether regulatory supervision for the purpose of the Financial Services (Jersey) Law 1998 (FSJL) is needed.

But regulating virtual currencies is difficult. How does a centralised government system regulate an application that exists on a decentralised, deliberately anonymous technology platform (blockchain) which has no obvious rules that govern it? 

The starting point for addressing the question of pro-active regulation is determining the nature of the "application" in this context. In previous years, the debate was focused on whether virtual currency should be regarded as a currency or a commodity.

Globally, it seemed we were yet to reach a consensus on the answer to this fundamental question.  In the US, for example, the United States Treasury has historically taken the view that Bitcoin is a form of currency, whilst a Florida Circuit Court Judge recently held[1]  that Bitcoin is not "real money". In Europe, tax authorities in countries such as Sweden have previously argued that Bitcoin should be treated like a commodity and thus subject to sales tax on transfer; however, in 2015 the European Union’s Court of Justice ruled[2] that for tax purposes, Bitcoin must be treated like a currency and not a commodity, an approach also followed by the UK at that time.

With this lack of consensus on the nature of virtual currencies, it was no surprise that a consistent approach to their regulation had yet to emerge. Two main possibilities then persisted: to categorise virtual currencies in a way that folds them into existing statutory regimes; or to introduce new regulations focussing specifically on virtual currency.

In most recent years however, it seems the debate has shifted towards whether crypto-assets can be considered as commodities or securities. This new debate is more prominently affecting the position on regulation of crypto-assets and has changed the positions taken so far. In the UK for example, in a decision in the case of AA v Persons Unknown & Ors, Re Bitcoin1 (2019), the English High Court settled that crypto-assets are properties, giving them a whole new dimension as they can now be the object of proprietary injunctions. Most recently, the Financial Conduct Authority (the FCA) has decided that even though crypto assets remain unregulated for the purpose of financial services laws, certain types of crypto assets may fall within the remit of investment business depending on how the crypto-asset is structured. The FCA considers that security tokens are regulated as they can provide rights such as:

  • ownership position
  • repayment of a specific sum of money
  • entitlement to a share in future profits

Another appearance that has prompted a shift in position on this debate is the recurrence of Initial Coin Offerings (ICOs). ICOs are digital ways of raising funds from the public, or creating decentralised networks, using crypto-assets. They have been increasingly used since 2018 and are mainly happening offshore which is of particular interest to the JFSC. ICOs offer parallels to Initial Public Offerings such as placement of securities, crowdfundings or collective investment funds which means they could potentially (and maybe will) fall within the remit of regulation for investment businesses.

This new position on the nature of crypto-assets allows therefore to answer the dilemma set out above – it appears financial regulators are keen to integrate crypto currencies' regulation as part of an existing regime, i.e. investment business. The JFSC's new approach is set out in more details below.

Jersey's regulatory approach so far

Consistent with the European and UK approach, the Regulations adopted in Jersey in 2016 amended the Proceeds of Crime (Jersey) Law 1999 (the 1999 Law) to provide for virtual currency to be categorised as a form of currency. Specifically, the Regulations define virtual currency widely as any currency which (whilst not itself being issued by, or legal tender in, any jurisdiction) digitally represents value, is a unit of account, functions as a medium of exchange and is capable of being digitally exchanged for money in any form.

By treating virtual currency as a currency rather than as a commodity, Jersey's approach has been to regulate virtual currency within its current statutory regime, but so far only for the purpose of AML/CFT protection. Exchangers have since been subject to the existing Money Laundering (Jersey) Order 2008 and the AML/CFT handbook and have been required to adopt normal policies and procedures to prevent and detect money laundering and terrorist financing. Similarly, businesses trading in goods worth at least €15,000 per transaction who receive payment in virtual currency have been brought within the same legislative regime applicable to so-called "high value dealers" under the 1999 Law.

However, in one important aspect, Jersey has combined the different regulatory approaches mentioned above by introducing a bespoke carve-out to the existing statutory regime for Exchangers with a turnover of less than £150,000 per calendar year (Exempt Exchangers). Although the general rule is that Exchangers are required to register with, and pay annual fees to, the JFSC, Exempt Exchangers will simply need to notify the JFSC that they are carrying on the business of virtual currency exchange. 

As such, whilst the JFSC will still maintain overall supervisory and investigative powers in relation to such Exempt Exchangers, Jersey has effectively created a safe harbour in which they can test innovative products, services, business models and delivery mechanisms in a live environment without immediately being subject to the usual costs associated with obtaining registered status for the fight against money laundering. This is expected greatly to reduce the initial burden associated with developing a virtual currency exchange platform through the testing and start-up implementation phases.

The proposed changes to the regulatory status of Exchangers

As we now have seen, the regulatory framework of Exchangers is limited to a "Schedule 2" notification under the 1999 Law. The JFSC has in late 2019 sought the opinion of the financial services industry in relation to the enhancement of the Investment Business regime, as part of the "appropriate development" approach agreed on in 2015. One of the proposed changes would be to amend the FSJL in order to cover the pro-active oversight of Exchangers by the JFSC

By proposing consultations on this topic, the JFSC explained that the way to approach a better regulatory supervision of Exchangers would be by enhancing the Investment Business regime to advance protection of the customer and the integrity of Jersey's financial industry. The proposed changes in the consultation paper promotes for better clarity of the Investment Business legislation and contributes towards the Island meeting the international regulatory standards.

The proposed changes to the FSJL are to create a legislation of supervision for the trading of investments, whether by electronic means or otherwise, to give the JFSC the ability to authorise, supervise and create relevant codes of practice to regulate Exchangers of any crypto-assets. The goal is to ensure that exchanges and markets are fair, efficient and transparent.

It is planned that this amendment to the FSJL would not come into force straight away but rather be adopted as and when required by way of a Ministerial Order. This change is anticipated in order to have the registration and licensing requirements aligned and ready to be implemented when needed.

There is yet no feedback available on this consultation.

Conclusion

The application of a ‘regulatory sandbox’ in this specific and evolving area of regulation was innovative and was the compromise found in 2016 to introduce a supervisory model of virtual currency whilst leaving breathing room for this area to evolve in Jersey. The establishment of a £150,000 economic threshold for Exchangers created a fair balance between giving innovators the chance to explore the opportunities created by virtual currencies, while applying a measured regulatory approach. However, it appears that the virtual exchange industry has sufficiently evolved in the last 4 years to trigger a need for  regulatory supervision no longer strictly based on AML/CFT concerns and to raise the bar to a financial services supervision.

 

[1] "Florida v. Espinoza". 22 July 2016 F14-2923, Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida. Circuit Court Judge T. Pooler

[2] Opinion of Advocate General Kokott.16 July 2015 Digital reports (Court Reports - general). ECLI identifier: ECLI:EU:C:2015:498 "Sktteverket v David Hedqvist"

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This client briefing has been prepared for clients and professional associates of Ogier. The information and expressions of opinion which it contains are not intended to be a comprehensive study or to provide legal advice and should not be treated as a substitute for specific advice concerning individual situations.

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