FATF Methodology with the Rapid Development of Virtual Assets
The Financial Action Task Force (FATF) was established in 1989 by Group of Seven (G-7) and is the global authority regulating Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT).
Blockchain, bitcoin, crypto assets, virtual currencies ... a whole new vocabulary describing innovative technology to swiftly transfer value around the world. The fast-evolving blockchain and distributed ledger technologies have the potential to radically change the financial landscape. But, their speed, global reach and above all anonymity also attract those who want to escape authorities’ scrutiny.
Blockchain originated just over 10 years ago. Since then, virtual assets have become widely available and have started to be used as payment products. However, without established regulation and oversight, the sector is often still referred to as the “wild west” of the finance industry.
How can criminals misuse virtual assets?
In 2017, the “Wannacry” ransomware attack held thousands of computer systems hostage until the victims paid hackers a ransom in bitcoin. This attack resulted in an estimated USD 8 billion in damages to hospitals, banks and businesses all around the world. Other ransomware attacks have happened since and appear to be on the rise.
FATF Focus on Virtual Assets since 2019
Virtual assets have many potential benefits. They could make payments easier, faster, and cheaper; and provide alternative methods for those without access to regular financial products.
Nevertheless, without proper regulation, they would risk becoming a virtual safe haven for the financial transactions of criminals and terrorists. The FATF has been closely monitoring the developments in the crypto space and in recent years has seen the first countries start to regulate the virtual asset sector, while others have prohibited virtual assets altogether. However, as yet, the majority of countries have not taken any action. These gaps in the global regulatory system have created significant loopholes for criminals and terrorists to abuse.
With support from the G20, the FATF has issued global, binding standards to prevent the misuse of virtual assets for money laundering and terrorist financing. The term “virtual asset” above refers to any digital representation of value that can be digitally traded, transferred or used for payment. It does not include the digital representation of fiat currencies.
“While crypto-assets do not pose a threat to global financial stability at this point, we are closely monitoring developments and remain vigilant to existing and emerging risks.”
—G20 learders, in the Osaka Summit in June 9th, 2019
Effective implementation of these standards globally in all countries will ensure that virtual asset technologies and businesses can continue to develop and innovate in a responsible manner, and will create a level playing field.
Where does the supervision take place?
Traditional banks that have physical headquarters and client bases near their offices.
Virtual asset service providers often have a global presence and customer base.
So where do these standards apply and who should be regulating them?
Regardless of where the server is located and where it operates, the country/region in which the virtual asset service provider is registered as a company is its primary regulator.
Building a Partnership of regulating
Regulating virtual assets service providers is challenging for everyone. National authorities need to develop skills to understand the technology involved, while the virtual asset service providers have to learn about the financial rules that now apply to their sector.
It is up to the sector itself to develop the technology to meet the FATF’s requirements, particularly when it comes to securely collecting and transmitting originator and beneficiary information.
To help governments and the industry itself, the FATF has developed a risk-based approach guidance with significant input from the sector itself. The guidance explains how to understand the risks, how to license and register the sector, and what the sectors needs to do to know who their customers are, store this information securely and detect and report suspicious transactions.
The FATF has engaged intensively with the virtual asset service provider sector to build a partnership between governments and the sector and better understand the issues and risks involved, including by hosting annual fintech/regtech forums since 2017.
Through its Contact Group, the FATF continues to further explain the FATF’s requirements to the industry and to monitor developments and understand how the industry is meeting the various challenges.
Countries need to:
- Understand the risk confronting money laundering and terrorist financing in the sector.
- Register and license virtual asset service providers.
- Regulate the sector, just as they do other financial institutions.
Virtual asset service providers need to:
- Implement the same precautions as financial institutions, including customer due diligence, recordkeeping, and suspicious transaction reporting.
- Access and hold the information with securely transmitting originator and beneficiary during the transaction.
Looking ahead and taking effectual action
The technology behind virtual assets is developing rapidly. Future developments should not create loopholes that terrorists and criminals can exploit. Countries should implement the FATF measures as soon as possible to ensure the transparency of virtual assets transactions and keep funds associated with crime and terrorism out of the crypto space.
Today, many virtual asset service providers are considered “risky businesses” and are denied access to bank accounts and other regular financial services. While the implementation of the FATF requirements is challenging for the sectors, it will ultimately increase trust in blockchain technology as it is the backbone behind a powerful and viable means of value transfer.
The FATF has revised its assessment methodology, which sets out how it will determine whether countries have successfully implemented the FATF recommendations and oversee the virtual asset service provider sector.
- FATF Methodology for assessing compliance with the FATF Recommendations and the effectiveness of AML/CFT systems
The FATF standard ensures virtual assets being treated fairly and taking the same protections as financial sectors. The regulations of the FATF apply to the conversion of virtual assets into legal tender and the transfer of virtual assets from one type of virtual asset to another.
- Virtual Assets Red Flag Indicators of Money Laundering and Terrorist Financing [September 2020]
- 12 Month Review of Revised FATF Standards – Virtual Assets and VASPs [July 2020]
- Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers [June 2019]
- The FATF Standards: FATF Recommendations [revised June 2019]
- FATF Report to the G20 Finance Ministers and Central Bank Governors on So-called Stablecoins [June 2020]
- Money laundering risks from “stablecoins” and other emerging assets
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