The Government of Gibraltar published recently a public consultation for a DLT regulatory framework. Gibraltar says it recognises the potential of the technology that underpins decentralised virtual currencies and its many other financial and non-financial use cases for DLT, including in government and the wider public sector. While other governments have been more hesitant to address the regulatory gaps that exist, the tiny British Oversees Territory wants to lead the way. Can the proposal be a beacon for others though? We reviewed the document and present you with both an overview and an outlook.
Jack “Blockchain” Bauer
It sounds like a version of 24 in the Blockchain age: a crypto analyst and former marine uncovers a single fragment of the Bitcoin algorithm that connects a collapsing bank, a child trafficking ring and a defrauded online casino he is instantly blamed for all three crimes. On the run from basically everyone, he sets out to clear his name and unravel a conspiracy of massive proportions.
That’s the background to the ambitious project of 21 Million, the world’s first crypto funded Blockchain tv series, which launches its initial coin offering (ICO) on 12 June to raise funds to produce a six-part mini-series build on this story. It is led by Nick Ayton, a global expert on Blockchain, and his team, who aim to achieve nothing less than to revolutionise the way films are produced and financed.
While an enthralling story, you’re probably wondering what this has to do with the Gibraltar proposal for a DLT regulation, now. Well, the 21 MCoins are Tokens that are supported by the Ethereum public network and use the standard ERC20 interface, but 21 Million have chosen Gibraltar as the jurisdiction for their ICO, because its authorities are very supportive with regard Cryptocurrencies as long as the structure is in the right way, according to Nick.
A regulatory beacon
Gibraltar already launched in January 2016 a consultation for a document titled, ’Virtual Currency: Outline Regulatory Framework’. This second consultation now wants to take the same philosophy and expand this to distributed ledger technology (DLT), according to the authorities. The government developed the proposal together with the Gibraltar Financial Services Commission (GFSC) and Gibraltar Finance.
The objective of the DLT framework is to position Gibraltar as a jurisdiction, which facilitates innovation whilst ensuring it continues to meet its regulatory and strategic objectives, and understands the modern need for a robust and speedy interaction with regulators in this fast moving area of business. The consultation paper states that the DLT framework will apply to activities not subject to regulation under another framework and that use DLT for the transmission or storage of value belonging to others, defined as DLT firms. Firms and activities that are subject to another regulatory framework will continue to be regulated under that framework. The proposed role of the GFSC will be to authorise and supervise these firms.
From a legislative aspect, it is intended to be implemented through amendments to regulations under the Financial Services (Investment and Fiduciary Services) Act 1989. The proposed start date is no later than 1st January 2018, while transitional arrangements will permit firms that apply in the first 3 months from that date to continue providing DLT activities until their application is determined, something that will be crucial to companies that are already active in this space.
The paper defines the scope of the regulation to apply to individuals and firms that engage in activities not subject to regulation under another framework and that, for business purposes, use DLT for the transmission or storage of value belonging to others. Everyone else will continue to be subject to other, already existing rules. The paper also presents a long list of Use cases and business activities for which DLT will be relevant. Investment advice about virtual currencies, however, will not fall within scope of the DLT framework.
The authors of the proposal appreciate the challenges in regulating activities that use rapidly-evolving technology, which is a reason for the hesitation of other regulators. Therefore, they propose an outcome-focused, principles-based approach that provides the necessary flexibility. Consequently, Gibraltar has chosen to establish fundamental regulatory principles that will (1) achieve required regulatory outcomes; and (2) remain equally applicable throughout the licensing lifecycle. DLT firms are ought to be measured by their ability to adhere to clearly set out principles rather than rigid rules. By doing so, the proposal seeks to achieve three regulatory outcomes in the form of Consumer Protection, Protecting the Reputation of Gibraltar, and provide Economic Benefit.
The 9 principles it has established are:
- A DLT firm must conduct its business with honesty and integrity.
- A DLT firm must pay due regard to the interests and needs of each and all its customers and must communicate with its customers in a way which is fair, clear and not misleading.
- A DLT firm must maintain adequate financial and non-financial resources.
- A DLT firm must manage and control its business effectively, and conduct its business with due skill, care and diligence; including having proper regard to risks to its business and customers.
- A DLT firm must have effective arrangements in place for the protection of client assets and money when it is responsible for them.
- A DLT firm must have effective corporate governance arrangements.
- A DLT firm must ensure that all systems and security access protocols are maintained to appropriate high standards.
- A DLT firm must have systems in place to prevent, detect and disclose financial crime risks such as anti-money laundering and countering terrorist financing (AML/CFT).
- A DLT firm must be resilient and must develop contingency plans for the orderly and solvent wind down of its business.
Conclusion
Gibraltar has chosen a very flexible approach to its DLT regulation that doesn’t really answer many of the questions that surround the application of Blockchain technology in financial services. Instead it provides a framework in the loosest sense, which will make clarifications necessary in many practical cases and contains the risk of inequalities in respect of its application. At the same time it provides guidance though, for instance, DLT firms will need to put AML systems in place (principle 8.) and even though the proposal doesn’t specify these controls, firms will know that nothing less is expected from them than from ordinary financial services firms regulated in Gibraltar.
It certainly is a step in the right direction and while it remains to be seen how it will work out in practice, it is good to see a regulator take action. Eventually, Jack Bauer never had the answers at the beginning of each season either…