Creating a safer environment
27 May 2021
With challenges around the FATF’s new Travel Rule, such as ‘Sunrise’ , it marks an extremely important requirement in the world of digital assets
Image: wimage72/stock.adobe.com
Cryptocurrencies, which represent a new form of a digital asset based on a network that is distributed across a large number of computers, have come under fire a few times with critics saying they can be used for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them.
The increasing global use of cryptocurrency means that more needs to be done to fight anti-money laundering (AML), among other challenges.
The global money laundering and terrorist financing watchdog Financial Action Task Force (FATF) sets international standards that aim to prevent illegal activities and the harm they cause to society.
As a policy-making body, the FATF works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas.
As part of its work FATF created ‘Recommendation 16’ in 2012 with the objective of preventing terrorists and other criminals from having unfettered access to wire transfers for moving their funds. It works to detect the misuse when it occurs to ensure that basic information on the originator and beneficiary of wire transfers is immediately available.
More recently, the FATF introduced the ‘Travel Rule’, an update to the previous FATF Recommendation 16, which covers cross-border and domestic wires.
Although there are challenges around this Travel Rule, such as the ‘Sunrise’ issue, its main aim is to prevent money laundering from the proceeds of illicit activity, making it an extremely important requirement, especially in the world of digital assets.
FATF Travel Rule
Some experts assert that the FATF’s June 2019 plenary, signalled disruptive changes to the cryptocurrency landscape especially its virtual asset service providers (VASPs).
The FATF agreed to pursue further work to strengthen the FATF Standards on countering the financing of proliferation by requiring jurisdictions and private sector entities to understand and mitigate their proliferation financing risks, as well as by enhancing requirements for domestic cooperation and coordination on proliferation financing.
FATF says it has conducted extensive analysis on a range of proposals, but has agreed to prioritise this work moving forward.
Other options considered included new requirements to use criminal justice measures and financial intelligence, expanded targeted financial sanctions tools, and more effective mechanisms to ensure international information sharing on proliferation financing activity. The FATF agreed to potentially consider these other options at a later date.
Meanwhile, jurisdictions under FATF had to provide sufficient information and solutions for this by June 2020.
Over 200 jurisdictions around the world have committed to the FATF Recommendations through the global network of FSRBs and FATF memberships. The FATF relies on a strong global network of FATF-Style Regional Bodies (FSRBs), in addition to their own 39 members.
Experts say that despite 200 countries being signed up to FATF, only 35 were able to report their transposition of Travel Rule legislation in June last year, which has been put down to the implementation challenges and the COVID-19 pandemic.
Consequently, the FATF has issued a new 12-month review set to conclude in June 2021.
This review is set to allow the virtual asset industry and FATF to deal with new challenges and establish interoperability between technical solutions.
Implications for digital assets
FATF’s updates addresses combatting the financing of terrorism (CFT) and AML challenges associated with the increasing global use of cryptocurrency. The update also helps law enforcement agencies better track malicious users who may abuse cryptocurrency for illicit activities such as money laundering.
According to experts, the Travel Rule’s regulatory focus means that it will have specific implications for VASPs, such as cryptocurrency exchanges and digital asset custodians.
Onchain Custodian, headquartered in Singapore and a member state of FATF, explains that the Monetary Authority of Singapore (MAS) has included elements of the Travel Rule into the Payment Services Act (PSA).
This is specifically in the MAS Notice PSN02 where the ordering institution needs to provide the name of the value transfer originator, the value transfer originator’s account number, the name of the value transfer beneficiary, and the value transfer beneficiary’s account number.
Onchain Custodian explains that where the value of transfer exceeds $1,500 (SGD), then the ordering institution needs to provide additional information including:
The value transfer originator’s (i) residential address, or (ii) registered or business address
The value transfer originator’s unique identification number or
The date and place of birth, incorporation or registration of the value transfer originator
Onchain Custodian is working on platform enhancements to align its process with the recommendations from FATF and regulation guidelines by the MAS.
In order to do so, it is working with service providers as its partners to create a system that will allow it and its clients to meet the regulatory requirement. These partners include Accuity, Merkle Science, CoolBitX and Notabene, among others.
“One of the challenges for VASPs is to adapt and implement compliance requirements swiftly and effectively while maintaining business operations at full pace and capacity,” says Michael Ou, founder and CEO of CoolBitX.
Ou affirms: “Sygna Bridge greatly reduces the implementation strain of meeting Travel Rule guidelines through a modular application programming interface architecture, flexibility, and the ability to adapt the product to meet VASP needs.”
“We are delighted to be able to assist Onchain with their Travel Rule implementation, from mapping scenario analysis through to integration.”
Given that the purpose of the Travel Rule is to prevent money laundering from the proceeds of illicit activity, Onchain Custodian says it is not just another regulatory requirement to them that they are implementing for licensing purposes.
“No upstanding VASP would be willingly complicit in allowing cryptocurrencies to be used as a value transfer vehicle to facilitate crimes such as children pornography, human trafficking, drug trafficking or the financing of terrorists,” says Onchain Custodian.
Pelle Braendgaard, CEO of Notabene, adds: “We are seeing a shift among customers from viewing the Travel Rule as a compliance obligation to seeing it as a competitive advantage.”
“The addition of a counterparty layer brings more trust to transactions, and product teams are starting to explore the possibilities this brings in terms of better UX for their users.”
Factors to consider
The Travel Rule of Recommendation 16 means the creators and beneficiaries of all digital fund transfers should exchange descriptive information and will be applied to all VASPs, financial institutions, and mandatory organisations but this is anticipated to come with a number of challenges.
Indeed, experts say the journey toward the implementation of the Travel Rule has not been easy for the VASP sector.
The Travel Rule was first introduced in 1996 by the Financial Crime Enforcement Network (FinCEN), a US federal bureau requiring banks and money services businesses to share information of both the originators and beneficiary tied to payments of $3,000 and higher.
Designed as an AML requirement for traditional banks means that applying it to cryptocurrencies is one such challenge. Cryptocurrencies operate on a fundamentally different technology stack.
Many banks have SWIFT, the global provider of secure financial messaging services, or other similar channels to exchange originator and beneficiary information as part of the message payload, but VASPs do not have that luxury.
According to Onchain Custodian, crypto payment rails operate on independent and autonomous blockchain infrastructures which do not cater for the transport of a lot of information.
“Despite the enormous challenges this mismatch has posed, the crypto industry has taken significant steps to build data standards to be able to transfer the required information as mandated by the FATF. A great number of technical protocols have been created to enable the movement of that information, but several challenges remain,” explains Onchain Custodian.
One such challenge is the ‘Sunrise challenge’, which relates to the way in which different member countries have responded in different ways to the FATF Travel Rule globally. Some say that while a few nations are taking the initiative, others are taking a more cautious wait-and-see approach.
In turn, countries could potentially implement the Travel Rule months and possibly years apart resulting in the ‘Sunrise’ issue. Experts expect that countries will balance their crypto regulatory frameworks against domestic legislation, infrastructure and market considerations.
Weighing in on this, Onchain Custodian notes: “Most jurisdictions have translated or are translating into law the Travel Rule, but they do so at a different pace, with different requirements.”
For example, the transaction volume threshold above which the Travel Rule applies, varies greatly between countries.
This is a problem, explains Onchain Custodian particularly as the crypto business is cross-border by nature, so having to juggle with different implementation deadlines and requirements across jurisdictions do not help achieve the common goals between policymakers, regulators and industry.
“Regulators should be conscious of this challenge and enable well-intentioned players in their market to gradually implement the Travel Rule rather than hoping for a 100 per cent approach from a specific date,” says Onchain Custodian.
Meanwhile, there is the issue of interoperability which poses the question: with so many different technical protocols, how can an originating VASP send information to the recipient VASP in a secure and automated way?
While this may seem like a rudimentary query, Onchain Custodian highlights that to provide context, it is as though one could not call an Android phone user with their IOS device.
“In the end, there is no singular protocol that will dominate, so there is an urgent need to ensure interoperability between them to benefit VASPs and implementation of the Travel Rule itself,” says Onchain Custodian.
Additionally, experts have identified two major challenges in the field of private wealth management. Firstly, there is the need to prove that a private wallet actually belongs to an identified customer when this customer withdraws from a VASP to its private wallet.
Onchain Custodian comments: “Solutions are coming, but it is not an easy process to put in place, so again, some leniency would be welcomed as we explore the best approaches with input and insights from the VASP industry.”
Secondly, FATF and some jurisdictions are now looking at similar know your customer requirements and AML/CFT standards for non-custodial wallets, as they are for VASPs.
There are consultations and other reach-out for comments and so experts suggest the hope is that the industry’s feedback will be given greater consideration than it was when the Travel Rule was introduced.
Onchain Custodian believes this is likely, now that the industry, as decentralised it may be, has proven to the regulator that it can work together for the common good.
The increasing global use of cryptocurrency means that more needs to be done to fight anti-money laundering (AML), among other challenges.
The global money laundering and terrorist financing watchdog Financial Action Task Force (FATF) sets international standards that aim to prevent illegal activities and the harm they cause to society.
As a policy-making body, the FATF works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas.
As part of its work FATF created ‘Recommendation 16’ in 2012 with the objective of preventing terrorists and other criminals from having unfettered access to wire transfers for moving their funds. It works to detect the misuse when it occurs to ensure that basic information on the originator and beneficiary of wire transfers is immediately available.
More recently, the FATF introduced the ‘Travel Rule’, an update to the previous FATF Recommendation 16, which covers cross-border and domestic wires.
Although there are challenges around this Travel Rule, such as the ‘Sunrise’ issue, its main aim is to prevent money laundering from the proceeds of illicit activity, making it an extremely important requirement, especially in the world of digital assets.
FATF Travel Rule
Some experts assert that the FATF’s June 2019 plenary, signalled disruptive changes to the cryptocurrency landscape especially its virtual asset service providers (VASPs).
The FATF agreed to pursue further work to strengthen the FATF Standards on countering the financing of proliferation by requiring jurisdictions and private sector entities to understand and mitigate their proliferation financing risks, as well as by enhancing requirements for domestic cooperation and coordination on proliferation financing.
FATF says it has conducted extensive analysis on a range of proposals, but has agreed to prioritise this work moving forward.
Other options considered included new requirements to use criminal justice measures and financial intelligence, expanded targeted financial sanctions tools, and more effective mechanisms to ensure international information sharing on proliferation financing activity. The FATF agreed to potentially consider these other options at a later date.
Meanwhile, jurisdictions under FATF had to provide sufficient information and solutions for this by June 2020.
Over 200 jurisdictions around the world have committed to the FATF Recommendations through the global network of FSRBs and FATF memberships. The FATF relies on a strong global network of FATF-Style Regional Bodies (FSRBs), in addition to their own 39 members.
Experts say that despite 200 countries being signed up to FATF, only 35 were able to report their transposition of Travel Rule legislation in June last year, which has been put down to the implementation challenges and the COVID-19 pandemic.
Consequently, the FATF has issued a new 12-month review set to conclude in June 2021.
This review is set to allow the virtual asset industry and FATF to deal with new challenges and establish interoperability between technical solutions.
Implications for digital assets
FATF’s updates addresses combatting the financing of terrorism (CFT) and AML challenges associated with the increasing global use of cryptocurrency. The update also helps law enforcement agencies better track malicious users who may abuse cryptocurrency for illicit activities such as money laundering.
According to experts, the Travel Rule’s regulatory focus means that it will have specific implications for VASPs, such as cryptocurrency exchanges and digital asset custodians.
Onchain Custodian, headquartered in Singapore and a member state of FATF, explains that the Monetary Authority of Singapore (MAS) has included elements of the Travel Rule into the Payment Services Act (PSA).
This is specifically in the MAS Notice PSN02 where the ordering institution needs to provide the name of the value transfer originator, the value transfer originator’s account number, the name of the value transfer beneficiary, and the value transfer beneficiary’s account number.
Onchain Custodian explains that where the value of transfer exceeds $1,500 (SGD), then the ordering institution needs to provide additional information including:
The value transfer originator’s (i) residential address, or (ii) registered or business address
The value transfer originator’s unique identification number or
The date and place of birth, incorporation or registration of the value transfer originator
Onchain Custodian is working on platform enhancements to align its process with the recommendations from FATF and regulation guidelines by the MAS.
In order to do so, it is working with service providers as its partners to create a system that will allow it and its clients to meet the regulatory requirement. These partners include Accuity, Merkle Science, CoolBitX and Notabene, among others.
“One of the challenges for VASPs is to adapt and implement compliance requirements swiftly and effectively while maintaining business operations at full pace and capacity,” says Michael Ou, founder and CEO of CoolBitX.
Ou affirms: “Sygna Bridge greatly reduces the implementation strain of meeting Travel Rule guidelines through a modular application programming interface architecture, flexibility, and the ability to adapt the product to meet VASP needs.”
“We are delighted to be able to assist Onchain with their Travel Rule implementation, from mapping scenario analysis through to integration.”
Given that the purpose of the Travel Rule is to prevent money laundering from the proceeds of illicit activity, Onchain Custodian says it is not just another regulatory requirement to them that they are implementing for licensing purposes.
“No upstanding VASP would be willingly complicit in allowing cryptocurrencies to be used as a value transfer vehicle to facilitate crimes such as children pornography, human trafficking, drug trafficking or the financing of terrorists,” says Onchain Custodian.
Pelle Braendgaard, CEO of Notabene, adds: “We are seeing a shift among customers from viewing the Travel Rule as a compliance obligation to seeing it as a competitive advantage.”
“The addition of a counterparty layer brings more trust to transactions, and product teams are starting to explore the possibilities this brings in terms of better UX for their users.”
Factors to consider
The Travel Rule of Recommendation 16 means the creators and beneficiaries of all digital fund transfers should exchange descriptive information and will be applied to all VASPs, financial institutions, and mandatory organisations but this is anticipated to come with a number of challenges.
Indeed, experts say the journey toward the implementation of the Travel Rule has not been easy for the VASP sector.
The Travel Rule was first introduced in 1996 by the Financial Crime Enforcement Network (FinCEN), a US federal bureau requiring banks and money services businesses to share information of both the originators and beneficiary tied to payments of $3,000 and higher.
Designed as an AML requirement for traditional banks means that applying it to cryptocurrencies is one such challenge. Cryptocurrencies operate on a fundamentally different technology stack.
Many banks have SWIFT, the global provider of secure financial messaging services, or other similar channels to exchange originator and beneficiary information as part of the message payload, but VASPs do not have that luxury.
According to Onchain Custodian, crypto payment rails operate on independent and autonomous blockchain infrastructures which do not cater for the transport of a lot of information.
“Despite the enormous challenges this mismatch has posed, the crypto industry has taken significant steps to build data standards to be able to transfer the required information as mandated by the FATF. A great number of technical protocols have been created to enable the movement of that information, but several challenges remain,” explains Onchain Custodian.
One such challenge is the ‘Sunrise challenge’, which relates to the way in which different member countries have responded in different ways to the FATF Travel Rule globally. Some say that while a few nations are taking the initiative, others are taking a more cautious wait-and-see approach.
In turn, countries could potentially implement the Travel Rule months and possibly years apart resulting in the ‘Sunrise’ issue. Experts expect that countries will balance their crypto regulatory frameworks against domestic legislation, infrastructure and market considerations.
Weighing in on this, Onchain Custodian notes: “Most jurisdictions have translated or are translating into law the Travel Rule, but they do so at a different pace, with different requirements.”
For example, the transaction volume threshold above which the Travel Rule applies, varies greatly between countries.
This is a problem, explains Onchain Custodian particularly as the crypto business is cross-border by nature, so having to juggle with different implementation deadlines and requirements across jurisdictions do not help achieve the common goals between policymakers, regulators and industry.
“Regulators should be conscious of this challenge and enable well-intentioned players in their market to gradually implement the Travel Rule rather than hoping for a 100 per cent approach from a specific date,” says Onchain Custodian.
Meanwhile, there is the issue of interoperability which poses the question: with so many different technical protocols, how can an originating VASP send information to the recipient VASP in a secure and automated way?
While this may seem like a rudimentary query, Onchain Custodian highlights that to provide context, it is as though one could not call an Android phone user with their IOS device.
“In the end, there is no singular protocol that will dominate, so there is an urgent need to ensure interoperability between them to benefit VASPs and implementation of the Travel Rule itself,” says Onchain Custodian.
Additionally, experts have identified two major challenges in the field of private wealth management. Firstly, there is the need to prove that a private wallet actually belongs to an identified customer when this customer withdraws from a VASP to its private wallet.
Onchain Custodian comments: “Solutions are coming, but it is not an easy process to put in place, so again, some leniency would be welcomed as we explore the best approaches with input and insights from the VASP industry.”
Secondly, FATF and some jurisdictions are now looking at similar know your customer requirements and AML/CFT standards for non-custodial wallets, as they are for VASPs.
There are consultations and other reach-out for comments and so experts suggest the hope is that the industry’s feedback will be given greater consideration than it was when the Travel Rule was introduced.
Onchain Custodian believes this is likely, now that the industry, as decentralised it may be, has proven to the regulator that it can work together for the common good.
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