On 2 November 2018 the Government published Subsidiary Legislation 590.01, the ‘Virtual Financial Assets Regulations’. Issued under Chapter 590 of the Laws of Malta the ‘Virtual Financial Assets Act’ (VFA Act), S.L 590.01 fleshes out the VFA regulatory regime by giving substance to some of the principles contained in the parent Act, regulating certain aspects of the VFA regime including exemptions, applicable regulatory fees, the control of clients’ assets and administrative penalties and appeals.
An initial consultation paper on the Virtual Financial Assets Regulations was published by the local Regulator, the Malta Financial Services Authority (MFSA) on 20 July 2018. Subsequently, on 24 October 2018, the Regulator published a feedback statement issued further to industry responses before delivering its final proposal to the Parliamentary Secretariat for Financial Services, Digital Economy and Innovation for its final stamp of approval, subsequent to which the Government published the final version of the Regulations in a supplement to the Government Gazette of Friday 2 November 2018, one day after the new blockchain laws (namely the VFA Act, the Innovative Technology Arrangements and Services Act, and the Malta Digital Innovation Authority Act) entered into force, positioning Malta as one of the first jurisdictions in the world to fully regulate the blockchain space.
The Regulations, made by the responsible Minister in exercise of the powers conferred upon him by Article 38 of the VFA Act, introduce an exhaustive list of exemptions applicable to persons who are to be exempt from the requirement to obtain a VFA Service Licence in terms of Article 13 of the VFA Act, which provides, inter alia, that “No person shall provide, or hold itself out as providing, a VFA Service in or from within Malta unless such person is in possession of a valid licence”. Therefore, as a general rule, persons providing VFA services (being those exhaustively listed in the Second Schedule to the VFA Act, such as, for example, VFA exchanges; custodial wallet service providers and market makers dealing in VFAs), require a licence in terms of Article 13 of the Act – unless one of the exemptions apply.
The exemptions, found in Regulation 4(1) (a) to (o) of S.L 590.01 are exhaustive, and while most of them are automatically operative, others either need to be notified to the MFSA prior to their application, or are subject to a prior determination in writing by the MFSA. Some of the exemptions have a regulatory or functional scope – such as in the case of a liquidator or a curator in a bankruptcy acting in the course of the liquidation or bankruptcy; or in the case of the MFSA (or any person appointed by it) in the course and for the purpose of its regulatory and supervisory functions. One particular exemption is designed for non-market makers dealing on their own account from. Although ‘Dealing on own account’ is listed in the Second Schedule to the VFA Act as one of the licensable VFA Services under the VFA Act, defined therein as ‘Trading against proprietary capital resulting in the conclusion of transactions in one or more virtual financial assets’, the Regulations clarifies that persons dealing on own account in terms of the Act and not providing any other VFA services or performing any other activities in virtual financial assets, are to be exempt – for as long as such persons are not market makers or are dealing on own account when executing client orders. An addition to the newly published Regulations is a definition of the term ‘market maker’, which is being defined as ‘a person who holds himself out, on a continuous basis, as being willing to deal on own account by buying and selling virtual financial assets against that person’s proprietary capital at prices defined by that person’. Therefore, in terms of Regulation 4(d), if a person dealing on own account is a market maker, or deals on own account when executing client orders, then the exemption will not apply and such person will require a full VFA Service Licence in terms of Article 13 of the Act. In any case, the exemption in terms of Regulation 4(d) is not automatically operative, and a person dealing on own account wishing to benefit from the exemption to the licensing requirement must request the MFSA to issue a determination in writing.
Natural persons who would want to build up and manage their own portfolios will not be covered by the ‘dealing on own account’ exemption mentioned above, as otherwise they would need to obtain a declaration from the MFSA as to the applicability of the exemption. Instead, they are covered by an exemption found in paragraph 4(1)(i) of Regulations. In terms of this exemption, natural persons would, for all intents and purposes be considered to be ‘managers’ in terms of Paragraph 4 of the Second Schedule to the VFA Act (Portfolio Management). But for the exemption to apply, their portfolio must only include VFAs belonging to them and to no other person. This exemption is automatically operative.
A question that was raised in the past weeks and months as the VFA regulatory framework was being developed, is whether holders of licences issued under the Investment Services Act (ISA) will require a separate licence issued under the VFA Act in the event that they provide VFA services within the meanings contained in the Second Schedule to the VFA Act. In its feedback statement issued further to industry responses to the MFSA Consultation Paper on the VFA Regulations, the MFSA insisted that it will maintain its position that there should be segregation between business under the traditional financial services framework and business under the VFA Act, and therefore, as a general rule, subject to a few exceptions, persons authorised and holding a licence under the ISA will not be exempt from licensing requirements under the VFA Act. This follows the principle contained in the VFA Act that ‘a purpose or object referring to any activity that requires any kind of authorisation whatsoever by the competent authority (MFSA) under any Maltese law, other than this Act, shall be deemed to be incompatible with the VFA services of a licence holder’, and therefore, operate as a basis for refusal to grant a licence applied for under the VFA Act.
But despite the general rule that persons already in possession of a licence under the ISA are not exempt from the licensing requirements under the VFA Act, the Regulator introduced three exceptions to the rule. The first exception applies to persons licensed in terms of paragraph 5(c) of the First Schedule to the ISA to act as custodians in relation to Collective Investment Schemes. These persons will only be exempt from the licensing requirement under the VFA Act if they provide a Custodian service within the meaning found in paragraph 5 of the Second Schedule to the VFA Act, and when such service is provided in relation to a Collective Investment Scheme. The second exception applies to persons licensed in terms of paragraph 4 of the First Schedule to the ISA to provide services of management of investments, provided that the exemption will only be applicable if such person carries out the VFA services listed in paragraphs 4 and 6 of the Second Schedule to the VFA Act, I.E, VFA Portfolio Management and VFA Investment Advice. Finally, the third exception applies to Collective Investment Schemes licensed under the ISA, who shall not require a licence under the VFA Act to invest in virtual financial assets (subject to specific rules determining which type of collective investment schemes may have an investment objective of investing in virtual financial assets). Therefore, in these three instances only, a person would not be required to obtain a licence under the VFA Act subject to the conditions aforementioned. The third exemption applies automatically, unlike the former two – which are subject to a determination in writing by the MFSA.
According to the MFSA, one of the industry respondents suggested the inclusion of an exemption from licensing which would be based on a case by case assessment of the activities to be carried out. However, the Regulator declined to on board this proposal, concluding that such an approach would be conflicting with its aim of promoting legal and regulatory certainty in this sector.
Of particular interest is an exemption applicable to Initial VFA Offerings (‘IVFAOs’; referred to as ‘ICOs’ in common parlance) who had started their offering prior to two weeks before the entry into force of the VFA Act. The exemption from drawing up and registering a whitepaper, applicable to persons who have commenced an IVFAO prior to two weeks of the coming into force of the VFA Act, is introduced in Regulation 3 of S.L 590.01, in an attempt to clarify several differing interpretations of Article 62 of the VFA Act concerning the transitory period applicable to persons who have commenced an IVFAO before 1 November 2018. The transitory provision contained in Article 62 (1) provided (and still does) that persons who had started an offering before the coming into force of the VFA Act, would be allowed a transitory period of three months within which to draw and duly register their whitepaper in terms of Article 3 of the VFA Act, as long as the offering would have started by ‘not earlier than two weeks prior to the coming into force of this Act’. The wording of this provision raised the question of wow would ICOs who started offering their VFAs prior to two weeks before 1 November be regulated. Would they need to comply with the requirements of the VFA Act immediately upon its coming into force, or would they remain forever unregulated? Regulation 3 of SL 590.01 seeks to answer this question by providing that a person who has commenced an offering in terms of Article 3 of the VFA Act prior to two weeks before 1 November, will be exempt from drawing up and registering a whitepaper. However, this exemption is limited to those persons whose offering will not continue after the 31 January 2019. A person would still need to draw up a whitepaper and register it with the MFSA if an IVFAO that started prior to two weeks before 1 November will continue after the 31 January 2019.
S.L 590.01 formally introduces four VFA license classes. VFAA Class 1 authorises licence holders to receive and transmit orders, to provide investment advice in relation to VFAs, and to place VFAs. VFAA Class 2 authorises licence holders to provide any VFA service except to operate a VFA exchange or deal for their own account. VFAA Class 3 authorises licence holders to provide any VFA service but not to operate a VFA exchange. Finally, Class 4 authorises licence holders to provide any VFA service – including operating a VFA exchange in or from within Malta. Furthermore, the Regulations cast the application and supervisory fees applicable to issuers of VFAs and VFA Service Providers in stone, being significantly higher than those proposed originally by the Regulator, citing ‘risks inherent to this sector’ as the main reason for the its re-estimation of the costs to carry out ‘proper authorization and supervision in this field.’
Whereas Class 1 licence holders are not authorized to hold or control clients’ assets or money, all other Classes may hold or control such monies as long as this is in conjunction with the provision of the respective VFA service. S.L 590.01 dedicates a whole part to the ‘Control of Assets’, basing all rules in this regard on the principle that a person ‘having the control of assets belonging to a client in the course of rendering a VFA service to such client, shall hold such assets solely for and on behalf of and in the interest of the client.’ The Regulations give considerable weight to the protection of VFA clients and goes a great length to ensure protection of one’s funds. For all intents and purposes, a client’s funds are deemed to constitute a distinct patrimony, separate from that belonging to the person holding the funds and such distinct patrimony cannot, in any case, be subject to the rights of creditors of the person holding the client’s assets. Neither shall such funds be affected by any law, regulation or measure regulating the insolvency or bankruptcy of the person holding the funds. This is based on the principle that a client enjoys a right of ownership in his assets ‘notwithstanding that they may be registered in the name and title of or are otherwise vested in the subject person’. With regards to segregation of funds, the Regulations are based on the general principle that a client’s assets must be segregated from those of the person holding the funds and from other clients’ assets. However, the person holding the funds may – subject to a written consent obtained from the client and in accordance with the terms of both parties’ agreement – place and keep the client’s assets in a common pool of identical assets.