In Regulatory Responses by Carel van Wyk / 2021-02-22 / 0 comments
Tags: FSCA, Regulation
TL;DR
The proposed FSCA draft declaration will force existing business, startups, entrepreneurs, tinkerers, hobbyists, makers and enthusiasts in the cryptocurrency space in South Africa to go through a currently unclear and potentially expensive Financial Services Provider application process with no guarantee of success.
While we in principle support the regulator in ensuring people are safely able to be part of this exciting space, we are concerned that the regulation as it stands will disadvantage many, especially smaller entrepreneurs. We recommend that there should be revenue-threshold based exemptions for entities to provide crypto asset services without a regulatory requirement to register as FSPs to operate, or with relaxed requirements.
Introduction
On 20 November 2020, the Financial Sector Conduct Authority (FSCA) published a draft declaration of crypto assets as a financial product in South Africa, which would require any business offering cryptocurrency-related advice or services to obtain a license from the FSCA as a registered Financial Services Provider (FSP). The FSCA is the market conduct regulator of financial institutions in South Africa and is responsible for market conduct regulation and supervision. Their mission is to “ensure a fair and stable financial market, where consumers are informed and protected, and where those that jeopardize the financial well-being of consumers are held accountable”.
Why was this draft declaration published?
Our view is that the draft declaration has been long considered, but was rushed to publication likely due to the adverse impact and growing popularity of a recent Ponzi scam, “Mirror Trading International” (MTI). This scheme is said to have taken almost R10bn (billion) from victims, most of them South African citizens. As local market financial conduct regulator, the FSCA is tasked with preventing the operations of entities like MTI that offer malicious investment advice and fraudulent investment services to the public.
What is the impact?
We believe the FSCA’s proposed requirement for any crypto asset business to register as a Financial Services Provider (FSP) is a logical next step for the regulator and we understand the need for regulation in the space to protect consumers, however the proposed implementation will have an adverse impact on the local cryptocurrency ecosystem and does not align with our (Crypto Asset’s) mission of promoting Blockchain innovation in South Africa. We have identified a number of problems with the draft declaration and responded to the official response mailbox at [FSCA.RFDStandards<at>fsca.co.za] with our recommendations. Our full response is available here: https://cryptoassets.co.za/wp-content/uploads/2021/01/cryptoassets.co_.za_Response_FSCA_Draft_Declaration_of_crypto_assets.pdf
What are the problems with the draft declaration?
The main problem with the proposed declaration is that it requires all crypto asset related companies to register as FSPs without distinguishing between large organisations and startups or small businesses and individuals that lack the required funds or dedicated organisational compliance structures to qualify. The current definition also includes “crypto-space” entities like node operators, routing channel liquidity providers, block validators and Decentralized Finance (DeFi) service operators amongst others.
South Africa in particular has seen a large number of early-adopter companies drive innovation in the crypto asset industry locally and internationally and continue to see new players enter the market that offer legitimate value to customers. Placing onerous and expensive registration requirements on local entrepreneurs with novel crypto asset business plans will drive our innovators out of our market.
We have identified a number of specific problems with the declaration below.
1) Insufficient time for public participation and compliance
The FSCA’s original document requests submissions for comments, but allows only two months for submissions from 20 November 2020 until the 28th of January 2021. A two month public comment window over the holidays is insufficient for this type of regulation which will have far reaching consequences for our industry and which relates to an entirely new class of financial instruments. It indicates an aggressive approach that is hostile to new and smaller players in the industry who lack dedicated legal teams to assess the document and prepare a professional response.
In addition, the declaration stipulates that any existing crypto asset service provider “must submit an application for authorisation as a financial services provider under section 8 of the Act within 4 months of the effective date of this Declaration”. This places a heavy burden of work on startups and small businesses to raise the required funds and figure out how to meet the complex set of requirements for approval in time.
2) Proposed definition is unclear
We consider the definition and scope proposed in the document as unclear and therefore it creates uncertainty on to who and how it will be applied. It engulfs more entities than the widely shared target of “advisors, exchanges and intermediaries” by potentially including node operators and Decentralised Finance (DeFi) service operators, as well as organisations such as ours.
3) Onerous requirements, especially for startups
It is difficult to form a clear picture of what will actually be required from crypto assets startups to qualify as licensed FSPs. We identify three main barriers to entrepreneurs and startups:
3.1) Expensive Registration Process: Our initial estimate is that registration costs may exceed R50 000 including expenses for “approval as an FSP”, “approval of a key individual”, “approval of an auditor / accounting officer / independent reviewer”, “application for approval as compliance officer”, “recognition of qualifications” and “regulatory examinations”. For more information see the linked FSCA fee structure document.
3.2) Uncertain Requirements: Section 8(1) of the FAIS Act for FSPs outlines requirements such as “competency of the application of key individuals, and representatives”, “personal character qualities of honesty and integrity” and “operational ability”. Many of the requirements such as these are subjective and it would be difficult for a young entrepreneur or small two-person startup to prove. There are at least five categories of FSPs, but there is no clear indication under which sub-category a crypto-asset FSP would fall.
3.3) Heavy Compliance Burden: Registration as an FSP requires certain compliance requirements such as regulatory training and examinations for staff, identifying key compliance individuals in the organisation with relevant experience, providing regular externally audited financial statements and engaging in an onerous registration process requiring a lot of work and effort. This would be impossible for a Bitcoin lightning node operator or Ethereum transaction validator to achieve.
What is our Suggestion?
We require further clarification on the definition and scope proposed in the FSCA document and the requirements for FSP registration. We suggest that there should be some revenue-based threshold of exclusion to allow new startups, entrepreneurs, tinkerers, hobbyists, makers and enthusiasts in the space to continue innovating and operating without having to register as FSP. It should only be necessary to engage the FSCA once a certain amount of revenue is generated, once a certain level of operation is met, once a business plan has gained a certain level of traction, once a certain amount of people are influenced. We should not take a heavy-handed approach that stifles the high-potential saplings of future innovation sprouting from South Africa’s fertile technological landscape.
Please see our full response to the FSCA based on the FSCA-required response template here: https://cryptoassets.co.za/wp-content/uploads/2021/01/cryptoassets.co_.za_Response_FSCA_Draft_Declaration_of_crypto_assets.pdf