The Abu Dhabi Global Market (ADGM), a financial free zone located in the UAE, has been one of the first regional regulators to adopt extensive regulations to address the concerns raised by token offerings and cryptocurrencies. On 25th June, 2018, the ADGM Financial Services Regulatory Authority (“FSRA”) issued Guidance on Regulation of Crypto Asset Activities in ADGM (the “Guidance”) which should be read in conjunction with FSRA’s Guidance on Regulation of Initial Coin/Token Offerings and Virtual Currencies under the Financial Services and Markets Regulations 2015 published on 9 October 2017 (the “ICO Guidance”). In this month’s newsletter, we summarize and discuss, ADGM’s approach on digital assets and regulating the crypto asset business.
DIGITAL ASSETS UNDER ADGM REGULATIONS
The Guidance together with the applicable ADGM Regulations and FSRA Rules governing ‘Crypto Asset activities’, is collectively referred to as the “Spot Crypto Asset Framework”. The ICO Guidance and the Spot Crypto Asset Framework collectively recognize various types of digital assets – ‘Security Tokens’, Non-Security tokens, “Crypto Assets” and Derivative of Crypto Assets. A graphical representation of the regulatory approach is shown below:
Under the ICO Guidance, the FSRA has explained that if the tokens in an Initial Coin Offering (ICO) exhibit the features and characteristics of a ‘Security’ pursuant to Section 58(2)(b)2 of Financial Services and Markets Regulations 2015 (FSMR), then such tokens shall be deemed as Securities. Such tokens may be referred to as ‘Security Tokens’.
Generally, for a token to be deemed to be a Security, it should exhibit the characteristics or features of a Share, Debenture or, Units in a Fund. Being deemed as Securities under the law, the issuance of Security Tokens would therefore be required to comply with all requirements for Offers of Securities to the Public under Sections 58 to 71 of FSMR and Chapter 4 of the Markets Rules.
These requirements include amongst others the obligation to publish a Prospectus unless such offer can be categorized as an ‘Exempt Offer’. Further, under Rule 4.3 of Market Rules, “Exempt Offer” includes offers which may meet any one of the conditions mentioned thereunder, which includes amongst others:
However, the rules and regulations prescribed by the FSMR or the Market Rules do not apply to tokens which do not have the features and characteristics of Securities under the FSMR. The offer of such Non-Security Tokens would not fall under the ambit of an Offer of Securities, nor is the trading of such tokens likely to constitute a regulated activity under FSMR.
In contrast to Security Tokens, a “Crypto Asset” has been defined as “a digital representation of value that can be digitally traded and functions as:
but does not have legal tender status in any jurisdiction. A Crypto Asset is:- (a) neither issued nor guaranteed by any jurisdiction, and fulfils the above functions only by agreement within the community of users of the Crypto Asset; and (b) distinguished from Fiat Currency and E-money.”
As is evident from the definition, Crypto Assets have a ‘value’ attached to them and can be exchanged for other things of value. However, since they do not have a legal tender status, they are different from ‘E-money’ which is a ‘digital representation of Fiat Currency used to electronically transfer value denominated in Fiat Currency’ . Crypto Assets are thus similar to physical commodities such as precious metals, fuels and agricultural produce. From a regulatory policy perspective, Crypto Assets are treated as commodities and an entity operating a Crypto Asset Business requires a Financial Services Permission (FSP) to carry out the activity of "Operating a Crypto Asset Business" (OCAB).
Under the ADGM framework, any Derivative of a Crypto Asset will be given the same regulatory status as the derivative of any other commodity. They are hence a type of Specified Investment under the FSMR. Accordingly, any market operators or market intermediaries dealing or managing investments in Derivatives of Crypto Assets will be subject to the appropriate regulations and rules applicable under FSMR and may need to be approved by FSRA as FSP holders, Recognized Investment Exchanges or Recognized Clearing Houses, as applicable.
OPERATING A CRYPTO ASSET BUSINESS
Particularly, the Spot Crypto Asset Framework has introduced a new regulated activity - “Operating a Crypto Asset Business” (OCAB) and any person who proposes to carry out such activity requires a Financial Services Permission (FSP) from the FSRA. The table below enumerates the list of activities that require / do not require the OCAB license:
|Activities Requiring the OCAB License||Activities Excluded from the OCAB License|
|· Buying, Selling or exercising any right in Accepted Crypto Assets (whether as principal or agent); · managing Accepted Crypto Assets belonging to another person; · making arrangements with a view to another person (whether as principal or agent) Buying, Selling or providing custody of Accepted Crypto Assets; · marketing of Accepted Crypto Assets; · advising on the merits of Buying or Selling of Accepted Crypto Assets or any rights conferred by such Buying or Selling; and · operating as a Crypto Asset Exchange; or as a Crypto Asset Custodian||· the creation or administration of Crypto Assets; · the development, dissemination or use of software for the purpose of creating or mining a Crypto Asset · the transmission of Crypto Assets · a loyalty points scheme denominated in Crypto Assets; or · any other activity or arrangement that is deemed by the FSRA to not constitute Operating a Crypto Asset Business.|
Accepted Crypto Assets
It is pertinent to highlight that the OCAB license holder (‘OCAB Holder’) is permitted to engage in activities relating to ‘Accepted Crypto Assets’ only. Accepted Crypto Assets are Crypto Assets that have been accepted and approved by the FSRA. In order to be categorized as an Accepted Crypto Asset, the FSRA will consider the maturity/market capitalization threshold of a Crypto Asset. As per the Guidance, Crypto Assets with a market capitalization in excess of at least US$4billion are considered to be meeting this threshold. Other factors that may be considered while undertaking this analysis include:
The Guidance has clarified that FSRA will not maintain a ‘public’ list of Accepted Crypto Assets. However, it may provide this information to potential applicants of an OCAB FSP, and OCAB license holders (‘OCAB Holders’).
Interested applicants can apply for an FSP for an OCAB license by making a payment of an initial authorization fees. Additionally, a Crypto Asset Exchange must pay a trading levy to FSRA depending on its average trading value. Once licensed, OCAB Holders is obligated to pay an annual supervision fees. The fee structure proposed is included below:
|Activity||Initial Authorisation Fee (in USD)||Annual Supervision Fees (in USD)|
|Crypto Asset Exchange||125,000/-||60,000/-|
|All Other OCAB Holders||20,000/-||15,000/-|
Due to the inherent nature and risks associated with Crypto Asset transactions, the FSRA requires that OCAB Holders must adopt a comprehensive application of Anti Money Laundering and Countering Financing of Terrorism framework and have a robust technology framework which can withstand, adapt, respond to the risks and vulnerabilities associated with the technology. OCAB Holders are required to have processes in place that enable them to disclose, prior to entering into an initial transaction, all material risks to their clients in a manner that is clear, fair and not misleading. An OCAB Holder is required to develop, implement and adhere to a “Crypto Asset Compliance Policy”, tailored to meet specific Crypto Asset business compliance requirements, and reflecting a clear comprehension of the OCAB Holder’s understanding of its compliance responsibilities. Additionally, an OCAB Holder operating a Crypto Asset Exchange or operating as a Crypto Asset Custodian would have additional compliance obligations under the FSRA regulations. For instance, an OCAB Holder operating a Crypto Asset Exchange is required to hold capital resources equivalent to 12 months’ operational expenses while all other OCAB Holders are required to hold capital resources equivalent to 6 months’ operational expenses.
Though the systems surrounding digital assets is here to stay, globally, the regulators are still analyzing the regulatory approach that they wish to adopt. In the midst of this regulatory confusion, ADGM has embraced its position as a torchbearer in the GCC region and implemented robust structures to support the use of digital assets within the ADGM. The framework is designed to address the full range of risks associated with crypto asset activities, including risks relating to money laundering and financial crime, consumer-protection technology governance, custody and exchange operations.
FSRA has also addressed issues around technology governance, disclosure/transparency, market abuse and the regulation of Crypto Asset Exchanges in a manner similar to the regulatory approach taken in relation to securities exchanges globally.
As an early adopter of the crypto asset regulatory framework in the GCC region, the ADGM has shown its willingness and keen interest in supporting this emerging technology. It would be interesting to see the overall impact of these regulatory developments on the crypto asset market in the UAE.
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