In October 2018, the FATF adopted changes to its Recommendations to explicitly clarify that they apply to financial activities involving virtual assets, and also added two new definitions in the Glossary, “virtual asset” (VA) and “virtual asset service provider” (VASP). The amended FATF Recommendation 15 requires that VASPs be regulated for anti-money laundering and combating the financing of terrorism (AML/CFT) purposes, licenced or registered, and subject to effective systems for monitoring or supervision. In June 2019, the FATF adopted an Interpretive Note to Recommendation 15 to further clarify how the FATF requirements should apply in relation to VAs and VASPs, in particular with regard to the application of the risk-based approach (RBA) to VA activities or operations and VASPs; supervision or monitoring of VASPs for AML/CFT purposes; licensing or registration; preventive measures, such as customer due diligence, recordkeeping, and suspicious transaction reporting, among others; sanctions and other enforcement measures; and international co-operation.
The FATF also adopted the present Guidance1 on the application of the RBA to VAs and VASPs In June 2019. It is intended to help both national authorities in understanding and developing regulatory and supervisory responses to VA activities and VASPs, and to help private sector entities seeking to engage in VA activities, in understanding their AML/CFT obligations and how they can effectively comply with these requirements.
This Guidance outlines the need for countries and VASPs, and other entities involved in VA activities, to understand the ML/TF risks associated with their activities and take appropriate mitigating measures to address them. In particular, the Guidance provides examples of risk indicators that should specifically be considered in a VA context, with an emphasis on factors that would further obfuscate transactions or inhibit VASPs’ ability to identify customers.
The Guidance examines how VA activities and VASPs fall within the scope of the FATF Recommendations. It discusses the five types of activities covered by the VASP definition and provides examples of VA-related activities that would fall within the VASP definition and that would be excluded from the FATF scope. In that respect, it highlights the key elements required to qualify as a VASP, namely acting as a business on behalf of the customers and actively facilitating VA-related activities.
The Guidance describes the application of the FATF Recommendations to countries and competent authorities; as well as to VASPs and other obliged entities that engage into VA activities, including financial institutions such as banks and securities broker- dealers, among others. Almost all of the FATF Recommendations are directly relevant to address the ML/TF risks associated with VAs and VASPs, while other Recommendations are less directly or explicitly linked to VAs or VASPs, though are still relevant and applicable. VASPs therefore have the same full set of obligations as financial institutions or DNFBPs.
The Guidance details the full range of obligations applicable to VASPs as well as to VAs under the Recommendation approach. This includes clarifying that all of the funds or value- based terms in the FATF Recommendations (e.g., “property,” “proceeds,” “funds,” “funds or other assets,” and other “corresponding value”) include VAs. Consequently, countries should apply all of the relevant measures under the FATF Recommendations to VAs, VA activities, and VASPs.
The Guidance explains the VASP registration or licensing requirements, in particular how to determine in which country/ies VASPs should be registered or licensed – at a minimum where they were created; or in the jurisdiction where their business is located in cases where they are a natural person, but jurisdictions can also chose to require VASPs to be licensed or registered before conducting business in their jurisdiction or from their jurisdiction. The Guidance further underlines that national authorities are required to take action to identify natural or legal persons that carry out VA activities without the requisite license or registration. This would be equally applicable by countries which have chosen to prohibit VA and VA activities at national level.
Regarding VASP supervision, the Guidance makes clear that only competent authorities can act as VASP supervisory or monitoring bodies, and not self-regulatory bodies. They should conduct risk-based supervision or monitoring, with adequate powers, including the power to conduct inspections, compel the production of information and impose sanctions. There is a specific focus on the importance of international co-operation between supervisors, given the cross-border nature of VASPs’ activities and provision of services.
The Guidance makes clear that VASPs, and other entities involved in VA activities, need to apply all the preventive measures described in FATF Recommendations 10 to 21. The Guidance explains how these obligations should be fulfilled in a VA context and provides clarifications regarding the specific requirements applicable regarding the USD/EUR 1 000 threshold for VA occasional transactions, above which VASPs must conduct customer due diligence (Recommendation 10); and the obligation to obtain, hold, and transmit required originator and beneficiary information, immediately and securely, when conducting VA transfers (Recommendation 16). As the guidance makes clear, relevant authorities should co-ordinate to ensure this can be done in a way that is compatible with national data protection and privacy rules.
Finally, the Guidance provides examples of jurisdictional approaches to regulating, supervising, and enforcing VA activities, VASPs, and other obliged entities for AML/CFT.The Guidance states
1. New technologies, products, and related services have the potential to spur financial innovation and efficiency and improve financial inclusion, but they also create new opportunities for criminals and terrorists to launder their proceeds or finance their illicit activities. The risk-based approach is central to the effective implementation of the revised Financial Action Task Force (FATF) International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation, which FATF members adopted in 2012, and the FATF therefore actively monitors the risks relating to new technologies.
2. In June 2014, the FATF issued Virtual Currencies: Key Definitions and Potential AML/CFT Risks in response to the emergence of virtual currencies and their associated payment mechanisms for providing new methods of transmitting value over the Internet. In June 2015, the FATF issued the Guidance for a Risk-Based Approach to Virtual Currencies (the 2015 VC Guidance) as part of a staged approach to addressing the money laundering and terrorist financing (ML/TF) risks associated with virtual currency payment products and services.
3. The 2015 VC Guidance focuses on the points where virtual currency activities intersect with and provide gateways to and from (i.e., the on and off ramps to) the traditional regulated financial system, in particular convertible virtual currency exchangers. In recent years, however, the virtual asset space has evolved to include a range of new products and services, business models, and activities and interactions, including virtual-to-virtual asset transactions.
4. In particular, the virtual asset ecosystem has seen the rise of anonymity-enhanced cryptocurrencies (AECs), mixers and tumblers, decentralized platforms and exchanges, and other types of products and services that enable or allow for reduced transparency and increased obfuscation of financial flows, as well as the emergence of other virtual asset business models or activities such as initial coin offerings (ICOs) that present ML/TF risks, including fraud and market manipulation risks. Further, new illicit financing typologies continue to emerge, including the increasing use of virtual-to-virtual layering schemes that attempt to further obfuscate transactions in a comparatively easy, cheap, and secure manner.
5. Given the development of additional products and services and the introduction of new types of providers in this space, the FATF recognized the need for further clarification on the application of the Standards to new technologies and providers. In particular, in October 2018, the FATF adopted two new Glossary definitions—“virtual asset” (VA) and “virtual asset service provider” (VASP)—and updated Recommendation 15 (see Annex A). The objectives of those changes were to further clarify the application of the FATF Standards to VA activities and VASPs in order to ensure a level regulatory playing field for VASPs globally and to assist jurisdictions in mitigating the ML/TF risks associated with VA activities and in protecting the integrity of the global financial system. The FATF also clarified that the Standards apply to both virtual-to-virtual and virtual-to-fiat transactions and interactions involving VAs.
6. In June 2019, the FATF adopted an Interpretive Note to Recommendation 15 (INR. 15) to further clarify how the FATF requirements should apply in relation to VAs and VASPs, in particular with regard to the application of the risk-based approach to VA activities or operations and VASPs; supervision or monitoring of VASPs for anti-money laundering and countering the financing of terrorism (AML/CFT) purposes; licensing or registration; preventive measures, such as customer due diligence, recordkeeping, and suspicious transaction reporting, among others; sanctions and other enforcement measures; and international co-operation (see Annex A).
7 Purpose of the Guidance
8. This updated Guidance expands on the 2015 VC Guidance and further explains the application of the risk-based approach to AML/CFT measures for VAs; identifies the entities that conduct activities or operations relating to VA—i.e., VASPs; and clarifies the application of the FATF Recommendations to VAs and VASPs. The Guidance is intended to help national authorities in understanding and developing regulatory responses to covered VA activities and VASPs, including by amending national laws, where applicable, in their respective jurisdictions in order to address the ML/TF risks associated with covered VA activities and VASPs.
9. The Guidance also is intended to help private sector entities seeking to engage in VA activities or operations as defined in the FATF Glossary to better understand their AML/CFT obligations and how they can effectively comply with the FATF requirements. It provides guidelines to countries, competent authorities, and industry for the design and implementation of a risk- based AML/CFT regulatory and supervisory framework for VA activities and VASPs, including the application of preventive measures such as customer due diligence, record-keeping, and suspicious transaction reporting, among other measures.
10. The Guidance incorporates the terms adopted by the FATF in October 2018 and readers are referred to the FATF Glossary definitions for “virtual asset” and “virtual asset service provider” (Annex A).
11. The Guidance seeks to explain how the FATF Recommendations should apply to VA activities and VASPs; provides examples, where relevant or potentially most useful; and identifies obstacles to applying mitigating measures alongside potential solutions. It is intended to serve as a complement to Recommendation 15 on New Technologies (R. 15) and its Interpretive Note, which describe the full range of obligations applicable to VASPs as well as to VAs under the FATF Recommendations, including the Recommendations relating to “property,” “proceeds,” “funds,” “funds or other assets,” and other “corresponding value.” In doing so, the Guidance supports the effective implementation of national AML/CFT measures for the regulation and supervision of VASPs (as well as other obliged entities) and the covered VA activities in which they engage and the development of a common understanding of what a risk-based approach to AML/CFT entails.
12. While the FATF notes that some governments are considering a range of regulatory responses to VAs and to the regulation of VASPs, many jurisdictions do not yet have in place effective AML/CFT frameworks for mitigating the ML/TF risks associated with VA activities in particular, even as VA activities develop globally and VASPs increasingly operate across jurisdictions. The rapid development, increasing functionality, growing adoption, and global, cross-border nature of VAs therefore makes the urgent action by countries to mitigate the ML/TF risks presented by VA activities and VASPs a key priority of the FATF. While this Guidance is intended to facilitate the implementation of the risk-based approach to covered VA activities and VASPs for AML/CFT purposes, the FATF recognizes that other types of policy considerations may come into play and shape the regulatory response to the VASP sector in individual jurisdictions.
Scope of the Guidance
13. The FATF Recommendations require all jurisdictions to impose specified, activities-based AML/CFT requirements on financial institutions (FIs) and designated non-financial businesses and professions (DNFBPs) and ensure their compliance with those obligations. The FATF has agreed that all of the funds- or value-based terms in the FATF Recommendations (e.g., “property,” “proceeds,” “funds,” “funds or other assets,” and other “corresponding value”) include VAs and that countries should apply all of the relevant measures under the FATF Recommendations to VAs, VA activities, and VASPs. The primary focus of the Guidance is to describe how the Recommendations apply to VAs, VA activities, and VASPs in order to help countries better understand how they should implement the FATF Standards effectively.
14. Further, the Guidance focuses on VAs that are convertible for other funds or value, including both VAs that are convertible to another VA and VAs that are convertible to fiat or that intersect with the fiat financial system, having regard to the VA and VASP definitions. It does not address other regulatory matters that are potentially relevant to VAs and VASPs (e.g., consumer protection, prudential safety and soundness, tax, anti-fraud or anti-market manipulation issues, network IT security standards, or financial stability concerns).
15. The Guidance recognizes that an effective risk-based approach will reflect the nature, diversity, and maturity of a country’s VASP sector, the risk profile of the sector, the risk profile of individual VASPs operating in the sector and the legal and regulatory approach in the country, taking into account the cross-border, Internet-based nature and global reach of most VA activities. The Guidance sets out different elements that countries and VASPs should consider when designing and implementing a risk-based approach. When considering the general principles outlined in the Guidance, national authorities will have to take into consideration their national context, including the supervisory approach and legal framework as well as the risks present in their jurisdiction, again in light of the potentially global reach of VA activities.
16. The Guidance takes into account that just as illicit actors can abuse any institution that engages in financial activities, illicit actors can abuse VASPs engaging in VA activities, for ML, TF, sanctions evasion, fraud, and other nefarious purposes. The 2015 VC Guidance, the 2018 FATF Risk, Trends, and Methods Group papers relating to this topic, and FATF reports and statements relating to the ML/TF risks associated with VAs, VA activities, and/or VASPs, for example, highlight and provide further context regarding the ML/TF risks associated with VA activities. While VAs may provide another form of value for conducting ML and TF, and VA activities may serve as another mechanism for the illegal transfer of value or funds, countries should not necessarily categorize VASPs or VA activities as inherently high ML/TF risks. The cross-border nature of, potential enhanced-anonymity associated with, and non-face-to-face business relationships and transactions facilitated by VA activities should nevertheless inform a country’s assessment of risk. The extent and quality of a country’s regulatory and supervisory framework as well as the implementation of risk-based controls and mitigating measures by VASPs also influence the overall risks and threats associated with covered VA activities. The Guidance also recognizes that despite these measures, there may still be some residual risk, which competent authorities and VASPs should consider in devising appropriate solutions.
17. The Guidance recognizes that “new” or innovative technologies or mechanisms for engaging in or that facilitate financial activity may not automatically constitute “better” approaches and that jurisdictions should also assess the risks arising from and appropriately mitigate the risks such new methods of performing a traditional or already-regulated financial activity, such as the use of VAs in the context of payment services or securities activities, as well.
18. Other stakeholders, including FIs and other obliged entities that provide banking services to VASPs or to customers involved in VA activities or that engage in VASP activities themselves should also consider the aforementioned factors. FIs should apply a risk-based approach when considering establishing or continuing relationships with VASPs or customers involved in VA activities, evaluate the ML/TF risks of the business relationship, and assess whether those risks can be appropriately mitigated and managed (see Section IV). It is important that FIs apply the risk-based approach properly and do not resort to the wholesale termination or exclusion of customer relationships within the VASP sector without a proper risk assessment.
19. In considering the Guidance, countries, VASPs and other obliged entities that engage in or provide covered VA activities should recall the key principles underlying the design and application of the FATF Recommendations and that are relevant in the VA context:
a) Functional equivalence and objectives-based approach. The FATF requirements, including as they apply in the VA space, are compatible with a variety of different legal and administrative systems. They broadly explain what must be done but not in an overly-specific manner about how implementation should occur in order to allow for different options, where appropriate. Any clarifications to the requirements should not require jurisdictions that have already adopted adequate measures to achieve the objectives of the FATF Recommendations to change the form of their laws and regulations. The Guidance seeks to support ends-based or objectives-based implementation of the relevant FATF Recommendations rather than impose a rigid prescriptive one-size-fits-all regulatory regime across all jurisdictions.
b) Technology-neutrality and future-proofing. The requirements applicable to VAs, as value or funds, to covered VA activities, and to VASPs apply irrespective of the technological platform involved. Equally, the requirements are not intended to give preference to specific products, services, or solutions offered by commercial providers, including technological implementation solutions that aim to assist providers in complying with their AML/CFT obligations. Rather, the requirements are intended to have sufficient flexibility that countries and relevant entities can apply them to existing technologies as well as to evolving and emerging technologies without requiring additional revisions.
c) Level-playing field. Countries and their competent authorities should treat all VASPs on an equal footing from a regulatory and supervisory perspective in order to avoid jurisdictional arbitrage. As with FIs and DNFBPs, countries should therefore subject VASPs to AML/CFT requirements that are functionally equivalent to other entities when they offer similar products and services and based on the activities in which the entities engage.
20. This Guidance is non-binding and does not overrule the purview of national authorities, including on their assessment and categorization of VASPs, VAs, and VA activities, as per the country or regional circumstances, the prevailing ML/TF risks, and other contextual factors. It draws on the experiences of countries and of the private sector and is intended to assist competent authorities, VASPs, and relevant FIs (e.g., banks engaging in covered VA activities) in effectively implementing the FATF Recommendations using a risk-based approach.
Structure
21. This Guidance is organized as follows: Section II examines how VA activities and VASPs fall within the scope of the FATF Recommendations; Section III describes the application of the FATF Recommendations to countries and competent authorities; Section IV explains the application of the FATF Recommendations to VASPs and other obliged entities that engage in or provide VA covered activities, including FIs such as banks and securities broker-dealers, among others; and Section V provides examples of jurisdictional approaches to regulating, supervising, and enforcing covered VA activities and VASPs (and other obliged entities) for AML/CFT.
22. Annexes A, B, and C include relevant resources that augment this Guidance, including the June 2014 FATF Virtual Currencies: Key Definitions and Potential AML/CFT Risks paper, the June 2015 VC Guidance, the updated text of Recommendation 15 and its Interpretive Note, and the “virtual asset” and “virtual asset service provider” definitions within the FATF GlossaryThe Annex to the Guidance deals with Recommendation 15 and its Interpretive Note and FATF Definitions -
Recommendation 15 – New Technologies Countries and financial institutions should identify and assess the money laundering or terrorist financing risks that may arise in relation to (a) the development of new products and new business practices, including new delivery mechanisms, and (b) the use of new or developing technologies for both new and pre-existing products. In the case of financial institutions, such a risk assessment should take place prior to the launch of the new products, business practices or the use of new or developing technologies. They should take appropriate measures to manage and mitigate those risks. To manage and mitigate the risks emerging from virtual assets, countries should ensure that virtual asset service providers are regulated for AML/CFT purposes, and licensed or registered and subject to effective systems for monitoring and ensuring compliance with the relevant measures called for in the FATF Recommendations.The Interpretative Note to Recommendation 15 states
1. For the purposes of applying the FATF Recommendations, countries should consider virtual assets as “property,” “proceeds,” “funds,” “funds or other assets,” or other “corresponding value.” Countries should apply the relevant measures under the FATF Recommendations to virtual assets and virtual asset service providers (VASPs).
2. In accordance with Recommendation 1, countries should identify, assess, and understand the money laundering and terrorist financing risks emerging from virtual asset activities and the activities or operations of VASPs. Based on that assessment, countries should apply a risk- based approach to ensure that measures to prevent or mitigate money laundering and terrorist financing are commensurate with the risks identified. Countries should require VASPs to identify, assess, and take effective action to mitigate their money laundering and terrorist financing risks.
3. VASPs should be required to be licensed or registered. At a minimum, VASPs should be required to be licensed or registered in the jurisdiction(s) where they are created. In cases where the VASP is a natural person, they should be required to be licensed or registered in the jurisdiction where their place of business is located. Jurisdictions may also require VASPs that offer products and/or services to customers in, or conduct operations from, their jurisdiction to be licensed or registered in this jurisdiction. Competent authorities should take the necessary legal or regulatory measures to prevent criminals or their associates from holding, or being the beneficial owner of, a significant or controlling interest, or holding a management function in, a VASP. Countries should take action to identify natural or legal persons that carry out VASP activities without the requisite license or registration, and apply appropriate sanctions.
4. A country need not impose a separate licensing or registration system with respect to natural or legal persons already licensed or registered as financial institutions (as defined by the FATF Recommendations) within that country, which, under such license or registration, are permitted to perform VASP activities and which are already subject to the full range of applicable obligations under the FATF Recommendations.
5. Countries should ensure that VASPs are subject to adequate regulation and supervision or monitoring for AML/CFT and are effectively implementing the relevant FATF Recommendations, to mitigate money laundering and terrorist financing risks emerging from virtual assets. VASPs should be subject to effective systems for monitoring and ensuring compliance with national AML/CFT requirements. VASPs should be supervised or monitored by a competent authority (not a SRB), which should conduct risk-based supervision or monitoring. Supervisors should have adequate powers to supervise or monitor and ensure compliance by VASPs with requirements to combat money laundering and terrorist financing including the authority to conduct inspections, compel the production of information, and impose sanctions. Supervisors should have powers to impose a range of disciplinary and financial sanctions, including the power to withdraw, restrict or suspend the VASP’s license or registration, where applicable.
6. Countries should ensure that there is a range of effective, proportionate and dissuasive sanctions, whether criminal, civil or administrative, available to deal with VASPs that fail to comply with AML/CFT requirements, in line with Recommendation 35. Sanctions should be applicable not only to VASPs, but also to their directors and senior management.
7. With respect to preventive measures, the requirements set out in Recommendations 10 to 21 apply to VASPs, subject to the following qualifications:
(a) R.10 – The occasional transactions designated threshold above which VASPs are required to conduct CDD is USD/EUR 1 000.
(b) R.16 – Countries should ensure that originating VASPs obtain and hold required and accurate originator information and required beneficiary information on virtual asset transfers, submit3 the above information to the beneficiary VASP or financial institution (if any) immediately and securely, and make it available on request to appropriate authorities.
Countries should ensure that beneficiary VASPs obtain and hold required originator information and required and accurate beneficiary information on virtual asset transfers, and make it available on request to appropriate authorities. Other requirements of R.16 (including monitoring of the availability of information, and taking freezing action and prohibiting transactions with designated persons and entities) apply on the same basis as set out in R.16. The same obligations apply to financial institutions when sending or receiving virtual asset transfers on behalf of a customer.
8. Countries should rapidly, constructively, and effectively provide the widest possible range of international co-operation in relation to money laundering, predicate offences, and terrorist financing relating to virtual assets, on the basis set out in Recommendations 37 to 40. In particular, supervisors of VASPs should exchange information promptly and constructively with their foreign counterparts, regardless of the supervisors’ nature or status and differences in the nomenclature or status of VASPs.The UK Jurisdiction Taskforce has meanwhile released a discussion paper as part of its Consultation on the status of cryptoassets, distributed ledger technology and smart contracts under English private law.
The paper states
Background to this consultation
The development of distributed ledger technology (“DLT”), cryptoassets, smart contracts and associated technologies has far-reaching implications for financial markets, both domestically and internationally. Nevertheless, the experience of market participants at present suggests that a lack of certainty regarding the legal status of cryptoassets, DLT and smart contracts could be hampering this development. This uncertainty does not solely arise in the context of English law and the jurisdiction of England and Wales. However, creating a measure of confidence in these issues would increase confidence in the use of cryptoassets, DLT and smart contracts and bolster the use of English law and the jurisdiction of England and Wales in transactions concerning cryptoassets, as well as in smart contracts more generally.
English law, as a well-developed flexible common law system, has the ability to provide the certainty and predictability that the commercial community demands, and is well able to adapt to deal with fast-changing technologies. Consequently, English law and the jurisdiction of England and Wales are well-positioned to provide the legal foundation for the development of these technologies.
Scope of this consultation
The LawTech Delivery Panel (“LTDP”) was established by the UK Government, the Judiciary and the Law Society of England and Wales and has as its overarching objective the promotion of the use of technology in the UK’s legal sector. The UKJT is one of six taskforces established by the LTDP for the purposes of achieving this objective.
The objective of the UKJT is to demonstrate that English law and the jurisdiction of England and Wales together provide a state-of-the-art foundation for the development and use of DLT, smart contracts and associated technologies. In pursuit of this objective, the UKJT is co-ordinating the preparation of an authoritative legal statement (“Legal Statement”) on the status of cryptoassets and smart contracts under English private law. The intention is that the Legal Statement will either demonstrate that English private law already provides sufficiently certain foundations in relation to the relevant issues, or will highlight particular areas of uncertainty that may be ripe for further clarificatory steps to be taken.
The purpose of this consultation is to seek input from stakeholders as to the principal issues of perceived legal uncertainty regarding the status of cryptoassets and smart contracts under English private law to inform what should be addressed in the Legal Statement.
In Annex 1 (Questions to be addressed in the Legal Statement), we have set out what the UKJT considers to be the principal issues. However, ultimately, for the Legal Statement to serve its purpose, it must address those issues that market participants themselves are most concerned with. This is why we hope that key industry stakeholders will find time to participate in this consultation.
In Annex 2 (Overview and key features of DLT), we outline the key features of DLT. This informs the UKJT’s understanding of the key legal issues arising in this context and, ultimately, those that will be addressed in the Legal Statement. In Annexes 3 (Cryptoassets) and 4 (Smart contracts), we provide further detail on the technical aspects of cryptoassets and smart contracts, again, each with the intention of informing an understanding of the issues to be addressed in the Legal Statement.
Overview of the key issues of legal uncertainty included in this consultation
As this consultation and the Legal Statement are focused on private law, the questions identified in Annex 1 (Questions to be addressed in the Legal Statement) are accordingly limited in scope.
Quite intentionally, they do not cover certain other areas of law insofar as they relate to cryptoassets or smart contracts, including (among others) their regulatory characterisation and treatment, matters of taxation, criminal law, partnership law, data protection, consumer protection, settlement finality,6 regulatory capital, anti-money laundering or counter-terrorist financing. We recognise that these are important areas, and ones in which market participants may feel there exists a degree of legal uncertainty in some instances. However, the UKJT feels that other bodies or organisations are better-placed to provide the necessary clarity on these issues, and so they do not form a part of this project. The questions also do not address certain areas of perceived legal uncertainty where too many potential factual scenarios would need to be considered in order for any helpful answers to be provided.
We set out below some background on the questions which we have included in Annex 1 (Questions to be addressed in the Legal Statement). Legal status of cryptoassets
Many aspects of the status of cryptoassets as a matter of English private law are considered by some to be unclear. In particular, notwithstanding that a significant amount of work has been undertaken in relation to a number of these issues by various academic, professional and public bodies, it is understood to be of general concern to the market that an authoritative response be given to the questions of whether, and, if so, the circumstances in which, a cryptoasset may be characterised under English law as property. The questions relevant to this are therefore set out in paragraphs 1.1 and 1.2 of Annex 1 (Questions to be addressed in the Legal Statement).
Property law matters both to users of a DLT system and to third parties dealing with those users. If a cryptoasset is not property, it cannot be owned. If it cannot be owned, it cannot be purchased, sold, otherwise transferred in law or rights to it asserted if it is stolen. Neither can a trust be declared, or security created, over it. The concept of a cryptoasset being recognised as property is therefore critical to the application of private law to transactions involving cryptoassets. If a cryptoasset is recognised as property, it is then necessary to understand the legal nature of that property. Traditionally, English law recognises physical things (choses in possession) and legal rights (choses in action) as property”.8 If a cryptoasset is recognised as property, does it fall into one of these categories or does it fall within some other category of property under English law? This is also critical to the application of private law to transactions involving cryptoassets because it is necessary to determine the location of property (its situs), under most legal systems, in order to determine the correct law governing transfers (alienation) of the property concerned. Consequently, the response to the threshold question of whether a cryptoasset may be recognised under English law as property either dictates to a large degree or is materially relevant to the outcome of a series of ancillary questions, including whether certain types of security may validly be granted over it and its treatment for certain purposes as a matter of English insolvency law. These questions are set out in paragraphs 1.2.1 to 1.2.6 of Annex 1 (Questions to be addressed in the Legal Statement).
Equally, if a cryptoasset is capable of being recognised as property under English law, there is a series of additional questions as to other characterisations under English private law which may also be relevant. These questions include whether a cryptoasset may be characterised as a “documentary intangible” or as being “negotiable” (i.e. in the sense that a transferee may, by the mere transfer of a cryptoasset, acquire better title to that cryptoasset than that of its transferor), and whether cryptoassets may be recognised as “goods” for certain statutory purposes. These questions are set out in paragraphs 1.2.7 to 1.2.11 of Annex 1 (Questions to be addressed in the Legal Statement).
The UKJT also understands that there is uncertainty among market participants as to whether DLT records of cryptoassets are capable of amounting to a “register” for the purposes of evidencing, constituting and transferring title to certain types of securities under English law.
This question is set out in paragraph 1.2.12 of Annex 1 (Questions to be addressed in the Legal Statement). In Annex 3 (Cryptoassets), we discuss the meaning of the term “cryptoasset”, building on the general overview of DLT provided in Annex 2 (Overview and key features of DLT). In doing so, we explain certain key features of cryptoassets within some commonly used DLT models, with the aim of providing the authors of the Legal Statement with a description of certain key common features, given the multiplicity of potential models which exist.
Enforceability of smart contracts
As noted by the Law Commission of England and Wales, to ensure that the English courts and English law remain competitive choices for business, there is a compelling case for reviewing the current English legal framework to ensure that it facilitates the use of smart contracts.
It is understood that market participants attempting to replicate contractual arrangements written in prose using smart contracts, are principally concerned that the circumstances in which smart contracts are capable of giving rise to binding legal obligations be clarified. This question is set out in paragraph 2.1 of Annex 1 (Questions to be addressed in the Legal Statement).
The UKJT is aware that some market participants may question the merits of this exercise, given that some among them may view one of the benefits of smart contracts as being that they are sometimes considered to remove the need for parties to rely on a legal framework to enforce their rights against each other. However, if smart contracts are capable of giving rise to binding legal obligations, it will be important for parties to be aware of the circumstances in which this will be the case (notably if the parties’ intention is not to create legal relations). It will also be important for parties to know if and how their rights might be enforced in the event that technology does not work as expected.
Again, depending on the answer to that principal question, a series of ancillary questions arises. Notably, how the general principles of contractual interpretation would be applied by an English court in the context of a smart legal contract and the circumstances in which a statutory signature or “in writing” requirement may be met in the context of smart legal contracts. These questions are set out in paragraph 2.2 of Annex 1 (Questions to be addressed in the Legal Statement).
In Annex 4 (Smart contracts), we discuss how the market currently understands the term “smart contract”, again building on the general overview of DLT provided in Annex 2 (Overview and key features of DLT). In doing so, we explain at a high level certain of the key features of smart contracts, and how they differ as between different implementations. As with Annex 3 (Cryptoassets), the aim of this section is to inform and help circumscribe the answers that will be provided in the Legal Statement.
Application of English law
Readers may note that, with the exception of the question posed in paragraph 1.2.3 of Annex 1 (Questions to be addressed in the Legal Statement), the question of the extent to which English law would be the applicable law in relation to dealings or other arrangements involving cryptoassets or smart contracts is not dealt with directly. The UKJT recognises that this is an area of much uncertainty for market participants. It is also of the view, however, that this is an issue which is highly fact-dependent, which limits the effectiveness of any attempt to provide a broad Legal Statement on the topic.
That said, the UKJT does consider that there would be value in setting out guidance within the Legal Statement as to the steps that may be taken by developers and participants to reduce uncertainty by ensuring, where desired, that English law will govern the relevant dealings or other arrangements, such as transactions within a DLT system or smart contracts to be deployed within such system.
