Thought leaders and experts in regulatory compliance agree that the implementation of the much-discussed Travel Rule is a challenge that will take industry cooperation to make work - and it’s work well worth doing.
The broadening of the Financial Action Task Force (FATF)’s anti-money laundering rules in 2019 to apply to ‘virtual assets’ (VAs) and ‘virtual asset service providers’ (VASPs) caused significant consternation throughout the digital asset industry. It had the effect of bringing digital assets and providers like exchanges within the ambit of many of the rules that apply to traditional financial institutions.
The Financial Action Task Force (FATF) is the global intergovernmental anti-money laundering (AML) and counter-terrorism financing (CFT) watchdog. It sets international AML and CFT standards via recommendations issued to its 39 member countries, in addition to more than 150 observing nations.
FATF recommendations are non-binding; however, countries are expected to implement FATF recommendations in their own jurisdictions or face being added to the 'call for action' list, formerly known as the FATF Blacklist. As a result, the recommendations carry significant weight and have a 'rising tide' effect on AML and CFT laws around the world.
The Travel Rule
The commotion from the 2018 changes concerned the application of the FATF's so-called 'travel rule' in the context of digital assets. The Rule had required traditional financial institutions to send identifying information about the sender and recipient of transfers over $1,000. Specifically, the following information must be exchanged between beneficiaries and originators of transactions:
- The names of the originator and beneficiary
- Account number or virtual wallet address of the originator and beneficiary
- Physical address of the originator
- National identity number or other unique identifying number of the originator
It is intended to facilitate the monitoring of transactions and allow for the reporting of suspicious activities – such as those involving money laundering and terrorist financing.
By introducing definitions for VAs and VASPs, the FATF made clear that the rules were intended to apply broadly. The FATF Guidance issued at the time said:
'..these definitions are expansive and there should not be a case where a relevant financial asset is not covered by the FATF Standards (either as a VA or as a traditional financial asset).'
'The expansiveness of these definitions represents a conscious choice by the FATF. Despite changing terminology and innovative business models developed in this sector, the FATF envisions very few VA (virtual asset) arrangements will form and operate without a VASP (virtual asset service provider) involved at some stage.'
In keeping with the FATF approach to enforcement, the organisation made clear that countries that do not implement the travel rule are to be considered of high AML and CFT risk. Still, the latest annual FATF assessment from June 2021 highlighted that jurisdictions had implemented the rule inconsistently, if at all. At the time, 58 jurisdictions had implemented the revised FATF standards.
The industry responds
With FATF’s new guidance, digital asset exchanges had to scramble to work out how they were going to comply. Until recently, the industry was one where it was unusual to be asked for identification when signing up to an asset exchange. To now be required to attach identifying information to each transaction they process is something of a departure for many digital asset providers.
The travel rule is so-called because it is concerned with the transfer of funds. This focus on transfers is common to anti-money laundering regulation because the transfer is typically the link between laundered and unlaundered funds. Therefore, it is a natural point of reinforcement for AML efforts. For example, a rule under the Bank Secrecy Act (BSA) was introduced in 1996 which requires all financial institutions to pass on specific information about transactions being sent between each other. It is this rule on which the FATF guidance is based.
One of the reasons for apprehension from certain corners of the industry was the lack of standardised protocols for information sharing of this kind. Unlike in traditional banking, there is no SWIFT-like standardised system for virtual asset providers (to use FATF language) to identify and communicate with one another.
That’s why, for example, the BSV Technical Standards Committee has prioritised the development of a Travel Rule technical standard, implementing a standardised protocol for VASPs on the BSV blockchain to collect and exchange the information required by the rule.
Some corners of the industry have had an easier time adjusting to the changes than others. Those who approach regulation on the basis that it is a positive factor for digital assets and the companies that leverage them will likely embrace the change. Fighting money laundering and terrorist financing is something any reputable service provider should take seriously.
At the same time, some consider it an added burden for digital asset companies. Compliance takes work. Not only does it require added effort and commitment from within an organisation, but it also requires the cooperation and support of its partners. Whether that means relying on RegTech solutions or the development of industry standards making compliance easier, it’s a global effort.
What shouldn't be missed is that the travel rule is just one example of an overall trend toward increased regulation over digital assets. Whether it’s applying existing laws and understandings to the industry or building entirely new legal frameworks, the gaps are being closed and the grey areas filled in. This will take ongoing effort from compliant businesses and innovators, but it’s for the benefit of the industry at large.
This post was contributed to the kompany blog by the Bitcoin Association.