Q&A: Gareth Parker, Bovill
AlphaWeek’s Greg Winterton caught up with Gareth Parker, a Consultant at financial services regulatory consultancy Bovill, to discuss the latest in cryptocurrency regulation.
GW: Gareth, thanks for taking the time. To begin, what are the implications for the hedge fund industry given the de-centralised and borderless nature of crypto assets?
GP: From a hedge fund investor’s perspective, the main consideration when working with crypto assets is to make sure service providers are highly experienced and credible to reduce both perceived and actual greater risk. With the pace of growth in this sector, and the lack of movement by the traditional players, new entrants continue to spring up. And the appetite of administrators to custody the asset has been somewhat lacklustre and mixed.
As the cryptocurrency asset class continues to grow, investors will need to get comfortable with the risks, asking questions such as:
- Given the myriad pricing sources for some cryptocurrencies, extreme illiquidity in others and entirely absent trading after many ICOs, how can a reliable valuation for each be established?
- Less familiar jurisdictions like Gibraltar and Malta have positioned themselves to be a centre of crypto storage. How and in which jurisdictions will the securities be safeguarded - particularly in regard to cold storage?
GW: Various regulators have issued warnings to investors regarding crypto assets and ICOs. What options are currently available for institutional investors which want access to crypto assets?
GP: The easiest access to crypto assets for institutional investors is likely to be via the various exchange traded products that are starting to appear, such as the XBTProvider exchange-traded notes (ETNs) listed in Stockholm, and via the various hedge funds or funds-of-funds that are active in the space. Here the key question for potential investors is much the same as for those investing in more traditional assets: whether they are looking for a primarily “passive” long-only strategy (and if so, how diversified they want it to be), or for a more traditional hedge-fund active strategy that looks to reduce drawdowns. Returns in Q1 2018 bear this out – many hedge funds broadly followed the crypto market’s 40% drop, but a number actually rose in value.
GW: Which fund jurisdictions are making the strongest push to be considered leading crypto jurisdictions, and what are they doing to achieve this?
GP: The jurisdictions in which we have observed most regulatory and market activity relating to crypto assets include: Germany; Luxembourg; Switzerland; Malta; Gibraltar; Japan; South Korea; Hong Kong; Singapore; UK; USA and Australia. Factors to consider when selecting a jurisdiction include: ease of corporation formation and operation; prevailing local regulatory environment; regulatory support for innovation; access to sufficient funding/investment; access to talent; access to appropriate third parties and suppliers; access to sufficient customer/client base; ease of cross-border operations; attitude of government and law enforcement to crypto.
GW: What do you see as being the direction of travel for regulation of crypto activities?
GP: Crypto assets have a number of uses which are closely aligned to existing regulated instruments or activities. It is therefore logical that crypto businesses become subject to some form of regulation. Some countries (e.g. Japan) have introduced dedicated regimes, other countries have or are incorporating crypto activity into existing regimes (e.g. Germany, Luxembourg, Singapore).
Ideally, crypto regulation will focus on where the real risks are. On that basis, we expect that crypto businesses will ultimately become subject to regulatory requirements regarding anti-money laundering (AML), counter-terrorist financing (CTF), financial sanctions, consumer/investor protection (e.g. disclosure, fair treatment, compensation schemes), and market conduct (e.g.KYC). We also expect future regulation to focus on the different economic functions of crypto assets (which is the approach favoured by FINMA in Switzerland). Some organisations have proposed codes of conduct and self-regulation, particularly regarding ICOs. However, in our view, that is unlikely to delay the onset of independent regulation. Further into the future, we anticipate the development of high-level global standards for crypto businesses but the different political and regulatory perspectives around the world mean that truly consistent interpretation, application and enforcement of such standards is unlikely.
GW: What are the current touch-points between crypto hedge funds and the regulatory framework?
GP: This currently varies greatly per jurisdiction but some of the most common interfaces at present are:
1) The nature of the crypto investments and whether the crypto investments need to be regulated. In the UK, cryptocurrencies are not currently regulated provided they are not part of other regulated products or services, however cryptocurrency derivatives such cryptocurrency futures, CFDs and options are regulated. In the US, there is a debate between the US regulators, CFTC and SEC as to whether a cryptocurrency is considered to be a commodity or security. Dependent on the definition of the cryptocurrency asset class, there will be differing regulatory demands from the US regulators
2) Money laundering and terrorist financing suspicion reporting requirements (eg. FinCen in the US, new Austrac requirements in Australia, upcoming 5MLD in the EU). As an example, in July 2017, FinCen fined BTC-e $110m for wilfully violating US AML laws.
3) Value transfer services – some countries (eg. Luxembourg and Singapore) have taken the view that businesses which enable users to transfer value in crypto form are providing money remittance or payments services and must be licenced accordingly.
4) Benchmarks Regulation – where a crypto index is used to determine the amount payable under a financial instrument or financial contract or is used to measure the performance of an investment fund, it may be well be a benchmark and the firm that provides it a benchmark administrator.
5) Trading venue/facility – where crypto assets are securities or derivatives are crypto-based, some firms are looking to operate trading venues or facilities.
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