Navigating financial crime risks: how financial institutions are approaching clients in the crypto-asset sector

This is part 2 in the series.

This article was first published on Thomson Reuters Regulatory Intelligence on November 8, 2021.

• Introduction
• Part 2: How financial institutions are approaching clients in the crypto-asset sector
• 1. UK
• 2. United States
• 3. Hong Kong
• 4. Australia
• 5. Global

Introduction

The risk of crypto-assets being used to further criminal activity is well recognised and considered a priority by authorities and industry alike. Various efforts are underway in a number of jurisdictions to address these risks. These efforts are important, not only to combat financial crime, but also to support the safe development of fintech and regtech initiatives and innovation.

In this four-part series the authors look at different jurisdictions' approaches to anti-money laundering (AML) and counter-terrorist financing (CTF) in the crypto sector to include insights on several areas; these include:

• The triggers to the AML/CTF regime for crypto-asset businesses and what this involves
• How financial institutions are approaching clients in the crypto sector
• The regulator's approach to suspicious activity reporting and the consequences of getting it wrong
• The future crypto landscape including opportunities and challenges.

The series is aimed at both financial institutions that are interested in the future development of crypto businesses, those looking to operate a crypto business, and existing providers of crypto products and services to navigate and manage financial crime risks.

Part 1 discusses the triggers to the AML/CTF regime for crypto-asset businesses which can be found here.

Part 2: How financial institutions are approaching clients in the crypto-asset sector

The risk of investing and transacting in crypto-assets to further criminal activity is well recognised by financial institutions globally. In parallel the evolution of the regulatory arena with respect to the authorisation and registration of crypto-asset businesses by regulators is becoming more commonplace across many jurisdictions.

This creates an interesting dynamic between the risk that financial institutions are willing to accept when interacting with crypto-asset businesses and the way in which such businesses are onboarded in the event they become clients of the financial institution as more crypto-asset businesses are approved by regulators.

The approach and treatment by financial intuitions when encountering crypto-asset businesses differs across sectors, markets and jurisdictions, and despite a broad willingness to embrace this new type of business, there is a clear reluctance to do this at any speed without fully understanding and managing the risks involved.

1. UK

In the UK, there appears to be growing enthusiasm generally towards crypto-asset businesses, but financial institutions still remain cautious and are not eager to readily change their policy or risk appetite in a more favourable direction just yet. Many financial institutions are instead continuing to adopt a low to no risk appetite where there is direct exposure to crypto-asset businesses.

For example, a number of institutions prefer not to transact with business customers who choose to accept crypto-assets as a form of payment, meaning it is difficult for crypto-asset businesses to obtain banking services such as opening a bank account.

Some financial institutions have limited the services offered to clients who are investing in crypto-assets and in some cases blocked accounts where clients have attempted certain transfers to or from crypto-asset providers.

Many crypto-asset businesses are undergoing registration under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (as amended) with the Financial Conduct Authority (FCA) and subject to the Temporary Registrations Regime, meaning financial institutions would gain comfort in interacting with those businesses which are subsequently
approved by the FCA.

It may be that financial institutions will be more likely to embrace the crypto-asset sector as there are advancements in the regulatory sphere and particularly where there is an increased level of transparency and stability in the sector.

A number of industry bodies are seeking to bridge this gap by providing a thorough analysis to financial institutions of the risks presented by crypto technology, business models and exchanges, as well as demonstrating the potential for innovation in managing financial crime risks through crypto technology.

2. United States

In the United States, the approach to crypto-asset businesses by banks is likely to depend on the activities that the crypto-asset businesses are involved in and their banking service needs.

While banks have no regulatory limitation that would prohibit the provision of general banking services to crypto-asset businesses, they must however comply with AML requirements and depending upon the services provided to their customers, may also have to consider safety and financial soundness related concerns.

As a result, banks should satisfy themselves that the services provided by the crypto-asset businesses are compliant with law which in some instances may be difficult to determine due to a lack of transparency and complexity associated with crypto-asset businesses.

3. Hong Kong

In Hong Kong, it has historically proved difficult for crypto-asset businesses to obtain banking services, however due to the commencement of regulation for crypto-asset businesses and the crypto-asset sector size growing exponentially, financial institutions are showing small signs of becoming more comfortable with doing business with them.

Despite this, there are still instances of clients of traditional financial institutions getting accounts blocked for transferring funds to and from crypto-asset businesses.

In Hong Kong, not all crypto-asset businesses are currently subject to regulation and this could be why the uptake from financial institutions is slow. The authors expect expect the situation to become clearer once Hong Kong introduces the Financial Action Task Force (FATF) rules in relation to certain Virtual Asset Service Providers, including in relation to AML requirements such as the travel rule.

4. Australia

In Australia, given the relatively limited regulation of the crypto-asset sector, many financial institutions are taking a cautious approach. Despite taking a cautious approach, many financial institutions do have some type of relationship with crypto-asset businesses albeit to varying degrees. There is an appreciation from financial institutions that crypto-assets and the technology that underpins it will continue to evolve, so early adoption could provide a competitive advantage.

This needs to be balanced however against existing regulatory requirements such as AML/CTF, which is made difficult by the anonymous nature of some crypto-assets.

One recent example is the Australian Securities and Investments Commission's response to an industry consultation on the use of "crypto-assets as underlying assets for exchange traded products". This response includes guidance on how product issuers and market operators can meet their regulatory obligations but there are some limitations; notably, only products linked to bitcoin and ether will be eligible for approval.

Furthermore, there is an expectation that fund managers issuing crypto-backed products will appoint a custodian with specific crypto expertise and at least $10 million in net tangible assets.

5. Global

In relation to financial institutions partaking in the crypto-asset activities themselves, the Basel Committee's recent public consultation on the prudential requirements of crypto-asset exposures by credit institutions put forward proposals for global banks to reserve enough capital to cover losses in full on any crypto-asset holdings. These proposals, if implemented by Basel Committee members, may discourage financial institutions from holding crypto-assets on a larger scale.

The approach of financial institutions to crypto-asset businesses have similar themes across the globe. First, it remains difficult for crypto-asset businesses to obtain banking services because of the perceived money laundering risk of crypto-asset businesses by financial institutions.

Secondly, the approach to crypto-asset businesses by financial institutions very much depends on the activities that the crypto-asset business is involved in and their service needs.

Thirdly, those financial institutions providing services to and onboarding crypto-asset businesses generally occurs with a degree of caution as the regulatory sphere evolves.

In the next article, the authors will continue to look at cross jurisdictional perspectives, specifically the regulatory approach to reporting suspicious activity by crypto-asset businesses and the consequences of getting this wrong.

Please keep an eye out for Part 3 in this series: "the regulator's approach to suspicious activity reporting and the consequences of getting it wrong".

Produced by Thomson Reuters Accelus Regulatory Intelligence

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