The Financial Action Task Force (FATF)’s reports on risks of virtual assets

12 August 2020, Banking & Finance, Newsletter by Simon Deane, James Tong

The Financial Action Task Force (FATF) recently published a report on its 12-month review of the Revised FATF Standards on Virtual Assets and Virtual Asset Service Providers, and a report on so-called stablecoins which highlighted associated risks of money laundering/terrorism financing (“ML/TF”). FATF concluded that there may be ML/TF risks associated with the stabilisation mechanism specific to stablecoin, and identified three particular ML/TF vulnerabilities (some of which may overlap with those for virtual assets in general):

  • Anonymity: The revised FATF Standards published in June 2019 (“revised FATF Standards”) impose requirements to address risks posed by anonymity by placing anti-money laundering and counter financing of terrorism (“AML/CFT”) obligations on entities carrying out financial activities involving virtual assets, such as virtual asset service providers (“VASPs”). These require VASPs to identify their customers and maintain transaction records. However, it was noted that such controls can be avoided by using peer-to-peer transactions without the use of a regulated intermediary.
  • Global Reach: Although virtual assets may not currently be widely used for cross-border payments, partly because of their unstable value, stablecoin address the volatility issue and purport to be a faster and cheaper means of cross-border transfer. Thus, the potential global reach of stablecoin heightens ML/TF risks as they often rely on infrastructure spread across several jurisdictions to transfer funds or execute payments; this segmentation of services means that the responsibility for AML/CFT compliance and enforcement may be unclear.
  • Layering: The use of ‘chain-hopping’ (quick exchanges between different virtual assets) allows the multiple layering of illicit funds within a short timeframe, allowing money laundering networks to disguise the origins of funds and launder illicit proceeds.

Generally speaking, the ML/TF risks depend on liquidity and exchangeability of stablecoin. Although virtual assets generally give rise to price volatility, complexity, and trust and security concerns meaning they are not widely used, stablecoin can overcome some of these concerns making them easier to use and potentially ready for mass-adoption. To mitigate stablecoin ML/TF risk, strong international co-operation is vital, focusing on information-sharing and co-ordinated supervisory and law enforcement action. The FATF recognised three further residual risks:

  • Unregulated anonymous peer-to-peer transactions via unhosted wallets.
  • Exploitation of weak or non-existent AML/CFT regulations in some jurisdictions to evade supervision and enforcement. FATF thus proposes an enhanced monitoring process for jurisdictions identified as having strategic AML/CFT deficiencies.
  • Stablecoin that, once launched and self-functional, would immediately dissolve the central body that created them. Decentralisation would necessitate exercise of supervisory powers before the stablecoin launch to ensure that AML/CFT protections are built in before release.

For general virtual assets, anonymous peer-to-peer transfers pose severe ML/TF risks as they are not explicitly subject to AML/CFT obligations under the revised FATF standards. FATF recommended that national authorities consider appropriate mitigation measures, such as banning or refusing to license platforms allowing unhosted wallet transfers and introducing transactional or volume limits on the platforms. The revised FATF Standards also introduce the “Travel Rule”, which requires VASPs to obtain, hold and exchange information about originators and beneficiaries of virtual asset transfers.  Besides anonymity, FATF also identified certain other main trends of virtual asset ML/TF risks, including:

  • VASPs registered/operating in jurisdictions with weak AML/CFT regulations, and the use of multiple VASPs (domestic and/or international) allowing more time for criminals to move criminal proceeds.
  • Increased anonymity of transactions by methods such as registering internet domain names, using atomic swapping exchanges and “dusting”.
  • With the ongoing COVID-19 pandemic, increased use of virtual assets to move and conceal illicit funds such as laundering proceeds earned from selling COVID-19 medicine.

To continue mitigating the ML/TF risks of virtual assets, FATF will:

  • request its members and the global network to implement the revised FATF Standards as a matter of priority, including building AML/CFT controls into regulatory regimes for stablecoin, urging the G20 to lead by example;
  • continue to monitor ML/TF risks posed by virtual assets and stablecoin and consider whether further action is necessary;
  • provide tailored, risk-based approach advice for AML/CFT regulation of stablecoin and address practical issues as part of a broader update of FATF’s Guidance on virtual assets; and
  • work to enhance the international framework for VASP supervision, particularly relating to information-sharing between supervisors and capability building amongst authorities designated to oversee VASPs’ compliance with AML/CFT requirements.