FATF Pushes Risk-Based Approach Toward Virtual Currencies, Services

THE WALL STREET JOURNAL

RISK AND COMPLIANCE JOURNAL

By SAMUEL RUBENFELD

Bitcoin (virtual currency) coins are seen in an illustration picture taken at La Maison du Bitcoin in Paris, on May 27, 2015. Reuters
Virtual currency payment products and services expose the global financial system to money laundering and terrorism financing risk, and their growing presence requires a risk-based approach to mitigate the potential ill effects, experts said after reading new guidance from the Financial Action Task Force.

The FATF, an international body that sets standards for anti-money laundering and combating terrorist financing, provided ways, in a 48-page guidance document, to help the private sector identify money laundering and terrorist financing risks in the virtual currency area, and for national authorities to develop legal and regulatory frameworks for addressing that risk.

Experts told Risk & Compliance Journal the greatest risks come from the anonymity of virtual currency systems, and that financial institutions have to develop effective know-your-customer procedures, or they may have to de-risk out of the growing sector.

“Transaction monitoring is a very difficult challenge [with virtual currencies] because the people involved are unnamed parties…You can’t know monitor transactions if you don’t know who the parties are,” said Fred Curry, a principal in the anti-money laundering and sanctions practice at Deloitte. Deloitte is a sponsor of Risk & Compliance Journal.

The FATF guidance suggests possibly developing or using “third-party digital identity systems” to make it easier to meet anti-money laundering compliance requirements. The systems could, for instance, create electronic identity signatures that meet specific customer due diligence, monitoring and reporting purposes, the guidance says. Of course, the custodians of the identities would themselves need to be regulated, it said.

But John Salmon, a partner at U.K. law firm Pinsent Masons, wrote in early June that such technology isn’t here yet. “There are still some questions that need to be addressed before its use can become a practical reality,” he wrote.

Among them, according to Mr. Salmon, are security vulnerabilities and a dependence on third-parties for validation processes, which in turn creates questions of centralization.

“As the technology requires computation to take place for blocks to be validated and transactions to be recorded on the ledger, someone needs to do the validating,” he wrote.

Two other experts said to Risk & Compliance Journal, though, that the enhanced due diligence required of virtual currency payment products and services under the FATF guidance could lead to de-risking them out of the financial system entirely.

Ross Delston, a Washington, D.C.-based attorney who advises companies on anti-money laundering compliance, said financial institutions would take the guidance and calibrate their risk metrics to determine whether they should continue doing business with anyone selling virtual currency payment products or services.

“If they then decide to continue, they would have to decide what controls, such as automated transactions monitoring, would be used to mitigate that risk,” said Mr. Delston.

But if the risk is too great, “large swaths of the banking system would be off-limits,” he said.

Christine Duhaime, a Canadian lawyer who founded the Digital Finance Institute, criticized the guidance as coming without a risk assessment of its own, resulting in a move by the FATF “to regulate or shut down” digital currency exchanges that could itself cause a wholesale de-risking of the sector.

“FATF’s guidance is a black-or-white approach, but [risk-based approaches] are not blank or white,” she said in an email. “If we cut digital currency exchange businesses off from the financial system by prohibiting them from operating or making it difficult for them to have bank accounts, we will lose financial intelligence that is necessary, and perhaps vital for international security.”

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