The Bahamas: A Complete and Compelling Choice November 2023

The Bahamas: A Complete And Compelling Choice A WealthBriefing Four Part Mini-Series On The Bahamas Financial Services Industry EDITION 4

2023

INTRODUCTION

When Markets Change Constantly, So Must Laws The Bahamas is one of the very first jurisdictions in the world to regulate digital assets through a comprehensive body of law. In order to keep pace with rapid evolution of the digital asset space, a second round of legislation is on the agenda. This overhaul will be explained by the primary regulator for digital assets business in The Bahamas, the Securities Commission of The Bahamas the following pages of this mini-report. Among the innovations to be found in the DARE Bill 2023, which is likely to become law before the end of the year, is a world first: a dedicated disclosure regime for activities to do with staking – the process of locking up digital assets for a certain period of time in return for a reward or for interest. The aim is to regulate the staking of digital assets that belong to clients or the management of staking pools as businesses, but not to bother high-net-worth individuals who stake assets on DLT-based networks on their own accounts.

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The Bill also seeks to introduce activities-based registration and risk-based supervision, both of which are essential to the integrity of modern markets and the protection of high-net-worth investors from sharp practice and/or the consequences of their own inexperience. Its categorisation of Non-Fungible Tokens (NFTs) is designed to depend on the distinction between financial or consumer assets, resulting in financial NFTs falling within the scope of regulation but consumer NFTs, particularly in the realm of gaming, falling outside.

This is part of a more general effort on the part of the jurisdiction to stay one step ahead of its competitors by reframing the laws that support its most modern financial innovations. By doing so, it hopes to remain at the forefront of world developments in tax, business licensing, payments, crypto-currencies, economic substance and much else besides.

For example, the new Commercial Entities (Substance Requirements) Act 2023 has now come into force and, for the first time, registered agents are required to report on behalf of the entities that they manage. The Act has also expanded the list of things that entities must report to the authorities and has changed some classifications for reporting purposes. New guidelines are online as well. Meanwhile, the Central Bank is pursuing many strategies to widen the use of the Bahamian Sand Dollar, the world’s first central-bank digital currency.

On top of this, the economy is advancing; last year, according to the International Monetary Fund, real GDP growth reached 14.4 per cent in a broad-based expansion that was especially strong in tourism but also impressive in financial services.

The Bahamas: A Complete And Compelling Choice 2023

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Navigating The Digital Frontier: The Bahamas’ Approach To Regulating Digital Assets * By Christina Rolle, Executive Director, Securities Commission of The Bahamas

The rapid emergence of digital assets and cryptocurrencies has presented many challenges for regulators in the global financial sector. Recognising the need for a robust regulatory framework to bring legal clarity to this dynamic, evolving space, The Bahamas has taken a progressive approach to the regulation of digital assets. This article explores the rationale behind The Bahamas’ decision to regulate digital assets, the development of the Digital Assets and Registered Exchanges (DARE) Act, 2020, and the key provisions shaping the regulatory landscape that influenced the new DARE Bill, 2023, which we anticipate will become law this year.

THE PATH TOWARD REGULATION The Securities Commission of The Bahamas, (the Commission), the statutory regulator for the nation’s capital markets, began developing legislation for digital assets in 2018 after monitoring the industry’s rapid growth over several years. The Commission took a thoughtful, deliberate approach to determining what threats, if any, the space represented. The Commission was faced with several considerations including the lack of legal definition and a globally agreed taxonomy for digital assets, as well as what its overarching approach to digital assets in or from within the jurisdiction would be.

The Commission also fielded significant interest from international and domestic digital asset businesses and related industry stakeholders who thought digital asset businesses could thrive in The Bahamas’ financial services ecosystem. Consistent with the Commission’s mandate to protect investors, facilitate clear and efficient markets, and reduce systemic risk, we opted not to rely on pre-existing frameworks as these did not clearly define or scope digital asset businesses and activities. Instead, the Commission sought to develop a bespoke regime that provided legal clarity and definitions for the oversight of digital asset operators and related business activities.

BENCHMARKING INTERNATIONAL BEST PRACTICES

“From a policy perspective, the Government of The Bahamas determined that it did not want to prohibit digital asset activities.”

First and foremost, The Bahamas had to determine whether it wanted to: (1) allow digital asset businesses to operate within the jurisdiction without a specific regulatory framework; (2) develop a specific regulatory framework to ensure that all digital assets and digital asset activities fall within the perimeters of the regulator’s scope; or (3) prohibit digital asset business activities altogether. From a policy perspective, the Government of The Bahamas determined that it did not want to prohibit digital asset activities, so the Commission then set out to ensure that, in the context of a virtually non-existent domestic market for digital assets, any digital asset businesses operating within the jurisdiction would only do so within an appropriate regulatory framework and with proper regulatory oversight.

Crucial to the development of The Bahamas’ regulatory framework was extensive research and evaluation of international regulatory policies, and engagement with policymakers, industry participants, and stakeholders. The DARE Act, 2020 framework was originally benchmarked against legislation from 13 jurisdictions. Careful consideration was given to best practices for activities-based approaches to registration, risk-based regimes for the supervision of digital asset business and related activities, as well as ensuring The Bahamas’ commitment to the global fight against money laundering, terrorism, and proliferation financing.

“The Bahamas’ commitment to the global fight against money laundering, terrorism, and proliferation financing.”

As a result of this comprehensive development process, the Commission established two important principles for providing the

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The Bahamas: A Complete And Compelling Choice 2023

appropriate levels of oversight. First, we determined the legislation would take an activities-based approach to registration. DARE aims to regulate the stated or intended activity of prospective registrants.

Secondly, our goal was to develop a risk-based supervisory approach.

Consequently, DARE assesses potential risks based on the nature, scope, and complexity of each individual digital asset business. Activities-based registration and risk-based supervision are fundamental to providing the appropriate levels of oversight, safeguarding market integrity, and protecting investors in this evolving digital asset space.

THE DARE ACT, 2020 The DARE Act, 2020, was enacted in The Bahamas in December 2020 as a robust, bespoke regulatory framework that was specifically designed to protect investors and consumers, align with international anti-money laundering, counter-terrorism and proliferation financing provisions (AML/CFT/CPF), and mitigate associated risks. From its inception, the Commission has intended for DARE to remain sufficiently flexible to adapt to the ever-changing digital asset landscape. This entails ongoing legislative reviews and appropriate updates to the legislation from time to time. In 2022, the Act underwent amendments and the DARE (AML/CFT/CPF) Rules were introduced. The DARE framework aligns with the Financial Action Task Force (FATF) Recommendations, and the legislation has received international recognition for its investor protection and globally compliant standards.

THE DIGITAL ASSETS AND REGISTERED EXCHANGES BILL, 2023 Significant developments in the digital assets space have continued since the DARE Act, 2020, was enacted. By the time the ‘Crypto Winter’ hit in 2022, the Commission had already begun to see new risks that were not apparent in previous years or even relevant to prior months.

Consequently, the Commission identified aspects of DARE that required further consideration. In April 2022, we began consolidating our ongoing review of DARE for the purposes of addressing any legislative gaps, ambiguities, and procedural concerns within the legislation.

Our work updating DARE coincided with the International Organization of Securities Commissions’ (IOSCO) development of crypto and digital asset markets recommendations for regulators, to which The Bahamas has significantly contributed.

“Significant developments in the digital assets space have continued since the DARE Act, 2020, was enacted.”

safeguards afforded to digital asset participants. Such protections include increased disclosure and reporting requirements for digital asset businesses; expanded activities-based registration obligations for potential registrants; and enhanced, ongoing supervision of operators.

Notably, the framework addresses the safekeeping and accessibility of digital assets, requiring operators to have adequate systems and controls in place.

“The framework addresses the safekeeping and accessibility of digital assets, requiring operators to have adequate systems and controls in place.”

OPERATING DIGITAL ASSET EXCHANGES Operators of digital asset exchanges must align their systems and controls with the scale and nature of their businesses. If an entity establishes and operates a digital asset exchange that also provides custody of digital assets or custodial wallet services, it must comply with all requirements applicable to digital asset businesses. Exchanges must segregate customer assets from their own, providing enhanced protection for clients. The Commission has the authority to prescribe additional rules for digital asset exchanges as necessary.

CUSTODY OF DIGITAL ASSETS OR CUSTODIAL WALLET SERVICES The DARE Bill, 2023, introduces a single comprehensive framework for custody of digital assets or custodial wallet services, prioritising the protection of client interests. The framework establishes clear procedures for the ongoing safety and accessibility of digital assets, along with transparent client disclosures and several requirements specifically concerning the segregation of client assets from the assets belonging to the operator or other non-client assets.

STAKING The DARE Bill, 2023, introduces a first-of-its-kind, dedicated disclosure regime for staking activities that promotes transparency and accountability within the digital asset ecosystem. Authorized registrants must disclose essential information to clients, including details of staking protocols, lockup periods, potential rewards or interest earned, penalties, and participant selection criteria.

STABLECOIN ISSUERS

To help address these revisions, the Commission engaged the international law firm Hogan Lovells to draft the amendments to DARE and benchmark the proposed DARE Bill, 2023 regime against legislation from jurisdictions such as Hong Kong, the European Union, and New York, USA.

The Bill includes a new stablecoin regime which requires stablecoins to be backed by reserve assets. Stablecoin issuers must disclose these assets for evaluation by the Commission. Under the Bill, the issuance of algorithmic stablecoins is expressly prohibited in The Bahamas.

EXPANDING DIGITAL ASSET BUSINESS ACTIVITIES

GUARDRAILS AND OTHER PROVISIONS

The DARE Bill, 2023, expands the scope of digital asset activities captured under international standards and best practices. Notably, the Bill encompasses a comprehensive range of digital asset activities and appropriate protection mechanisms for the registration and ongoing supervision of operators. The Bill represents an even greater focus on consumer and investor protection by strengthening the existing

The Bill brings a significant set of guardrails to DARE that provide more clarity and legal definitions to its bespoke regime. For example, the categorisation of Non-Fungible Tokens (NFTs) under the DARE Bill, 2023, now depends on the distinction between financial or consumer assets, resulting in financial NFTs falling within the scope of regulation, whereas consumer NFTs, particularly in the realm of gaming, do not.

The Bahamas: A Complete And Compelling Choice 2023

Moreover, the Commission has taken proactive measures to address liquidity events through mandatory reporting requirements, while also granting flexibility to introduce additional safeguards for investor protection. Furthermore, the Bill introduces specific standards to address conflicts of interest and regulate connected third-party relationships.

Notably, the Bill also prohibits the issuance of privacy tokens under the legislative framework, although digital asset businesses are not prohibited from conducting business with privacy tokens.

“The new Bill demonstrates the commitment by The Bahamas to investor protection.”

The DARE Bill, 2023, builds on the foundation of the DARE Act, 2020, with an even stronger, comprehensive regulatory framework for digital assets and digital asset businesses. This pioneering legislation establishes

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a new precedent for current, proactive, and internationally compliant standards and best practices. With refined definitions and exclusions, and expanded provisions and requirements, the new Bill demonstrates the commitment by The Bahamas to investor protection while maintaining a regulatory environment that is designed for innovation, development, and responsible growth in the digital asset industry. * Christina Rolle can be reached on 242.397.4100 or at info@scb.gov.bs

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The Bahamas: A Complete And Compelling Choice 2023

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Key Developments and Latest Trends in Banking and Finance in The Bahamas

*by Christel Sands-Feaste and Alexandra T Hall, both partners at the law firm of Higgs & Johnson, and Julia Koga da Silva who is Of Counsel at the firm.

On the rebound from the worst pandemic in a century, The Bahamas is not only prospering anew; it is also keeping one step ahead of its competitors by reframing the laws that support its most recent financial innovations. By doing so, it remains at the forefront of world developments in tax, business licensing, payments, crypto-currencies, economic substance and much else besides.

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ith the worst of the COVID-19 pandemic and related restrictions firmly in the past, the Bahamian economy has continued to recover over the last 12 months. Most of this is due to the fact that tourists are flocking back to The Bahamas in large numbers, perhaps in order to fight back against their memories of lockdowns and indulge in some “revenge tourism.”

In its Monthly Economic and Financial Developments Report for July 2023, the Central Bank of The Bahamas indicated that “the growth trajectory of the domestic economy persisted, although at a moderated pace...as the recovery from the COVID-19 pandemic neared completion” and expected it to continue growing for the remainder of the year.

This is good news, but the cost-of-living crisis, high inflation, record energy costs and climate change remain uppermost in the minds of Bahamian consumers, as they do in the minds of those in other countries.

“31 December 2024 remains the target date for the elimination of cheque usage.”

A number of themes have continued to dominate the legal and regulatory landscape in relation to financial services in The Bahamas, including:

• the continued focus of policymakers on strengthening public finances; • the ongoing modernisation of the Bahamian payment system; and • the establishment of a new regulatory framework for digital assets.

While not restricted to the financial services sector alone, another important development impacting all Bahamian entities is the recent overhaul of the economic substance legislative framework.

THE DRIVE TO RAISE REVENUE In an effort to increase revenue and strengthen public finances, the Government has allocated additional human resources to the revenue-collecting sections of the Department of Inland Revenue. It has also added to the enforcement provisions in various revenue-related statutes, including the Value Added Tax Act 2014. In addition, the new Business Licence Act 2023 came into force on 1 July as a part of the annual budget exercise. The new BLA, among other things, repealed the prior Business Licence Act 2010 and expanded the categories of businesses that have to pay business licence tax. The requirement for financial institutions to pay an annual tax based on turnover remains.

TOWARDS A MORE MODERN PAYMENT SYSTEM The Central Bank of The Bahamas’ Payment Systems Modernization Initiative is ongoing. 31 December 2024 remains the target date for

The Bahamas: A Complete And Compelling Choice 2023

the elimination of cheque usage. Local financial institutions continue to encourage customers to use [European HNWs do not say utilise] virtual platforms for the delivery of their services.

Regarding the “Sand Dollar,” a digital currency denominated in Bahamian dollars, the authorities have redoubled their efforts to raise public awareness of it and promote its use in place of cash.

MODERNISATION OF THE DIGITAL ASSETS REGIME The legislation regulating the digital assets space (the DARE Act) was initially implemented in 2020. In 2022, the Government of The Bahamas published its Policy White Paper on The Future of Digital Assets in The Bahamas, outlining its vision and for the next five years. It wanted to encourage the sector to grow, to make The Bahamas more attractive to digital-asset businesses, to establish The Bahamas as a leading digital assets hub and to encourage innovation in fintech.

In order to address the rapid evolution of the sector and to strengthen the robustness of the regime, the Securities Commission of The Bahamas confirmed its intention to review and amend the DARE Act during the first half of 2022. It then circulated a draft of the Digital Assets and Registered Exchanges Bill for industry consultation earlier this year. The new Bill seeks to offer investors better protection while maintaining sufficient flexibility to facilitate innovation.

The SCB’s suggestions include: • the subjection of more digital-asset activities to regulation; • the introduction of capital requirements as prescribed by the Commission; • mandatory ongoing financial reporting (including audited financial statements); • the mandatory segregation of client assets; and • more investigation and enforcement powers for the Commission.

It is anticipated that the new Bill will be brought into force later in 2023.

OVERHAUL OF THE ECONOMIC SUBSTANCE FRAMEWORK The recent overhaul of the regulatory framework relating to economic substance has impacted all Bahamian entities, not just those in the financial services sector. In 2018, in accordance with international best practices, The Bahamas implemented legislation that required Bahamian entities engaged in certain activities to establish a substantial economic presence in The Bahamas and also required all Bahamian

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entities to comply with substance reporting requirements. On 1 September this year, the 2018 legislation was repealed and the Commercial Entities (Substance Requirements) Act 2023 (the new CESRA) was brought into force.

“CESRA has shifted the reporting obligation from the entity itself to its registered agent.”

The new CESRA, among other things, has: • shifted the reporting obligation from the entity itself to its registered agent or, if the entity does not have a registered agent, to the Compliance Commission, i.e. the regulatory body; • expanded the list of facts which entities must report to the competent authority; • mandated that either registered agents or the Compliance Commission should obtain this information from each Bahamian entity; and • made some modifications to the classifications for reporting purposes.

The accompanying guidelines for the new CESRA were circulated on 8 September 2023.

REGULATION FOR A GROWING ECONOMY The recent legislative changes reflect The Bahamas’ commitment to complying with international best practices and maintaining a sound regulatory framework while still encouraging innovation. With the help of such careful governance, the economy of The Bahamas continues to prosper. * Christel Sands-Feaste can be reached at csands-feaste@higgsjohnson.com; Alexandra T Hall can be reached at ahall@higgsjohnson.com; Julia Koga da Silva can be reached at jkoga@higgsjohnson.com