Ellul & Co article "Gibraltar's DLT Regulatory Framework"

GIBRALTAR LEADS THE WAY IN REGULATING DLT BUSINESS Introduction On 12th October Gibraltar became the first jurisdiction to introduce laws 1 to regulate firms carrying on business, from Gibraltar, using Distributed Ledger Technology (“DLT”). Limited regulation of certain DLT use cases exists in a handful of places but no other country has introduced the comprehensive regulatory framework we have set up in Gibraltar. The laws come into effect on 1st January 2018.

The Gibraltar Government and our regulator, the Gibraltar Financial Services Commission (“GFSC”), recognise that DLT is delivering innovative and transformational changes in the way the world conducts business. Those familiar with DLT will know that without the blockchain, a type of distributed ledger, Bitcoin and other crypto currencies could never exist. Gibraltar has moved quickly to embrace this technology and provide the framework for a well-regulated and safe environment for DLT business to flourish.

Regulatory Framework The new law provides for the regulation of any person or company: • Carrying on by way of business, in or from Gibraltar, the use of distributed ledger technology for storing or transmitting value belonging to others.

It will allow a multitude of businesses to be regulated if they conduct their operations from Gibraltar. These include the following 2: • Centralised VC scheme administrators (e.g. loyalty points, in-game currency) • Custodian VC wallet providers • Non-custodian VC wallet service providers

• Holding, as a business, VC for others

• Custodian providers

• Remittance service providers

• Issuers of devices containing pre-loaded VC

• B2B payment network operators

• Issuers of VC vouchers and pre-loaded paper wallets

• Payment service providers

VC

wallet

• Escrow service providers

• Issuers of securities

• Trading platforms

• Issuers of asset-backed tokens

• Peer-to-peer gaming platform operators

• VC exchanges (between fiat & VC, and VC-to-VC)

• Issuers of income distribution tokens

• Peer-to-peer platforms

• Clearing and settlement systems

unregulated

insurance

• Peer-to-peer VC exchange platform operators

Our Government and the GFSC have recognised that the framework must be responsive to new use cases of DLT and needs to be flexible enough to adapt. The traditional way to regulate financial services firms is to require strict adherence to 1

The Financial Services (Distributed Ledger Technology Providers) Regulations 2017 (http://www.gibraltarlaws.gov.gi/articles/2017s204.pdf) together with a Bill for an Act to amend the Financial Services (Investment and Fiduciary Services) Act.

2

HM Government of Gibraltar, Ministry for Commerce, Gibraltar Finance, consultation paper on proposals for a DLT Regulatory Framework, May 2017 (http://www.gibraltarfinance.gi/downloads/20170508-dltconsultation-published-version.pdf?dc_%3D1494312876).

voluminous rule books but it is simply not possible to do this with new and ever evolving DLT business. So how will DLT firms be regulated? Gibraltar found the answer by means of a framework based on nine key principles.

The nine regulatory principles The new law establishes nine principles which DLT firms must adhere to. They are principles which all existing financial services firms will be very familiar with. The law requires DLT firms to: 1. Conduct their business with honesty and integrity.

2. Pay due regard to the interests and needs of each and all its customers and communicate with them in a way that is fair, clear and not misleading.

3. Maintain adequate financial and non-financial resources.

4. Manage and control their business effectively, and conduct their business with due skill, care and diligence; including having proper regard to risks to its business and customers.

5. Have effective arrangements in place for the protection of customer assets and money when they are responsible for them.

6. Have effective corporate governance arrangements.

7. Ensure that all of their systems and security access protocols are maintained to appropriate high standards.

8. Have systems in place to prevent, detect and disclose financial crime risks such as money laundering and terrorist financing.

9. Be resilient and have contingency arrangements for the orderly and solvent wind down of its business.

The GFSC will require DLT firms to adhere to these principles but will also impose proportionate conditions, for example, “those relating to use case, business model, market, geographical exposure, product, service, size of firm, scale of operation, management experience and track record, and financial and technical risk. Such conditions and restrictions may be applied to all DLT firms, to a single firm or to groups of firms, or by category of firm, use case, business model or risk profile, or by type of product and service provided.” 3 It may be legitimate to ask whether DLT business should be regulated as most DLT firms operate worldwide without such controls. However, the case for regulation is compelling.

The case for regulation You need look no further than the infamous Bitcoin exchange BTC-e, which was reported as having been used to launder money, to exemplify the risks associated with DLT businesses. In July of this year Reuters reported: •

3

Since 2011 the 38-year-old has been running a criminal organization which administers one of the most important websites of electronic crime in the world,” police said in a statement, describing an alleged money laundering operation that “legalizes proceeds

HM Government of Gibraltar, Ministry for Commerce, Gibraltar Finance, consultation paper on proposals for a DLT Regulatory Framework, May 2017.

from illegal activities”. It was thought that ‘at least’ $4 billion in cash had been laundered through a bitcoin platform since 2011; the platform had 7 million bitcoins deposited, and 5.5 million bitcoins in withdrawals.

There are many DLT operators out there; good and bad. The truth is that it is often impossible to tell the difference and to know who you are dealing with.

Gibraltar addresses this fundamental issue through its regulatory framework as consumers will have the protection of knowing that DLT firms must adhere to the nine key principles and that they will be actively supervised.

DLT firms will benefit from the certainty that they are operating within the law. They will no longer need to rely on legal opinions or on uncertain grey areas. Gibraltar will allow such firms to operate legally within the established regulatory framework.

This will increase confidence in Gibraltar-licensed DLT firms and in the products and services provided by them. In this way, consumers can have faith in the integrity of their owners and managers. Regulation will also significantly enhance the appeal and marketability of DLT products.

All of this ensures a degree of consumer protection which, together with protecting against financial crime, is the key aim of any regulatory system.

The GFSC The GFSC must be commended for its proactive approach in this new area and for taking the lead in establishing the DLT regulatory framework. They have also set up a dedicated “Innovate and Create Team” to encourage and support businesses looking to develop and introduce new ideas for financial products or services. This team has been crucial in successfully developing the DLT regulatory framework.

Applicants are able to meet with this team and receive first hand feedback on their ideas and proposals. This is something unique to Gibraltar.

Why choose Gibraltar?

The new law does more than just establish a set of rules to regulate DLT business. It sends the message that Gibraltar understands DLT business, embraces innovation and is willing and able to license good quality firms. Other jurisdictions are working towards similar aims but we have got there first.

Our DLT firms will have credibility and the confidence of their customers; central features of any successful business. Such firms will find a comfortable home in Gibraltar.

13th October 2017 Marc X. Ellul | marc@ellul.gi Managing Partner

Ellul & Co. Suite 7, Hadfield House Library Street Gibraltar www.ellul.gi

Neil A. Lopez | neil@ellul.gi Senior Associate