Building resilience in a crypto-powered financial system

The European Banking Authority (EBA) has taken another significant step towards integrating crypto assets into the regulatory framework, with its recent consultation on draft technical standards. This consultation is a key move in ensuring financial stability while supporting innovation in such a rapidly evolving sector.

As businesses and financial institutions increasingly engage with crypto assets, the challenges of managing associated risks have become more present. The EBA’s proposed standards, rooted in the Basel Committee’s prudential guidelines, aim to provide clarity on capital requirements for crypto-asset exposures. By doing so, they seek to strike a balance between risk mitigation and maintaining a level playing field in the financial ecosystem.

These are the key aspects of the consultation:

  1. Classification of crypto-assets: The framework outlines distinctions between tokenized traditional assets, stablecoins, and unbacked crypto-assets, tailoring capital requirements to the specific risk profiles of each category.
  2. Risk sensitivity: The draft standards propose different treatments for crypto assets based on their volatility, liquidity, and transparency. This approach helps address concerns related to potential market disruptions.
  3. Operational and market risks: Beyond credit and counterparty risks, the standards consider the operational and market risks unique to crypto assets, ensuring a complete risk management.

For firms operating in the crypto space, this consultation signals the importance of aligning operational practices with growing regulatory expectations. Compliance professionals must stay ahead of these developments, proactively assessing their exposure and ensuring robust frameworks to meet potential requirements.

At Compliance Champs we understand the complexity of managing regulations like these, therefore we are here to help businesses interpret and implement these changes effectively.

The EBA’s initiative is the proof to the increasing recognition of crypto assets within mainstream finance. While challenges remain, this regulatory clarity is a step forward in enabling sustainable growth and innovation.

What are your thoughts on these draft standards? Let’s discuss how these measures might shape the future of crypto-asset regulation.

New EU travel rules go into effect in 2025, some crypto coins and bank cards can’t be used.

Elevating TBML Risk Management: from window dressing to data-driven approach

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Financial Freedom against Money Laundering

Tornado cash, what is it? Tornado cash is a cryptocurrency tumbler, a decentralized application built on the Ethereum blockchain that facilitates privacy for its users. It facilitates privacy by pooling the crypto of all its users, mixing them, and send the user different crypto making it almost impossible to trace the origin of the transaction. Blockchains are very transparent, and you can see which wallets make transactions with each other. To use Tornado Cash, you deposit funds into the protocol and claim your deposit minus a fee in your wallet.

On the seventh of august 2022, the Office of Foreign Asset Control (OFAC) placed Tornado Cash on the sanctions list. The protocol would have helped criminals to launder their money. Crypto analyst company Elliptic concluded that 1,5 billion dollars were laundered with Tornado Cash. It is now illegal for US citizens and companies to use the tool.

There is a lot of skepticism about placing Tornado Cash on the sanction list, Tornado Cash is not a company but a DAO (Decentralized Autonomous Organization) – simplified, a protocol that runs without any human interaction. An interesting recent example is that someone made a transaction to Black Rock, the world’s largest investment management firm based in the US, using Tornado Cash. This would imply that BlackRock is unwittingly involved in an illegal transaction.

Does Tornado Cash have any legal value? Yes, if someone lives in an oppressive regime, they might want to increase their privacy. An example demonstrating the legitimate utility of Crypto Mixers occurred when Vitalik Buterin, one of the co-founders of Ethereum, donated funds to Ukraine in support of its conflict against Russia. Consider the significance of privacy for a Russian individual seeking to contribute financially to Ukraine’s cause.

Alexey Pertsev, one of the developers of Tornado Cash, got arrested right after the US placed Tornado Cash on the sanctions list. He is held responsible for laundering over 1,2 billion dollars and might face a 64-month sentence. The controversy in this case is that crypto mixers are not illegal by law, which is why some find the accusation unfair.

In conclusion it all comes back to the question: “How do we provide a high level of privacy while making money laundering impossible?”

AMLD5 versus MiCAR

With the MiCAR approaching, a lot of parties involved with crypto-assets, including crypto-asset service providers (CASPs), will have to implement this new regulation. Services like the placing of crypto-assets and providing advice on crypto-assets need to comply to an extensive set of requirements, while these services were not yet regulated under the AMLD5.

Under the AMLD5, CASPs in the Netherlands providing the services for the exchange between virtual currencies and fiat currencies and providing custodian wallet services fall under the scope of the Money Laundering and Terrorist Financing (Prevention) Act (Wwft), which includes the AMLD5 implementation.

In this article we would like to look at some of the most significant differences between the current AMLD5 regime and the new MiCAR regime:

  • MiCAR requires a license, which takes a lot more effort to receive than a registration, due to the more extensive range of requirements included in the regulation. AMLD5 only requires a registration.
  • Where the AMLD focusses on AML-CFT issues and risks, the MiCAR has broadened this scope and includes rules on for example market abuse and sets prudential requirement for CASPs.
  • MiCAR is a Regulation instead of a Directive (AMLD5). A Regulation is directly applicable in Member States after its entry into force (another example is the GDPR). A Directive first needs to be implemented in the national laws of a member state. Just like the AMLD5 was implemented in the Wwft.
  • The competent authority for most service providers under the MiCAR, including the crypto-asset services that currently require a registration, will be the AFM instead of the DNB under which they are currently registered. The DNB will however become the competent authority for issuers of ARTs and EMTs.
  • MiCAR introduces passporting opportunities, whereas registration only permits service providers to offer and market services in one country. As a result, under the old regime, a CASP (Crypto-Asset Service Provider) needed to apply for registration in multiple countries to offer and market services there.
  • Lastly, a lot more services are in scope of the MiCAR. The registration only focuses on service providers offering services for the exchange between virtual currencies and fiat currencies and providing custodian wallet services. The MiCAR focusses on a lot more crypto-asset services (full list of CASP-services can be found in article 3 (1) under 16 MiCAR).

The MiCAR regime leads to further regulation in the crypto market, with more crypto parties required to obtain and maintain a license. It is an understatement to say that challenging times are ahead.

Travel Rule

Let’s start at the beginning. Initially, the Travel Rule only applied to financial institutions. AMLD4 was adopted to ensure that the Financial Action Task Force (FATF) requirements on wire transfer service providers, and in particular the obligation on payment service providers to accompany transfers of funds with information on the payer and the payee, were applied uniformly throughout the EU. The latest changes introduced in June 2019 in the FATF standards on new technologies, have provided new and similar obligations for crypto-asset service providers, also known as CASPs, to facilitate the traceability of transfers of crypto-assets.

The Travel Rule is established for the purpose of preventing, detecting, and investigating money laundering and terrorist financing. The Travel Rule applies to transfers of funds, in any currency, which are sent or received by a payment service provider, or an intermediary payment service provider established in the EU. It shall also apply to transfers of crypto-assets, including transfers of crypto-assets executed by means of crypto-ATMs, where the CASP, or the intermediary CASP, of either the originator or the beneficiary has its registered office in the EU.

Since the Travel Rule is new in the crypto sector, we will focus on the requirements and implications for CASPs and financial institutions that are engaged in crypto- assets transfers. The Travel Rule requires CASPs to accompany transfers of crypto assets with information on the originators and beneficiaries of those transfers. CASPs are also required to obtain, hold, and share that information with their counterpart on the other end of the crypto assets transfer and make it available to competent authorities on request. The CASP should carry out due diligence of its counterparty. Because the personal data of the transacting parties ‘travels’ with their transfers, the regulation was dubbed the “Travel Rule”. Examples of information that needs to be shared with the counterparty are the name of the originator or beneficiary, blockchain address, address, country, and personal document number.

Interesting to mention is that the FATF recommends that countries adopt a de minimis threshold of 1,000 USD/EUR for Crypto- assets transfers, while keeping in mind that there would be fewer requirements for Crypto-assets transfers below the threshold compared to those above the threshold. The Transfer of Funds Regulation however applies to all transactions regardless of the amount. There is only one exception: A CASP is only required to verify the information on the user of a self-hosted address in the case of a transfer of an amount exceeding EUR 1 000 that is sent or received on behalf of a client of a CASP to or from a self-hosted address.

Of course, every new regulation has its own challenges and implications for the market it will apply to. We would like to name a few:

  • Lack of technical resources and extra costs for CASPs: Compliance with the Travel Rule requires implementations and adjustments of the systems that are in place, which will most likely add costs to the business operations.
  • Lack of interoperability: CASPs use various protocols and solutions that are not always able to interact with each other, complicating communication, and data exchange.
  • Non-uniformity among jurisdictions: countries adopt the Travel Rule based on their own regulations, which may deviate from FATF standards. In particular, jurisdictions may have different de minimis thresholds as mentioned before, varying originator and beneficiary data to be collected and transferred, etc.
  • Another industry concern is the so-called ‘Sunrise Issue’. The Travel Rule requirements are enforced at a different pace across jurisdictions. This means that one CASP may be Travel Rule-obligated while its cross-border counterparty may not be.

The EU Travel Rule shall apply as of the 30th of December 2024. In the meantime, the crypto market will be working hard on implementing the Travel Rule within its business.

Something to look out for is that by 1 July 2026, the Commission of the EU shall issue a report assessing the risks posed by transfers to or from self-hosted addresses or entities not established in the EU, as well as the need for specific measures to mitigate those risks, and propose, if appropriate, amendments to the Transfer of Funds Regulation.

Compliance Champs and ChainComply announce partnership

Dutch-based crypto asset compliance advisory Compliance Champs and Belgium-based Crypto AML SaaS provider ChainComply today announced its intention to create a strategic partnership to strengthen the offering for both companies, specifically for clients within Europe.

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We are thrilled to announce this partnership with ChainComply, which allows us to further mitigate the financial economic crime risk for financial institutions and crypto asset service providers. ChainComply provides a customer-friendly solution to obtaining transaction data, source of funds information and identifying the potential risks of these end-clients. In addition, it is a highly efficient way of performing KYC investigations which will enable a large cost reduction for financial institutions and crypto asset service providers.

, , :
We are pleased to announce the establishment of a strategic partnership between Compliance Champs and ChainComply. SaaS companies like ours may have a fantastic product, but implementation can be tricky for customers. Compliance Champs brings deep knowledge and experience, helping our customers get the most out of our SaaS product by customizing it to their specific needs and workflows.

info@compliancechamps.com

ChainComply
lukasz.lukaszewski@chaincomply.io

Compliance Champs is a Rotterdam-based niche consultancy firm which focuses on advising financial institutions (banks, insurance companies and asset managers) and crypto service providers regarding their compliance risk management. Energised by the intersection of laws and regulations, business operations and the rapid technological developments and leveraging extensive experience and expertise in the field, Compliance Champs is able to deliver end-to-end solutions that help clients to become and stay compliant. This is done by applying a holistic approach which covers the full spectrum of delivery, from regulatory gap and impact analysis and policy development until operational implementation.

ChainComply provides enhanced KYT due diligence solutions for banks and crypto exchanges’ fin-crime departments and relieves them from stressing over their interactions with crypto exchanges.

ChainComply develops a SaaS tool that scans the client’s crypto exchange and blockchain transaction history to reveal the source of funds of crypto holders. The company solution simplifies complex transaction streams and identifies high-risk transactions and patterns, enabling AML teams to understand their clients better and meet regulatory obligations efficiently. Learn more at: www.chaincomply.io

The European Central Bank competes with Bitcoin

The ECB has several reasons for developing a CBDC. They want to reduce reliance on private money. Money put into circulation by the central bank is what we call public money. These are physical banknotes and coins. Private money is money put into circulation by commercial banks. This is money you can access online. With current technological developments and their adoption, cash is becoming increasingly obsolete. The ECB wants to avoid becoming completely dependent on private money because it has a number of downsides.

The Austrian school of economics questioned monetary policy as early as the 19th century. Monetary policy would cause fluctuations in the business cycle. Ideas from the Austrian school have been adopted in the most famous crypto: Bitcoin.

In short, Bitcoin is the largest cryptocurrency in market size. Bitcoin is an alternative payment currency and therefore offers competition with the euro. Friedrich Hayek an economist from the movement of the Austrian school of economics states in a report “Choice in Currency,” that people should be able to choose which currency they want to pay with. As a result, the best currency will be used the most. The ECB sees the increase in the adoption of cryptocurrencies as a threat and would like to have more control over payments itself. By innovating the euro, people would regain confidence in the euro. An example of a possible advantage is that payments could go directly between parties (peer-to-peer), like the possibilities that Bitcoin offers. This means there is no third party to whom you must pay transaction fees. This should make cross-border payments cheaper.

Through the CBDC, the ECB can properly track financial traffic. The ECB would be able to track the financial behavior of individuals. To use the CBDC, users must follow an onboarding process like opening a bank account. In doing so, they provide personal data. Governments have indirect visibility into the data at the ECB. In other words, the financial behavior of individuals may become visible to the government. This creates privacy concerns. For the CBDC to be a success, the ECB needs to ensure the privacy of the people using the CBDC. Studies suggest that people will use a CBDC only if it offers good privacy. Privacy is a basic human right, and it helps against unjust power abuse. But to what extent should we allow privacy within the CBDC process without blurring compliance requirements.

The offline CBDC should provide more privacy for lower transactions. This involves limiting the amount and number of transactions. This should make it less attractive for criminals to abuse the digital euro.

For the online CBDC, the current plan is to screen transaction data in the same way as the regular banking system does. The transaction monitoring will be done by Payment Service Providers, most likely commercial banks. Only the most necessary data will then be shared with the ECB, and this will be done pseudo anonymously. This means that not the individual’s data will be sent, but for example only his/her account number.

Not only Europe is developing a CBDC. Other countries are looking into the possibilities as well. China is working on the Digital Yuan, which they see as an additional tool for monitoring and controlling citizen behavior. Strangely enough, they are offering the same possibilities as the ECB is planning with the Digital Euro. According to a press release of the Central bank of China, the digital yuan would be anonymous for small transactions and monitored according to legal requirements for larger amounts. Again, the data would not be shared with governments, only where required by law. China is trying to get citizens to use the CBDC, but less than 20% actually do so. It seems that the people who created a wallet did so to participate in the lotteries offered when creating an account and not to use the CBDC.

China is trying to get its citizens to use the E-yuan because the CBDC could be programmable. This means that the government can attach conditions to the money. This means that the government could potentially only allow people to spend the CBDC for certain spending purposes. For example, the government can stipulate that their citizens cannot buy more than one airline ticket. This way of financial control is the biggest dream of an authoritarian superstate. Europe says it will not make the digital euro programmable and wants to establish this by law.

Is programmability always bad? This can be debated. Programmability can also protect individuals. For example, a gambling addict could gamble only a limited portion of his income, or an alcoholic could buy limited liquor. People in debt can also be helped by using part of their income immediately to pay off debts. However, this does raise the question of whether this is not the responsibility of the individual rather than the government.

The government could also have an interest in programmable money. They could send grants directly from the government to the allocation for which the grant is intended. Thus, subsidies could not be used for other purposes. In addition, taxes could be paid directly to the government.

Venezuela launched the Petro in 2018, this CBDC would be backed by commodities such as oil, gold and diamonds. Therefore, its value would be much more stable than the bolivar, Venezuela’s currency, which is subject to hyperinflation. Despite the government’s effort, adoption of the Petro remained limited. After a corruption scandal involving the mismanagement of the underlying commodities, Venezuela decided to stop the CBDC project.

A CBDC was also introduced in Nigeria: the eNaira. The population shows little interest. The government is trying to encourage the eNaira by placing restrictions on cash, among other stimulants. In the Bahamas, the Sand Dollar is also not a success despite all the incentives offered by the government.

We can conclude that for the innovative digital euro to be a success, the ECB will have to be able to safeguard the privacy of its users. More importantly, convince the public that their data is safe with the ECB. Global examples show that there is little interest in a CBDC. The most common argument against this is privacy concerns. Overall, the question remains: how do we meet the compliance requirements without citizens sacrificing their privacy?

In this article, by CBDC, we mean retail CBDC.

Digital Operational Resilience Act (DORA)

We like to discuss the 5 primary areas which DORA focusses on:

  • ICT risk management (Chapter II DORA): Financial entities need to have a framework in place setting principles and requirements on ICT risk management, including a business continuity policy and a disaster recovery procedure. When distributing resources and capabilities for the implementation of the ICT risk management framework, financial entities need to balance their ICT-related needs to their size and overall risk profile, and the nature, scale, and complexity of their operations. The ICT risk management framework shall include at least strategies, policies, procedures, ICT protocols and tools that are necessary to adequately protect all information assets and ICT assets from risks including damage and unauthorized access or usage.
  • ICT-related incident management, classification, and reporting (Chapter III DORA): Financial entities need to define, establish and implement an ICT-related incident management process to detect, manage and notify ICT-related incidents. They need to establish appropriate procedures and processes to ensure a consistent and integrated monitoring, handling, and follow-up of ICT-related incidents, to ensure that root causes are identified, documented, and addressed to prevent the occurrence of such incidents.
  • Digital operational resilience testing (Chapter IV DORA): Financial entities need to establish, maintain, and review a comprehensive digital operational resilience testing program, including a range of assessments, tests, methodologies, practices and tools for the testing and advanced testing of the ICT tools, systems and processes based on threat-led penetration testing.
  • Managing of ICT third-party risks (Chapter V DORA): Financial entities need to manage ICT third-party risks as an integral component of ICT risk within their ICT risk management framework. This entails that, among other things, contracts in relation to the provision of ICT services will be required to contain certain key contractual provisions. The management of ICT third-party risks need to be implemented considering the nature, scale, complexity, and importance of ICT-related dependencies.
  • Information-sharing arrangements (Chapter VI DORA): Financial entities may, under certain circumstances, exchange amongst themselves cyber threat information and intelligence. The sharing arrangement needs to be in accordance with the GDPR, take place within trusted communities of financial entities and aim to enhance the digital operational resilience of financial entities.

In addition to the DORA, Regulatory Technical Standards are being published by the EBA, EIOPA and ESMA to ensure the consistent harmonization of the requirements laid down in DORA. Financial entities which are under the scope of DORA need to take these into account when implementing DORA.

On 27 December 2022, DORA was published in the Official Journal of the EU. It entered into force on 16 January 2023 and will apply as of 17 January 2025.

FinCrime & Surveillance summit event

We look back with great pride on today’s FinCrime & Surveillance summit event of standard chartered. We are grateful that we were allowed to present at this very well organized event.

For those who wish to see the presentation or for those who missed it, the presentation is available HERE!

If you have any further questions or would like to continue the conversation on the topics covered, please don’t hesitate to reach out to us. We’re here to answer your questions and engage in discussion.

Peterengering@compliancechamps.com

+31625212287

Additionally, for those interested in deepening their knowledge, we invite you to enroll in our programme Certified Compliance Professional in Cryptocurrency Financial Crimes which is an 11 hour elearning in and covers amongst others Financial Economic Crime with Crypto. You can find more information and sign up via this LINK. Please use the code C9014FAC for a 10 % discount.

Please follow us via LinkedIn if you want to be kept up to date regarding crypto and Financial Economic Crime.

Article: Risk based approach for NPOs

When thinking non-profit organizations (NPOs), most individuals immediately associate them with clear objectives. For instance, Greenpeace advocates for the climate, Unicef for children’s rights, and the Red Cross for disaster relief. NPOs primarily focus on fundraising and then allocating those funds towards charitable, religious, cultural, educational, or social causes. While these organizations often maintain a positive image, regrettably, some non-profit entities are exploited for money laundering and terrorist financing. NPOs present an attractive structure for criminals to launder money, as they aren’t obligated to maintain high levels of transparency and may not always publish comprehensive financial statements.

The Prevention of Money Laundering and Terrorist Financing Act (WWFT) delineates the expectations for financial institutions in preventing money laundering and terrorist financing. However, this law is broadly framed, placing financial institutions under regulatory pressure to adhere to its stipulations. Although it’s commendable that banks are keen on complying with these laws and are internally driven to prevent abuse of the financial system, this compliance motivation inadvertently results in adverse effects within the legislative framework, known as de-risking.

De-risking is a strategy wherein financial institutions minimize or steer clear of dealings with customers or transactions deemed risky. This is done to align with the stringent requirements and avoid potential fines imposed by the regulator in the battle against money laundering and terrorist financing.

Unfortunately, non-profit organizations bear the brunt of this strategy. Due to heightened scrutiny by financial institutions, NPOs face significantly increased administrative burdens and prolonged approval processes when opening or managing bank accounts. Consequently, NPOs encounter operational challenges that impede their ability to efficiently manage their finances and fulfill their mission.

The Dutch Banking Association (NVB) has not overlooked this hurdle. To establish a transparent and level playing field, the NVB, in collaboration with De Nederlandsche Bank, relevant trade associations, and the Ministry of Finance, has devised a standardized framework. This framework identifies risk factors and estimates the risks of money laundering and financing terrorism at a non-profit organization. The comprehensive standard, available on the NVB’s website, swiftly illuminates the governance, funding sources, activities, geographical reach, and beneficiaries of the NPO. The responses to these aspects are correlated with specific risk-enhancing and mitigating factors identified by the NVB.

risk-enhancing and mitigating factors identified by the NVB.

These novel benchmarks ensure that risks of money laundering and terrorist financing are accurately identified without penalizing honest and upright NPOs. Financial institutions will still request data from NPOs, but thanks to the new methodology, these requests will be more precise, thereby alleviating the burden on NPOs. This is also emphasized in the subsequent crucial paragraph:

For most NPOs, the bank will initiate contact to gather necessary information and documentation. By providing isnsights on pertinent risk factors, this information request can be tailored proportionately to the potential levels of money laundering (ML) and terrorist financing (TF) risks. Furthermore, a targeted, risk-based approach is imperative to curtail unnecessary information requests from customers and enhance access to financial services.

Compliance Champs believes that these standards mark a significant stride in elucidating to both financial institutions and their clientele what can be requested and, more importantly, why such requests are made. In the ensuing months, the NVB will release additional standards for various sectors, including crypto companies, retail, and automotive businesses. Naturally, we will keep you informed about these updates via our LinkedIn page and website (www.compliancechamps.com) as soon as they are made public.