The Cayman Islands Government has introduced a bespoke legislative regime to attract cryptoasset and other fintech businesses to its shores, writes Ian Mason.

The Cayman Islands has long been a leading offshore jurisdiction for investment funds, as well as a significant global financial centre overall. It is therefore not surprising that, reflecting global trends, the fintech market has been developing rapidly in the Cayman Islands, as the Government has sought to attract new business.

One of the key (and constantly evolving) areas of fintech is cryptoassets, and how various jurisdictions seek to regulate them. The UK Government in its recent consultation1 has indicated that it intends broadly to fit the regulation of cryptoassets within the existing regulatory framework, rather than creating a separate bespoke regime. European regulation has adopted a slightly different approach, and the Markets in Crypto-Assets Regulation (MiCA) was the first comprehensive effort to tackle cryptoassets; it brings rules contained in MiFID, as well as the Market Abuse and Prospectus Regulations, to the cryptoasset industry.

Cayman Islands Virtual Asset Regime

The Cayman Islands has introduced a coherent and relatively bespoke virtual asset regime. It is based on, and aligned with, global standards, set out by the Financial Action Task Force (FATF). The Virtual Asset (Service Providers) Act (Revised) (the VASP Act) is being implemented in phases. The first phase came into effect on 31 October 2020, and focuses on anti-money laundering (AML) and the counter-financing of terrorism (CFT) compliance, supervision and enforcement.

The VASP Act provides a registration and licensing regime for any person offering a 'virtual asset service' in the course of a business using a Cayman Islands entity or otherwise from within the Cayman Islands.Such persons are called virtual asset service providers (VASPs).

Definition of a virtual asset

The concept of 'virtual asset' is key to determining if a person is offering a virtual asset service and is therefore a VASP. A virtual asset is defined as a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes.However, a digital representation of a fiat currency (essentially, legal tender) is excluded.Similarly, 'virtual service tokens' (being digital representations of value that are not transferable or exchangeable with third parties, such as digital tokens that only provide access to an application or service or that provide a service or function directly to their owner) are not treated as virtual assets.

Definition of a virtual asset service

A 'virtual asset service' means the issuance of virtual assets or the business of providing one or more of the following services or operations for or on behalf of another person:

  • exchange between virtual assets and fiat currencies;
  • exchange between one or more other forms of convertible virtual assets;
  • transfer of virtual assets;
  • virtual asset custody service; or
  • participation in, and provision of, financial services related to a virtual asset issuance or the sale of a virtual asset.

The sale of newly created virtual assets to the public, in exchange for some form of consideration, is also included in the definition of virtual asset service.This means that although certain kinds of non-public issuances (such as employee or intra-group issuances or private sales) should not be regulated, a person will need to be registered if they issue virtual assets to the public using a Cayman Islands vehicle.

The effect of this is that some, but not all, token issuers will be VASPs and will be required to register with the Cayman Islands Monetary Authority (CIMA).

Definition of a VATP

A virtual asset trading platform (VATP) is defined under the VASP Act to mean a centralised or decentralised digital platform that facilitates the exchange of virtual assets for fiat or other virtual assets on behalf of third parties for some form of reward and that (i) holds custody of or controls the virtual asset on behalf of its clients to facilitate an exchange; or (ii) purchases virtual assets from a seller when transactions or bids and offers are matched, in order to sell them to a buyer. However, VATPs do not include a platform that only provides a forum where sellers and buyers may post bids and offers, or a forum where the parties trade on a separate platform or in a peer-to-peer manner.

Generally, a provider of virtual asset custody services or a VATP operator will need to be licensed under the VASP Act, when phase two of the VASP Act is activated (see below), but currently they only need to be registered.Other virtual service providers will only generally be required to register.

CIMA registered 18 VASPs in Q4 2022, compared with six VASPs in Q1 2022, so clearly their popularity is growing. The services offered by the VASPs included trading exchange and platform, custody, initial coin offerings, virtual asset dealers, along with virtual currency to virtual currency/fiat conversion. CIMA has recently indicated that it intends to process applications under the VASP Act within ten weeks.

Ongoing compliance obligations

Persons registered or licensed under the VASP Act will be subject to ongoing requirements. There is a strong emphasis on AML compliance. Ongoing requirements include the registrant or licensee:

  • undertaking audits of their AML systems and procedures at the request of CIMA;
  • obtaining prior approval from CIMA to appoint senior officers or AML compliance officers;
  • providing certain notices to CIMA confirming their compliance with the AML Regulations and data protection laws and ensuring that all communications relating to the virtual asset service are accurate;
  • designating an employee as the officer with responsibility for the procedures for combatting money laundering, terrorist financing and proliferation financing;
  • preparing audited accounts and submitting those to CIMA annually;
  • ensuring its senior officers and beneficial owners are fit and proper persons; and
  • obtaining prior approval from CIMA before issuing or transferring shares or other equity interests totalling ten per cent or more of the registrant or licensee.

There are additional requirements for custody providers and operators of VATPs.

Next stage of the VASP Act

Phase two of the legislation, which will bring into force the licensing and virtual asset issuance approval process, is expected to commence at some time in 2023.

Sandbox licence regime

As a further incentive to VASPs and certain other fintech providers to set up in Cayman, CIMA is following the approach taken by regulators such as the Financial Conduct Authority in the United Kingdom. Under the VASP Act, a time-limited regulatory sandbox licence (up to one year) will be available to both VASPs and fintech providers. However, the sandbox regime is not yet in force.

Additional incentives for fintech firms

The Cayman Islands Government has also introduced a number of other incentives to encourage fintech firms to set up on Cayman. These include:

  • A Special Economic Zone (SEZ), granting incentives to companies (particularly fintechs) to relocate their businesses and employees. The SEZ has over 285 companies, including around 80 blockchain companies;
  • TechCayman – in addition to the SEZ, TechCayman was established in 2018 to encourage technology entrepreneurs to establish their businesses in the Cayman Islands, and to create a tech hub for collaboration and expansion;
  • IP rights – the intellectual property legislation in the Cayman Islands was updated in 2017 to strengthen and protect IP rights, and permits direct registration of IP rights in the Cayman Islands rather than indirectly via the UK; and
  • Code Cayman – this government initiative is intended to provide coding programmes for the community (targeting women and younger members of the community in particular).

Conclusion

The Cayman Islands is a leading offshore hub for fintech. The VASP Act offers a clear and robust framework, which is already proving attractive to many firms in the cryptoasset market.

Footnote

1. 'Future financial services regulatory regime for cryptoassets', HM Treasury, 1 February 2023: www.gov.uk/government/consultations/future-financial-services-regulatory-regime-for-cryptoassets.

Originally published by Compliance Monitor.

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