Financial technology, or fintech, in the broadest sense of the word involves the use of software in the provision of banking and financial services. The transformative nature of the fintech sector is the manner in which fintech companies use financial technology to disrupt the way traditional financial companies do business.
The fintech sector has rapidly developed with innovation in multiple sub-categories, driving adoption in sectors such as insurance and regulation as well as the continued development of blockchain technology within distributed ledger technologies, digital currencies and other digital assets, and there has also been the emergence of entirely new models of funding. The utilization of initial coin offerings (ICOs), the tokenization of assets, and other token funding methods have created complex legal and regulatory challenges in many jurisdictions.
The offshore space has long been recognized for its efficient and flexible structures to facilitate overseas investment, and it can also play a key role in developing successful structures for fintech businesses.
The major challenge from a global perspective is to develop sensible regulation and clarification regarding the fintech sector. Key offshore jurisdictions have recently either enacted legislation to specifically address certain categories within the fintech sector, or have engaged in a "wait and see" approach before introducing key legislation.
In Bermuda, we have already seen the introduction of a prudential regulatory framework for digital assets with the Initial Coin Offering Act and the Digital Asset Business Act 2018 (DABA). The DABA became effective on 10 September 2018. The initial application fee for any "digital asset business" conducting its business in or from Bermuda is US$2,266, and additional fees are payable upon the granting of a licence.
DABA regulates the provision of any or all of the following activities to the general public:
- Issuing, selling or redeeming virtual coins, tokens or any other form of digital asset;
- Operating as a payment service provider business utilizing digital assets, which includes the provision of services for the transfer of funds;
- Operating an electronic exchange;
- Providing custodial wallet services; and
- Operating as a digital asset services vendor.
- Unless exempt, digital asset businesses must apply for one of two licences under DABA:
- Class F: The applicant is licensed to provide any or all of the digital asset business activities; and
- Class M: The applicant is licensed to provide any or all of the digital asset business activities for a defined period determined by the Bermuda Monetary Authority (BMA), which may be extended upon application to the BMA.
The Class F licence is a full digital asset business licence, and the Class M licence is a "sandbox" licence, affording start-ups to experiment with new products or services for a limited period of time.
Securing banking services has been a global and common challenge for Fintech businesses. From a banking perspective, Bermuda is tackling this issue by creating a new banking regime for fintech businesses. The new banking bill, the Banks and Deposit Companies Amendment Act 2018 (Restricted Banks Act), approved by the House of Assembly on 27 July 2018, amends Bermuda's existing bank licensing framework and is intended to establish a restricted banking licence, encouraging banks to provide banking facilities locally to blockchain-related businesses.
The British Virgin Islands (BVI) recently introduced changes to its Anti-Money Laundering and Terrorist Financing Code of Practice, 2008, which permit entities in the BVI to use digital verification of identities and receive electronic copies of documents, instead of the "wet ink" paper-based processes. The amendments, which came into force on 1 August 2018, are further evidence of regulators in the BVI embracing the blockchain revolution, and will set a new standard for know-your-client verification in the region. The BVI has also seen the emergence of leading fintech companies being incorporated in the BVI.
These changes present an opportunity for BVI entities to adopt forward-thinking and technologically supported anti-money laundering policies, with the comfort of regulatory backing. A number of entities will turn to blockchain's distributed ledger technology, for its immutable and instantaneous qualities, and the ability to encrypt data. These changes will also provide comfort to the increasing numbers of token issuers wishing to incorporate in the BVI.
While most utility token issues will not fall within the scope of the BVI financial services regulations, it is advisable that issuers align their due diligence process with the code as much as possible, in anticipation of changing legislation, and to generally protect issuers from falling foul of the Proceeds of Criminal Conduct Act, 1997.
With a large proportion of token issuers utilizing the services of third parties to electronically verify the identity of participants, the amendments to the code validate this approach and provide a useful gauge of the BVI legislator's forward thinking in this area.
The Cayman government has not as yet introduced key legislation targeted at the fintech sector, but has recently recommended an adaptable, technology-neutral, regulatory sandbox-type framework to the relevant Cayman minister. The government is collaboratively engaged in the process of resolving the necessary legislative changes to implement such a regulatory sandbox.
The government is open to, and the ministry is actively exploring, how regulated digital identification systems could help revolutionise and streamline anti-money laundering compliance, locally and globally.
In June 2018, the Financial Services Legislative Committee's fintech subcommittee was formed in the Cayman Islands. Through a series of consultations, this group, together with the Digital Assets Working Group, have been creating a framework that the Cayman Islands should adopt to promote and regulate new financial technologies such as crypto assets and fintech solutions.
Challenges still remain in terms of how certain aspects of the fintech sector will be regulated. This is a global challenge to be tackled, and not a challenge just within the offshore space.
Trends in Asia-Pacific
The Asia-Pacific region contains a mass base of fintech start-ups, service players, suppliers, consumers and investors. The region has already seen a rush for certain key jurisdictions to position themselves as the fintech hub in Asia-Pacific.
Certain trends have developed in the region in the past year. The utility token model appears to have been surpassed by security tokens (albeit, we are now seeing more in the way of sophisticated utility token projects). In a nutshell, security tokens are token-based fundraising, which are compliant with securities regulation.
Security tokens have a number of advantages over ICOs, given that investors have rights of recourse and so are better protected and can mitigate regulatory risks from an issuer's perspective. However, there are numerous issues that the sector is still considering with regard to how security token offerings will actually work in practice.
In addition, only private placement security tokens are in existence, and there is the problem of lack of liquidity in the market, given that there are not many digital exchanges licensed to list and trade security tokens. From a cost-based perspective, security tokens tend to be more costly for the issuer, as they are undertaken via private placement and fall within the ambit of regulatory scrutiny, and so are more geared towards professional investors and established start-ups.
From an offshore perspective, the regulatory sandboxes in Bermuda (and in the future, Cayman) could prove to be a useful testing ground for digital asset businesses seeking to launch security tokens or exchanges. In Bermuda, it could also be useful for insurtech-related start-ups.
In respect of crypto-focused funds, Cayman's longstanding reputation as a leading investment funds jurisdiction has led to an increase in crypto-focused fund-related activity, under which investment managers are seeking to raise funds for investments in crypto assets and/or into blockchain technologies.
We expect that 2019 will bring more regulatory clarity around digital assets, but a key challenge will be whether the approaches adopted by different jurisdictions will be consistent, or co-ordinated on a global level.
In the meantime, while waiting for regulators to catch up with the technology, the industry and legal advisers could work together to create a self-regulatory set of unified principles for security tokens that could apply to cross-border offerings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.