The kind of volatility your financial regulator hates
The Financial Sector Conduct Authority (FSCA) is not impressed by the volatility on display from cryptocurrencies like Bitcoin and Ethereum and the sea of alt-coins, non-fungible tokens (NFTs) and financial platforms that have sprouted up on the back of decentralised finance (DeFi) technologies. They are unhappy about the complexity of these financial solutions; the fact that most operators in the sector are unregulated; and the prospect of naïve investors losing their proverbial shirts by chasing the insane and irresponsible returns that many crypto opportunities promise.
Keeping a close eye on crypto
Central banks, governments and market conduct regulators have been keeping a close eye on cryptocurrencies and crypto assets for years. In South Africa, the FSCA has been working closely with other financial sector stakeholders as part of an Intergovernmental Fintech Working Group (IFWG) to better understand and regulate crypto assets. This body published a comprehensive positioning paper on the topic in June 2021, with the foreword in the paper offering clues as to why regulators are so concerned. The IFWG observed: “The crypto asset ecosystem has grown to include more than 10000 unique crypto assets [with] global daily trading values averaging in excess of US$200 billion, and on some days exceeding US$400 billion”.
The more recently-published FSCA Financial Sector Outlook Study 2022 reveals that crypto trading has become increasingly popular in South Africa, with daily crypto asset trading exceeding US$145 million in January 2021. PS: This does seem high given the global trade estimate contained in the IFWG report, but we will take it as the more accurate estimate for now. “Many South African investors have been attracted to the high publicised returns, however crypto assets remain highly volatile and inherently risky given their decentralised and disintermediate nature,” noted the Outlook Study. Similar concerns informed the IFWG recommendation to regulate crypto assets to promote responsible innovation.
One of the problems facing the FSCA, National Treasury and the South African Reserve Bank (SARB) is that the extent of investor’s cryptocurrency exposures are unclear. They do not know how many of the country’s citizens hold cryptocurrencies, how many are actively trading these currencies and / or related assets, or how much of this currency is held domestically or offshore, among other shortcomings.
The South African Revenue Services (SARS) has been clear that income and capital gains earned from crypto investing and / or trading will be taxed, and has started asking taxpayers to indicate whether or not they hold such assets in their annual tax returns. And they have already approached various crypto trading platforms for access to client lists to verify taxpayers’ information. You can read ‘Advice for your crypto asset clients’ for more on the tax side of things.
Addressing emerging market conduct risks
The FSCA is on record that it will undertake targeted interventions to address emerging market conduct risks in a timeous manner. They are particularly concerned about “increasing cyber and systems threats, which can expose consumers to loss of assets or identity” and are thus busy developing and implementing systems and approaches to collect and analyse relevant data to inform next steps. In their latest fact-finding mission, the FSCA is reaching out to local Financial Services Providers (FSPs) via a comprehensive online survey about crypto-asset related activities. Good move, we reckon, because nobody is better-placed than South Africa’s FSPs to get to grips with consumer and investor interactions with the emerging asset class.
FSCA Information Request 3 of 2022, published in terms of section 131 of the Financial Sector Regulation (FSR) Act, requires FSPs to spill the beans on their and their client’s crypto asset related activities. The Authority says this information request will “assist it in obtaining a better understanding of the extent to which FSPs are currently operating in the crypto asset environment [and that] the information will assist it in making more informed decisions regarding the potential future regulation of crypto asset related activities”. FSPs have until 31 May 2022 to complete the online survey, or face sanction per section 267 of the FSR Act. This writer confesses to a wry grin at this point, having unsuccessfully attempted to navigate to the online survey link moments earlier.
Building a legal framework
The survey information will no doubt assist the various regulatory bodies in building out a legal framework that will not unnecessarily restrict innovation in the emerging crypto asset class. Per the Outlook Study, this framework will have to address concerns over a range of risks, notably “the potential for maladministration, failings of service providers, misleading advertising, product complexity and unclear price formation and pricing practises”. Regulators are also worried about increases in crypto-related fraud and scams, as illustrated by the Johannesburg-based Mirror Trading International [debacle], where around US$581 million reportedly went missing.
Finally, the Authority warns that crypto assets remain highly volatile and inherently risky. The 115% year-on-year return from Bitcoin since its inception has left many local investors with the perception that crypto assets offer high returns and that cryptocurrency-related assets are a one way ‘bet’ to instant riches. IFAs will know the type, having frequently interacted with excited clients who blurt out “Bitcoin” and “where Lambo” in the same sentence. Against this backdrop, regulation is inevitable. “To date, crypto asset trading platforms have been operating outside the purview of financial sector regulators such as the FSCA, but have been considered a taxable asset,” commented the Authority.
Crypto assets already a financial product under FAIS
The status quo will not last. “In November 2021, [we] published a draft Declaration of crypto assets as a financial product under the Financial Advisory and Intermediary Services Act, to aid in the regulation of crypto assets,” wrote the FSCA in its Outlook Study, before referencing the IFWG paper. This paper proposes that crypto assets be brought into the South African regulatory purview in a phased and structured manner across three main areas: anti money laundering and combating the financing of terrorism; cross-border financial flows; and consumer protection through the application of financial laws. You can expect a more comprehensive crypto asset regulatory framework soon!
Writer’s thoughts:
You cannot have a conversation about crypto assets without someone mentioning the stellar multi-year returns delivered by the likes of Bitcoin and Ethereum… The reality is that recent investors have not benefited to the same extent as those who got in at ground level. Do you think that tougher regulation will reduce the risk and volatility in the emerging crypto asset class? And will crypto assets remain ‘attractive’ to younger investors and traders if this volatility is removed? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.
