Cayman Islands Adopts Crypto Regulatory Framework for ICOs and Exchanges

In late May 2020, Cayman Islands lawmakers officially passed five new and amended legislative acts that will help to regulate its cryptocurrency sector. In particular, its centerpiece law, the Virtual Asset Service Provider (VASP) Bill, aims to effect licensing and the better regulation of cryptocurrency exchanges and custodial service providers. The Cayman’s new crypto regulations bring it in alignment with global anti-money laundering (AML) and counter-terrorism funding (CFT) endeavors such as the FATF’s Travel Rule.

The Cayman legislators consulted and engaged extensively with domestic financial industry stakeholders throughout the development of the new legislation. Passed on 25 May 2020 by the Legislative Assembly, the laws have been promulgated only a month before the June plenary of the Financial Action Task Force, during which the FATF will review member countries’ implementations of its Recommendation 16 Travel Rule.

The Cayman Islands and virtual asset regulation

The Cayman Islands, a British Overseas Territory, is attractive to corporations thanks to its minimal tax policies. It does not directly tax companies under its jurisdiction and levies no withholding tax on dividend or interest payments. Due to this lenient taxation and registration regime, it frequently draws the ire of regulators and politicians as a high-profile tax haven.

The quaint Caribbean destination is in particular a popular domicile for investment funds around the globe, thanks to its tax neutrality, political stability, and well-developed legal system, and currently hosts over 10,000 such funds. These investment funds are now increasingly adding cryptocurrency investments to their portfolios thanks to the lucrative returns.

The Cayman Islands has also extended these favorable financial conditions to crypto-related businesses who are often shunned elsewhere as a result of the AML risks they pose. For largely unregulated entities like Initial Coin Offerings (ICOs) and cryptocurrency exchanges, the Cayman Islands Special Economic Zone makes it easy to register a physical address and employ staff in the Cayman Islands.

By Cayman law, virtual assets like Bitcoin are defined as a digital representation of value that can be traded electronically and used for investment purposes.

Until the publication and approval of these new bills, the Cayman Islands had no existing or even proposed laws to help legislate and regulate crypto assets and the companies and products that make up its industry, such as Initial Coin Offerings (ICOs), Security Token Offerings (STOs) or virtual asset service providers (VASPs) like exchanges and investment firms.

How will the new laws change crypto regulation in the Cayman Islands?

On 28 April the Cayman Islands Gazette published these five proposed pieces of legislation:

Source: http://www.gov.ky/portal/pls/portal/docs/1/12948639.PDF

Spearheaded by the VASP Bill, these regulatory updates introduced three important new requirements for Cayman crypto asset service providers: to register as a VASP, and/or apply for a Virtual Asset Service License or Sandbox License:

The VASP bill aims to effect a new regulatory framework to govern digital assets like Bitcoin. The newly approved law will require VASPs such as cryptocurrency exchanges (both centralized and decentralized) and custodians to register and be licensed in the Cayman Islands. The VASP Bill is accompanied by 4 other bills that furthermore propose an amendment of the Caribbean territory’s current stock exchange and financial securities laws, as well as the establishment of a regulatory sandbox that will help to smoothen the Caymans’ adoption of cutting-edge technology and financial services delivery.

Sandbox license for emerging technologies

Cayman lawmakers have acknowledged the high risks that come with emerging digital technologies and the companies working with them as well their necessity to ensure the Cayman Islands remains a financial services innovator.

The new framework mitigates the risks surrounding new crypto companies without stifling their innovation. It requires that cryptocurrency and blockchain entities dealing with emerging technologies are issued a 1-year sandbox license (SL) to continue testing and improving their operations in accordance with AML rules on a limited basis.

Registered individuals or licensed VASPs that use innovative technology or render advanced services may be required to participate under the sandbox. Persons who don’t offer crypto-asset services but use related technology may also volunteer to apply for a sandbox license.

The Sandbox License (SL) will help regulators customize restrictions and create limits on the technology offerings in order to supervise and monitor them effectively for a limited period. It will allow authorities the time to figure out how to optimally regulate these new services and develop further legislation if needed.

Why did the Cayman Islands introduce new crypto legislation?

A few high-profile money laundering scandals in recent years have drawn attention to the Cayman’s tax haven status. Already blacklisted by the EU, the Cayman Islands is under pressure from FATF and its regional body, the Caribbean Financial Action Task Force (CFATF).

The FATF introduced its FATF travel rule in 2019 and expects member countries to implement regulatory frameworks in response by June 2020. The CFATF meanwhile undertook a mutual evaluation of the Cayman’s AML/CFT regime in March 2019. It identified certain technical deficiencies that had to be addressed by October 2019 when the CFATF conducted their on-site visit for a follow-up report.

The results of this report will be presented to the FATF during its June plenary, so it’s vital for the Cayman Islands to gain a favorable technical re-rating from the G20’s financial watchdog, which will most likely be delivered at the FATF’s October 2020 plenary.

Who must be licensed?

The passed new regulatory framework will now require that entities that provide or wish to offer virtual asset services to Cayman-based or overseas customers be officially recognized as VASPs. These VASPs will need to apply for a Virtual Asset Service License, register, or acquire a waiver before they can offer their services.

The Cayman Islands Government has identified that virtual asset custodians and trading platforms currently present the biggest threat to consumers. Therefore, custodial service providers (such as digital wallets) and virtual asset trading platforms like cryptocurrency exchanges will need to apply for a CIMA license.

The licensing process will in part review whether “the applicant has the necessary skills, knowledge, experience, facilities, adequate capital and cybersecurity measures as appropriate having regard to the size, scope and complexity of the business”.

Applicants will also need to adhere to specific requirements such as minimum disclosure, insurance, net worth and operation-based benchmarks.

Who needs to register?

People and businesses offering crypto-related services that do not require a license will still have to register with CIMA and adhere to AML/CFT obligations as detailed in the AML Regulations.

Entities that have already been licensed under a different law will need to notify the Cayman Islands Monetary Authority (CIMA) and outline the type of crypto service they want to offer. CIMA may then either waive the new registration and Virtual Asset Service license requirement or subject these companies and individuals to the new VASP bill once it is ratified.

Who will not be affected?

It’s important to note that only business entities that issue digitally transferable or exchangeable assets will be subject to the new laws, not investment funds who issue digital tokens that can be exchanged digitally.

The legislation will not apply to individuals who use cryptocurrencies only for their personal use.

How are ICOs impacted by the new VASP laws?

According to the Ministry of Financial Services:

“A person must be registered or licenced under the proposed VASPs law in order to issue newly created virtual assets directly to the public, in or from within the islands. Additionally, registered persons may only issue virtual assets to the public under a certain threshold.

Registered persons who wish to issue virtual assets over this threshold will have to engage licensed or supervised virtual asset trading platforms and issue the virtual assets via these trading platforms.”

How much will VASP registration or licensing in the Caymans cost?

Registration and license applicants will have to include an assessment fee in their applications. Once approved, the regulator will determine an application fee (to be determined later by the new laws), which must be paid prior to registration or licensing. The fees will be in line with current regulatory costs.

Cayman Islands is going long on crypto regulation

The Cayman Islands’ comprehensive new regulatory framework is not only a knee jerk response to help gain the favor of the FATF and CFAT.

Its upgraded legislation will also help its play catchup with neighbors Bermuda and the Bahamas, who respectively already had a regulatory sandbox for crypto projects and a framework for ICOs in place by 2018.

Financial Service Minister Tara Rivers’ comments indicate that the territory is indeed playing a long game to attract more investment and gain a technological edge over other crypto-destinations.

“The Cayman Islands would be one of the few countries in the world to adopt such a cutting-edge framework that is in alignment with global regulatory standards.

This type of regulated FinTech activity will help our financial services industry attract new clients and, in turn, contribute further to government revenue.

“The legislative enhancements being put forward are designed to increase the jurisdiction’s attractiveness as a domicile for virtual assets business while ensuring Cayman meets international obligations.”