Game Changer! Introduction of the Regulation of Virtual Assets in the Cayman Islands – Part 1

On 25 May 2020 the Cayman Islands government passed The Virtual Asset (Service Providers) Law, 2020 (“VASP Law”), which provides a legislative framework for the conduct of virtual assets business in the Cayman Islands and for the registration and licensing of persons providing virtual asset services. The VASP Law is intended to place the Cayman Islands with a cutting edge, robust framework which is in alignment with global regulatory standards, protect consumers and meet the requirements of the Financial Action Task Force recommendations in respect of virtual assets. In this two part series (this being Part 1) we look at the new VASP Law and its requirements with respect to registration. Part 2 will look at the requirements with respect to licensing.

1. WHAT IS A VIRTUAL ASSET?

The VASP Law defines a “virtual asset” as “a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes but does not include a digital representation of fiat currencies”.

The VASP Law makes a distinction between a “virtual asset” as defined above which will be regulated and a “virtual service token” which is defined as “a digital representation of value which is not transferrable or exchangeable with a third party at any time and includes digital tokens whose sole function is to provide access to an application or service or to provide a service or function directly to its owner.”

The distinction is meant to deal with the usual question as to whether or not a digital token or coin is a security or a utility token. Virtual service tokens will be treated as utility tokens and therefore will fall outside the registration regime and the licensing regime under the VASP Law.¹

2. WHAT ARE VIRTUAL ASSET SERVICES?

The VASP Law states that “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 a natural or legal person or legal arrangement:

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

3. WHO IS A VIRTUAL ASSET SERVICE PROVIDER?

A person is a “virtual asset service provider” (“VASP”) under the VASP Law, if it is (1) a company, or a general partnership, or a limited partnership, or a limited liability company, or a foreign company registered in the Cayman Islands, and (2) provides a virtual asset service as a business or in the course of business in or from within the Cayman Islands and is registered or licensed in accordance with the VASP Law or is an existing licensee that is granted a waiver under the VASP Law. 

A natural person cannot carry on or purport to carry on a virtual asset service as a business or in the course of business in or from within the Cayman Islands.  
The VASP Law requires a VASP to either register with Cayman Islands Monetary Authority (“CIMA”) or be licensed by CIMA. Whether the VASP will have to register or be licensed will be dependent on the activity carried out by the VASP. However, broadly speaking, in the case of the provision of virtual asset custodial services or the operation of a virtual asset trading platform, the VASP is required to have a virtual asset service licence. It appears that in most cases where the VASP is carrying on business as a VASP but is not providing virtual asset custodial services or the operation of a virtual asset trading platform, registration with CIMA is required.

4. REGISTRATION OF VASPS

Any person who is already carrying on business as a VASP at the date of commencement of the VASP Law or wishes to carry on a virtual asset service (for which a licence is not required under the VASP Law), will be required to apply to CIMA in order to become a “registered person” under the VASP Law.

5. CIMA CONSIDERATIONS: LICENCE OR REGISTER

In determining whether to grant a virtual asset licence, a sandbox licence, register an applicant as a “registered person” or to waive a requirement to licence or register under the VASP Law, CIMA will take into account the following:

1. size, scope and complexity of the virtual asset service, underlying technology, method of delivery of the service and virtual asset utilised;
2. knowledge, expertise and experience of the applicant;
3. the AML procedures that the applicant has in place;
4. internal safeguards and data protection systems being utilised by the applicant;
5. the similarity of the virtual asset service to securities investment business or any other regulated activity under any of the other Cayman Islands regulatory laws;
6. the risks involved;
7. whether the virtual asset service business involves the offering of virtual asset custodial services or the operation of a virtual asset trading platform;
8. the net worth, capital reserves and financial stability of the applicant;
9. the likelihood that the service will promote innovation, competition and benefits to consumers; and
10. the applicant’s senior officers, trustees and beneficial owners are fit and proper persons.

6. GENERAL REQUIREMENTS APPLICABLE TO A VASP AFTER REGISTRATION

The VASP Law sets out the continuing obligations which apply to a VASP after registration, including the following:

1. prepare accounts annually which are made available for inspection (including unaudited reports) to CIMA upon request (note: the VASP Law does not specify that the accounts need be audited);
2. ensure its senior officers and trustees are fit and proper persons to hold the respective positions;
3. ensure beneficial owners are fit and proper persons to have such control or ownership;
4. take such steps as are necessary to protect and secure the personal data and virtual assets of its clients;
5. ensure all communications relating to the virtual asset service are accurate;
6. comply with the Cayman Islands’ Anti-Money Laundering Regulations (2020 Revision), as amended (“AML Regulations”) i.e. including the appointment of AML officers and putting in place AML systems and procedures;
7. where performing a transfer of virtual assets, a VASP is required to collect and maintain information on the beneficiary and originator of the transfer in accordance with the AML Regulations, which are to be made available within 48 hours of receipt of a request by CIMA;
8. to notify CIMA within 15 days of any changes made to the information in the application form submitted to CIMA;
9. pay an annual renewal fee by the 15th January of each year; and
10. subject to certain exceptions, the prior approval of CIMA is required for the issue, voluntary transfer or disposal of 10% or more of the total shares or interest in a VASP – the incoming shareholder or partner also needs to be a “fit and proper” person. 

In addition, a VASP is not permitted to engage in securities investment business (as defined under the Securities Investment Business Law (2020 Revision) as amended (“SIBL”)) (this is likely where, e.g. a VASP is an investment manager or adviser or is providing brokerage services), unless the person is a licensee or registered person under SIBL and cannot appoint a senior officer or trustee of AMLCO without the prior approval of CIMA. 

Given the “four eyes” principle applied by CIMA in respect of other registered persons and licensees, it is likely that a VASP will be required to have a minimum of two directors, members or partners, as applicable.

7. ISSUE OF VIRTUAL ASSETS

1. Direct issue by VASP – In order to issue newly created virtual assets directly to the public in or from within the Cayman Islands in excess of a “prescribed threshold”, a registered person (i.e. a VASP which has already registered with CIMA) must first submit an “issuance request” to and obtain approval from CIMA. The VASP Law is silent on the value of “prescribed threshold” – this is essentially an amount in fiat currency or equivalent which can be raised by public issue by an issuer within a given timeframe, which will likely be confirmed by further amending regulation. 
2. Issue by a VATP on behalf of a VASP – However, a registered person may engage on one or more virtual asset trading platforms (“VATP”) in order to issue virtual assets over the prescribed threshold on the VATP. This is provided that the VATP is either (i) licensed under the VASP Law or (ii) licensed or registered and supervised for virtual assets by a government regulatory body in another non high-risk jurisdiction. Prior to engaging a VATP for the issuance of newly created virtual assets, a registered person is required to submit a virtual asset issuance request to and obtain approval from CIMA. 
3. Direct issue by a VATP – A licensee who operates a VATP may issue virtual assets directly on its own behalf to the public over the prescribed threshold by submitting an issuance request to CIMA for approval, where permitted by the terms of its licence. 
4. Issue by a VATP on behalf of a VASP – A VATP that is licensed under the VASP Law may issue virtual assets on behalf of a VASP directly to the public over the prescribed threshold where it is permitted under the terms of its licence and the VASP which is creating the virtual assets has obtained CIMA approval for the issuance. 
5. Obligations on issuer under the prescribed threshold – If a virtual asset issuance is within the prescribed threshold or involves the transfer or exchange of other virtual assets or fiat currency, a registered person is required to maintain records containing all the information required by CIMA for every transaction of the issuance and to make such records available to CIMA when requested. 
6. CIMA conditions – On approval of an issuance which is over the prescribed threshold, CIMA may impose requirements in relation to (i) the method by which the issuer may solicit members of the public to participate in the issuance (ii) the information provided to the public
   i.e. disclosure of risks (iii) the information that the licensee is required to collect from members of the public who participate in the issuance and (iv) the reporting requirements to CIMA. 
7. Reporting duty of licensee – If a licensee operating a VATP which is facilitating the issuance of newly created virtual assets on behalf of a VASP knows or has reasonably grounds to believe that the virtual asset issuance does not comply with an applicable requirements, the licensee shall immediately give CIMA written notice of its knowledge or belief, with reasons. 
8. CIMA response time – CIMA shall notify the licensee/ virtual asset issuer who submitted the issuance request whether it has been approved within 21 days of receipt of the issuance request.

8. CIMA CONSIDERATIONS: APPROVAL OF AN ISSUE OF VIRTUAL ASSETS

The VASP Law sets out a number of factors that CIMA will take into account in determining whether to approve an issuance request by a VATP or a registered person. This includes the following:

1. the nature of the virtual asset, including whether the virtual asset is a “security”, as defined in SIBL;
2. the functions and purpose of the virtual asset and the nature of the underlying asset which the virtual asset may represent (if applicable);
3. the accuracy and completeness of the disclosures made to the public regarding the issuance of virtual assets;
4. whether the VASP wishes to solicit the public directly for the purchase of the virtual assets;
5. the total number of virtual assets that will be available for purchase and the amount to be raised;
6. the period of time during which the issuance will take place;
7. the platform from which the virtual assets will be issued; and
8. the AML processes of the virtual asset issuer.

9. CIMA’S ENFORCEMENT POWERS

As a general note, CIMA has broad discretionary supervisory powers in respect of a registered person or licensee under the VASP Law, including but not limited to, the following: 

1. Examine the affairs – Whenever CIMA considers it necessary, examine the affairs of business of any VASP i.e. by way of regular returns, on-site inspections, auditor’s reports or in any such other manner as CIMA determines in compliance with the VASP Law.
2. Cease and desist – Where CIMA is of the opinion that a VASP is carrying out, pursuing or about to carry or pursue out an act that is unsafe or an unsound practice in conducting the business of VASP, CIMA may direct the VASP to cease and desist from carrying out the act or conduct.
3. CIMA direction – If at any time it appears to CIMA that a VASP has failed to comply with any of the requirements under the VASP Law, CIMA may by written notice direct the VASP to comply with the requirement within such period of time and on such conditions as specified in the notice.
4. Enforcement powers – If CIMA knows or has reasonable grounds to believe that a VASP:

• • is unable or appears likely to become unable to meet its obligations as they fall due;
  • is carrying on business fraudulently or otherwise in a manner detrimental to the public interest, to the interest of its clients or to the interest of its creditors;
  • has contravened any provision of the AML Regulations;
  • has failed to comply with a condition of its licence/ registration;
  • has not conducted the direction and management of its business in a fit and proper manner or has senior officers, managers or persons who have acquired ownership or control who are not “fit and proper persons”;
  • is a “corporate services provider” and has contravened the applicable law; or
  • has failed to comply with any lawful direction from CIMA.

CIMA may take certain actions, including, but not limited to the following:

1. 1. revoke the virtual asset licence or sandbox licence or cancel the registration;
   2. impose conditions upon the licence or amend or revoke such conditions;
   3. apply to the court for any order which is necessary to protect the interests of clients or creditors of the licensee or registered person;
   4. at the expense of the VASP, require that a licensee or registered person obtain auditor’s report to be submitted to CIMA on its anti-money laundering systems and procedures for compliance with the AML Regulations;
   5. require the substitution of any senior officer or trustee of the VASP appointed, or the divestment of ownership or control;
   6. appoint a person to advise the licensee on the proper conduct of its affairs and report the same to CIMA;
   7. requiring such action to be taken by the VASP as CIMA reasonably believes necessary.

CIMA may revoke a virtual asset service licence, sandbox licence or cancel the registration if the licensee of registered person has ceased or wishes to cease carrying on virtual asset service or has not commenced business within 1 year of the date of grant of the licence of the registration.

1.   Section 3(2) of the VASP Law makes this clear by stating: “For the purposes of this Law, virtual service tokens are not virtual assets and a person or legal arrangement that provides services that involve virtual service tokens only are not required to have a licence or registration under this Law.”

 This publication is not intended to be a substitute for specific legal advice or a legal opinion.
For specific advice, please contact either:

E: gary.smith@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: santiago.carvajal@loebsmith.com