In a previous briefing note (available here), we prepared a set of Q&A to offer a high-level overview of proposals on which the Dubai Financial Services Authority ("DFSA") was consulting earlier this year, to regulate crypto assets that were outside the scope of its existing rules.
Having considered the feedback from that consultation, the DFSA has now finalised its proposals and its new regime for the regulation of those crypto assets (the "Crypto Token Regime") will come into force on 1 November 2022.
On 17 October 2022, the DFSA published a detailed feedback statement (available here), explaining its conclusions following the feedback it received, along with the changes it has made to the proposals that were issued for consultation.
We have prepared the revised Q&A below, to provide a selective, high-level overview of those parts of the Crypto Token Regime we expect to be of general interest. While it does not attempt to summarise the entire Crypto Token Regime, we hope it serves as a useful starting point in understanding whether, and how, that new regime may impact your planned business or activities in this area.
Were any major changes made to the proposals consulted on?
The changes made by the DFSA in finalising its Crypto Token Regime have largely focused on providing clarification and removing potential ambiguities. There are, however, two more significant changes worth highlighting.
First, the DFSA now intends to publish an initial list of Crypto Tokens that are "pre-recognised", to coincide with the coming into force of the Crypto Token Regime. Those Crypto Tokens will be immediately available to be used by firms with appropriate permissions in conducting financial services in or from the Dubai International Financial Centre ("DIFC"). For any Crypto Tokens that are not on that list, the position will be as proposed in the consultation; an application for the DFSA to recognise that Crypto Token must be granted before it is available for use by a DFSA authorised firm in conducting financial services (other than providing custody – see further below).
Second, while Non-Fungible Tokens and Utility Tokens will remain outside the scope of financial services regulation, they will be brought within the remit of the DFSA's anti-money laundering and counter terrorist financing ("AML") regime. Issuers of such Tokens (unless their issuance does not exceed a USD15,000 de minimis threshold), as well as service providers (such as auction houses, issuance platforms and safekeeping services), will have to be registered with the DFSA as a designated non-financial business or profession and comply with the associated AML requirements.
Authorised firms who are already engaging in Crypto Token activities that will now amount to financial services, will no doubt note with relief that they will be given a six-month transitional period, in which they can continue those activities while seeking to obtain an appropriate licence variation.
What is the purpose of the Crypto Token Regime?
In October 2021, the DFSA launched its regulatory framework for Investment Tokens. This was phase one of the DFSA's Digital Assets regime (as discussed in its Consultation Paper No. 138 ("CP 138")). This clarified and extended the DFSA's regulatory regime to cover Security Tokens or Derivative Tokens (collectively known as Investment Tokens). Investment Tokens are essentially crypto assets that are the same as, or substantially similar in purpose or effect to, the pre-existing categories of conventional, regulated investments.
The Crypto Token Regime will cover a broader scope of crypto assets and bring them, and those who conduct specified activities in respect of them, within the DFSA's regulatory perimeter. The DFSA considers this necessary in order to mitigate the risks posed by crypto assets, which go beyond AML risks, to include those relating to consumer protection, market integrity, safe custody and the adequacy of a service provider's financial resources.
What crypto assets fall within the Crypto Token Regime?
The Crypto Token Regime introduces new, defined categories of "Crypto Tokens", "Excluded Tokens" and "Prohibited Tokens" as summarised in the table below.
What are examples of Crypto Tokens?
The definition of Crypto Tokens is deliberately broad and will cover cryptocurrencies such as Bitcoin, Ethereum and Solana, as well as stablecoins with a value determined by reference to fiat currency ("Fiat Crypto Tokens" of this nature will be a defined sub-category of Crypto Tokens), and Tokens that purport to reference their price against other assets.
While Utility Tokens are generally outside the scope of financial services regulation under the Crypto Token Regime, they will be captured by the definition of Crypto Tokens where they have relevant hybrid features that go beyond the scope of a pure Utility Token. Pure Utility Tokens operate in a closed ecosystem to give access to products, services or discounts provided by their issuer (or a member of the issuer's group). Relevant hybrid features that go beyond a pure utility use case may include, for example, the Utility Token being used as a more widely accepted medium of exchange, or developing a secondary market. Well-known, hybrid Utility Tokens cited by the DFSA when consulting on the Crypto Token Regime included the Basic Attention Token and Filecoin.
While many examples of stablecoins will fall within the definition of a Crypto Token, the DFSA has prohibited any stablecoins which use an algorithmic mechanism to adjust the supply or demand of the Token to maintain a stable price (defined as "Algorithmic Tokens"). DFSA guidance also cautions more broadly that asset referenced Tokens may, depending on their design, take on characteristics of regulated investments (such as commodity derivatives, or units of a fund), in which case they will be treated as such.
What is the process for a Crypto Token to be "recognised"?
As in some other crypto regulatory regimes, including that already in place in the Abu Dhabi Global Market ("ADGM"), the DFSA proposes that only Crypto Tokens approved as Recognised Crypto Tokens will be permitted for use in the provision of financial services in or from the DIFC. The application for recognition may be made by a DFSA authorised person (or applicant for authorisation), or the issuer/developer of the Crypto Token, upon payment of the appropriate fee. The applicant will have to submit an assessment of the Crypto Token against specified criteria (discussed below). The DFSA will then consider whether to designate it as "recognised" following its consideration of that assessment.
Interestingly, and in contrast to the ADGM regime, once a Crypto Token is designated as "recognised", it will be added to a centralised register, maintained by the DFSA, and it will be open to anyone with the required permissions to provide regulated services in respect of that Crypto Token. The ADGM's regime currently involves maintaining an individual list of accepted crypto assets for each person providing relevant regulated services, which permits only that person to use the crypto assets on that list.
The DFSA will, generally, issue a notice on its website when it has received an application for recognition of a particular Crypto Token. It will also publish a notice where, following consideration of an application, it decides not to recognise a particular Crypto Token. As noted above, the DFSA intends to publish an initial list of Tokens that are "pre-recognised" to coincide with the coming into force of the Crypto Token Regime.
It is worth noting that providing financial services in respect of a derivative of a Crypto Token, will only be permitted where the Crypto Token referenced by the derivative is a Recognised Crypto Token. Similarly, a Fund in the DIFC will only be permitted to invest in Crypto Tokens that are Recognised Crypto Tokens. Funds established outside the DIFC that invest in Crypto Tokens (whether recognised or not) may not be offered or marketed in or from the DIFC, or managed by a DFSA authorised fund manager.
What are the criteria for Recognised Crypto Tokens?
Applications for recognition of Crypto Tokens will be decided by the DFSA on a case-by-case basis, taking account of the following factors (each of which will need to be considered and explained in the applicant's assessment):
- Regulatory status of the Crypto Token in other jurisdictions;
- Whether there is adequate transparency relating to the Crypto Token (including in respect of its purpose, protocols, consensus mechanism, governance arrangements, founders, key persons, miners and significant holders);
- Size, liquidity and volatility of the global market for the Crypto Token;
- Adequacy and suitability of the technology used in connection with the Crypto Token;
- The risks associated with the Crypto Token (including AML risks), and whether they are adequately managed or mitigated; and
- Where it is a Fiat Crypto Token, whether: (i) information on the value and composition of its reserves is published at least quarterly and independently verified; (ii) that information demonstrates the reserves meet stipulated value and adequacy requirements and are appropriately protected; (iii) the Crypto Token is able to maintain a stable value relative to its reference currency; and (iv) a person is clearly responsible and liable to investors.
The DFSA has set out detailed guidance on the matters it may consider in assessing the above factors, which gives some insight into what would make a strong case for a Crypto Token to be recognised. The factors are not given specific weights, however, and do not operate as a pass/fail checklist, so there will be an element of judgment involved in reaching a wholistic view on the application.
What regulated activities will be permitted?
The following services in relation to Crypto Tokens will be permissible:
- Dealing in Investments as Principal;
- Dealing in Investments as Agent;
- Arranging Deals in Investments;
- Managing Assets;
- Advising on Financial Products;
- Providing Custody;
- Arranging Custody;
- Operating a Clearing House; and
- Operating an Alternative Trading System.
Conducting permitted activities in respect of Crypto Tokens will, broadly speaking, be subject to the existing regulations applicable to those financial services, adapted to reflect risks and features specific to Crypto Tokens.
However, in order to maintain a clear distinction between regulated and unregulated crypto asset activities, no authorised person will be permitted to provide services in relation to both Crypto Tokens and Excluded Tokens. The one exception to that position is in respect of Providing Custody. A firm authorised to Provide Custody may do so in respect of a Crypto Token (whether recognised or not), NFT or Utility Token.
The financial promotions regime will also be extended to apply to Crypto Tokens in the same way as for other specified financial products. It will be prohibited for financial promotions to be made in respect of Crypto Tokens that are not "recognised", Privacy Tokens and Algorithmic Tokens.
Who can offer these services?
The general position will be that only entities incorporated in the DIFC will be permitted to carry on regulated activities in respect of Crypto Tokens. Branches of entities established in other jurisdictions will not be allowed to offer these services unless certain strict conditions are met (including that it was authorised by the DFSA prior to the introduction of the Crypto Token Regime, and that its head office is authorised and supervised to carry on the crypto activity in a recognised jurisdiction). Representative Offices (branches of firms regulated outside the DIFC, with a licence to perform limited marketing activities) will not be permitted to conduct any marketing activities in respect of Crypto Tokens.
The DFSA has, for the time-being, excluded the possibility of crowdfunding platforms in the DIFC using Crypto Tokens, although it will reassess this position as part of a planned review of the crowdfunding regime.
Existing money services providers will only be permitted to use Crypto Tokens for limited purposes, in the context of performing back-office functions where the originator and beneficiary of the transactions operate in fiat currency.
Existing DFSA authorised firms will be able to seek to vary or amend their DFSA licence in the usual way, to perform the above financial services for Recognised Crypto Tokens, insofar as this wouldn’t be restricted under any of the limitations of the regime.
How will trading venues for Crypto Tokens be regulated?
Operating a multilateral trading facility as a trading venue for Recognised Crypto Tokens, including those that allow direct market access to retail clients, will be permitted with the appropriate permissions. Such activity will be subject to additional requirements, disclosures and limitations compared to operating a trading venue for conventional investments, many of which are carried across from the proposals for Investment Tokens implemented following CP 138.
Four notable, new limitations imposed upon operators of such trading venues are as follows:
- The DFSA is not minded to allow the same operator to offer trading in both Crypto Tokens and Investments/Investment Tokens (although it will consider applications to do so if the risks can be properly managed);
- The operator will be expressly prohibited from trading on its own venue for its own account;
- The operator must carry out an appropriateness assessment in respect of a retail client, prior to granting that retail client direct access to its facility; and
- Operators will not be eligible to participate in the innovative testing licence program.
Operators will also have to give careful thought as to the clearing and settlement arrangements that will be appropriate.
To address market integrity risks, the DFSA has applied all existing market abuse provisions (set out in Part 6 of the Markets Law) and the Code of Market Conduct to all persons using Crypto Tokens. Operators of trading venues who provide a discussion forum will have a duty to monitor it for any behaviour that might constitute market manipulation.
Will there be additional requirements when providing Crypto Token services to retail clients?
The DFSA has proposed introducing a number of protections that will apply when financial services relating to Crypto Tokens are provided to retail clients, many of which will be familiar to those who followed last year's introduction of requirements relating to restricted speculative investments.
They include the introduction of an "appropriateness test" before allowing a retail client to transact on an execution only basis, prohibiting the use of credit cards by retail clients to fund their trading accounts, and restricting the leverage offered to a retail client engaging in derivative transactions.
Will issuing new Crypto Tokens be permitted in the DIFC?
The DFSA does not propose to allow for the issuance of new Crypto Tokens in or from the DIFC at this stage. It will, however, keep that policy position under review as it gains experience of regulating Crypto Tokens.