Malta was the first jurisdiction within the EU to develop a regulatory system for collective investment schemes that invest in cryptocurrencies. A new paper offering what it calls a “top-down analysis” of hedge funds involved with cryptos details the regulatory framework now in force in Malta, highlighting the set-up and licensing process applicable to such funds. The authors, Damiano Di Maio (an independent scholar) and Andrea Vianelli, who is affiliated with the Amagis Capital, write of “the industry-specific risks related to cryptocurrencies and the regulatory and operating pitfalls which hedge fund managers may incur when setting up a fund investing into” such currencies. The authors’ underlying view is that blockchain-based technologies are reshaping the old ways of doing business throughout the financial world and that as a consequence “the regulatory framework surrounding the financial industry will be, and already is, in constant development to follow the innovation in the market.” It is unsurprising that hedge funds want to get in on this. Terminology One somewhat confusing aspect of the Di Maio and Vianelli discussion is their use of the phrase, “the VC market” where VC stands not for “venture capital” but for “virtual currencies.” Once one is accustomed to that usage though, statements like the following are tolerably clear: “In this respect, the increasing pace at which hedge funds are looking at the VC market is pushing the main financial centres around the globe to embrace the fintech innovation by means of creating an ecosystem suitable to create a balance between investors protection and financial innovation.” A key question is whether cryptocurrencies constitute “financial instruments” under the definition in Europe’s MiFID II. According to Article 1, para 1, no. 15 of MiFID II, financial instruments include transferable securities, money market instruments, units in collective investment schemes, financial derivative instruments, and emission allowances in accord with Europe’s emissions trading scheme. A Sweeping Assessment or a Case-by-Case Approach? So again: does it include cryptos? The French supervisory authority, AMF, has made a very sweeping statement in this regard: “The Bitcoins are not considered as financial instruments as the law stands, so ‘crypto’ assets do not fall within the scope of direct supervision of the AMF.” For more of a pan-European opinion, Di Maio and Vianelli turn to the European Securities and Market Authority, which has adopted a case-by-case approach to the matter of whether a particular firm involved in an initial coin offering is issuing financial instruments. But let us look to Malta. There has been a fair amount of speculation of late that Malta will benefit from Brexit—hard or soft. Malta has the infrastructure already in place and it has an English speaking and educated workforce, so it is poised to be a conduit between Britain and the EU. In terms of Malta’s Investment Services Act, a CIS operating within Malta must have a valid license issued by the MFSA. A CIS is defined as “any scheme or arrangement which: (i) has as its object or one of its objects the collective investment of capital; (ii) acquired by means of an offer of units for subscription, sale or exchange; and (iii) which has the following characteristics…”—risk spreading, pooling of contributions, repurchase or redemption of units out of the assets of the scheme, and either the continuous issuance of the units or their issuance at units of short interval. In regard to those schemes working within the crypto world, the MFSA is showing how complicated the above-referenced notion of a “case-by-case assessment” can be. The MFSA has created a set of 12 checklists, each looking into some of the factors that should go into determining whether a virtual currency constitutes a financial instrument. Key Points Key points on the evolving regulatory system in Malta include: a CIS must have a compliance officer, and that officer must have the experience and expertise that the MFSA deems necessary. The VC/CIS will establish a valuation function which will account for the value of the assets in its portfolio. The valuation can be accomplished either internally or externally. Asset values may be retrieved from the data published by exchanges, if that way of determining value has been disclosed in the offering documentation for the fund. The VC will appoint an independent auditor with the approval of the MFSA and the auditor will have access to all the information necessary to do a proper audit and adhere to MFSA requirements. The VC will also have a risk management function in place. This is the locus of assessments as to whether the risk profile of the assets in the portfolio is aligned with the risk profile of the fund, and of monitoring of the fund’s ability to meet redemptions under normal and exceptional market conditions.
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