Guernsey: Regulation Of Virtual Asset Service Providers (VASPs) In Guernsey

This briefing is the fourth in a series of briefings by Walkers on the Lending, Credit and Finance (Bailiwick of Guernsey) Law, 2022 (the "LCFL"), and provides an overview of the licensing regime applicable to Virtual Asset Service Providers ("VASPs") under Part III of the LCFL (a "Part III VASP Licence") and the key aspects of the Lending, Credit and Finance Rules and Guidance, 2023 (the "Rules"), issued by the Guernsey Financial Services Commission (the "GFSC") applicable to the holder of a Part III VASP Licence (a "Licensee").

Related briefings on the LCFL licensing regimes in Guernsey are available here:

• Overview
• Consumer Credit
• Financial Firm Business
• Financial Platforms and Crowdfunding

Who needs a Part III VASP Licence?

All businesses that carry on VASP activities in or from within the Bailiwick of Guernsey ("Guernsey") and all Guernsey businesses that carry on VASP activities anywhere in the world will need a Part III VASP Licence unless an exemption applies. This is the case irrespective of whether such a firm holds a VASP licence (or its equivalent) in another jurisdiction.

The LCFL sets out the scope of the VASP activities which require a Part III VASP Licence:

• exchanging between virtual assets and fiat currencies;
• exchanging between one or more forms of virtual asset;
• transferring of virtual assets;
• safe-keeping and/or administration of virtual assets or instruments enabling control over virtual assets;
• participation in and provision of financial services relating to an issuer's offer and/or sale of virtual asset (including, without limitation and by way of example, an initial coin offering), whether by the issuer of the asset or a service provider affiliated or unaffiliated with the issuer in respect of the issue, offer, sale, distribution, ongoing market circulation and trading of the asset (including book-building, underwriting and market making); or
• any other service or activity or class or description thereof in respect of virtual assets specified for the purposes of the LCFL by regulations of the Committee.

"Virtual assets" are defined by the LCFL as a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes, but virtual assets do not include digital representations of – (a) fiat currencies (e.g. if the UK was to issue the digital pound), or (b) general securities and derivatives and other financial assets.

However, virtual assets do not include a transaction in which a person grants value as part of a store or gift card, affinity or rewards programme, where said value cannot be taken from or exchanged with the person for legal tender, bank credit or any digital asset, or a digital representation of value issued by or on behalf of a publisher of games and used solely within an online game, game platform, or family of games sold by the same publisher or offered on the same game platform.

The GFSC acknowledges that there is a wide range of activities being carried out in the virtual asset space and these activities are constantly evolving and changing. As such the LCFL and the Rules broadly define virtual assets and the GFSC intends to broadly interpret the definition of virtual assets to ensure that emerging products and services are appropriately captured in order to align with The Financial Action Task Force's guidance on virtual assets which is a key move in Guernsey's development as a leading VASP jurisdiction. The GFSC will take a functional approach to determining whether VASP activities are carried out by focusing on the real and economic effect of the potential Licensee's business model and activities.

It is important to note that the outsourcing of VASP activities to a group company or third party may under certain circumstances still require a Part III VASP Licence.

What if the business is already regulated?

There is no exemption for firms licensed under any other regulatory laws in Guernsey.

It is important to note that the GFSC does not recognise equivalence of licensing. This means that even though a firm is licensed for VASP activities in another jurisdiction, the GFSC will require such a firm to also be licensed under
the LCFL where such services or activities are provided in or from within Guernsey.

Are there any exemptions?

The Class Exemptions Notice provides for certain activities be exempt from the licensing requirement under the Part III VASP licensing regime, the main exemptions being for:

• Persons who make investments, hold or trade in virtual assets for their own benefit;
• Persons who accept or make payment for goods or services in virtual assets;
• Authorised or registered funds investing, holding or trading in virtual assets; and
• Licensees who hold a regulatory licence under certain of the supervisory laws in the course of providing administration or management services to VASPs which either hold a Part III VASP Licence or are exempt as they hold or trade in virtual assets for their own account above.

What requirements apply to a Licensee?

At present the GFSC is of the view that virtual assets present significant risks for consumer and investor detriment due to (i) high price volatility exhibited by the majority of virtual assets; (ii) large trading which occurs on unregulated exchanges; (iii) increased risk of market manipulation; and (iv) frequent reports of hacks, theft, scams, fraud and "pump-and-dump" schemes.

Licensed VASPs in Guernsey will therefore only be permitted to provide VASP services to institutional and wholesale counterparties and will not be allowed to provide VASP services to the retail public, including individuals that are regarded as high net worth individuals or those that would qualify as professional or sophisticated investors. Additionally, Licensees are prohibited from dealing in, trading in, or offering virtual assets, or virtual asset services, which aim to obscure the parties to the transaction, or virtual assets, or virtual asset services, which aim to obscure the flow of the assets.

All VASP activities carried out within Guernsey are subject to enhanced regulatory substance requirements and none of the services connected to the VASP may be outsourced to another jurisdiction without GFSC consent. Licensees will be subject to liquidity and financial resources requirements which are agreed with the GFSC at the time of licensing.

Due to the wide variety of potential VASP business models and activities, the GFSC may grant licences subject to certain restrictions based upon the nature of the VASP business and its risk profile. For example, a virtual asset exchange and virtual asset custodian will likely have different licence conditions in terms of capital requirements and different rules may apply to each business model.

The GFSC notes that many virtual asset networks are immensely energy intensive and compares the energy consumption of the Bitcoin network to that of a small or medium sized industrial nation. Therefore in light of Guernsey's international commitment to reaching net zero emissions by 2050, Licensees will have to be transparent about the environmental impact of their virtual asset activities. Publicly available data and sources may be used when calculating emissions and energy consumption, however care should be taken to establish the reliability thereof and whether any assumptions made are prudent and not exaggerated.

Whilst the Rules require Licensees to publish information annually it does not state in what format such information must be published. It does state that where a Licensee elects to disclose its environmental declaration on its website, the location thereof should be apparent and easily accessible and that historical disclosures should remain published and accessible.

Licensee responsibilities

The Rules include certain corporate governance and management responsibilities, common to all persons licensed under the LCFL which mirror those required under other regulatory law licensed persons. These requirements relate to:

• Minimum criteria for licensing - a Licensee must meet the minimum criteria for licensing set out in the LCFL (the requirements are similar to that in other regulatory laws in Guernsey). The GFSC also has the full range of supervisory, enforcement and rule-making powers under the LCFL that it has under those other regulatory laws;
• Conduct of business principles – these ten principles relate to integrity, skill, care and diligence, conflicts of interest, information about customers, customer assets, market practice, financial resources, internal organisation, and relations with the GFSC;
• MLRO and MLCO – Licensees must appoint a Guernsey resident Money Laundering Reporting Officer and a British Isles resident Money Laundering Compliance Officer;
• Audited accounts – Licensees must have their accounts audited (except for the holder of a Part II Licence that is only providing services ancillary to credit);
• Conflicts of interest policy – Licensees must have a policy on managing conflicts of interest appropriate to their business;
• Outsourcing – Licensees remain responsible for outsourced functions, and must have appropriate systems in place to oversee, control and monitor outsourced functions. Before appointing an outsourced service-provider, a Licensee must carry out due diligence on the provider and conduct a risk assessment;
• Complaints – including a requirement for a complaints procedure and a complaints log,together with an escalation process and GFSC notification;
• Customer money – customer money is required to be held in a segregated customer money bank account with an approved bank; and
• Marketing – Licensees must ensure that promotions and advertising are fair, transparent, and honest. Other requirements apply to advertising and promotions.

Walkers comments

Although the Part III VASP Licence and Rules provide a framework for firms wishing to conduct VASP business from or within the Bailiwick, its application is very narrow. It appears that the GFSC is taking a cautious approach by only permitting VASP services to be provided to institutional and wholesale counterparties.

The VASP licence application and annual fees are high compared to other offshore jurisdictions, and exceed the fees for any other licence type under the LCFL.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.