FCA urges banks to act against financial crime risks associated with cryptoassets

Maria Nikolova

The latest “Dear CEO” Letter by the FCA addresses the topic of how banks handle the financial crime risks posed by cryptocurrencies and other cryptoassets.

The latest “Dear CEO” Letter authored by the UK Financial Conduct Authority (FCA) urges banks to consider carefully the risks associated with cryptoassets, as a growing number of clients are engaged in cryptoasset-related activities or hold such products.

The regulator is particularly worried that this class of product can be abused because it offers potential anonymity and the ability to move money between countries. The banks are told to take “reasonable and proportionate measures” to lessen the risk of their firm facilitating financial crimes which are enabled by cryptoassets.

With regard to clients offering services related to cryptoassets, banks are told that it may be necessary to enhance their scrutiny of these clients and their activities. The services that may require extra attention are those of cryptoasset exchanges which effect conversions between fiat currency and cryptoassets and/or between different cryptoassets, as well as trading activities where banls’ clients’ or counterparties’ source of wealth arises or is derived from cryptoassets.

The list of appropriate steps or actions to consider includes developing staff knowledge and expertise on cryptoassets and carrying out due diligence on key individuals in the client business including consideration of any adverse intelligence. For clients which are involved in ICOs, banks are advised to consider the issuance’s investor-base, organisers, the functionality of tokens (including intended use) and the jurisdiction.

Concerning banks’ customers using cryptoassets, the FCA pays attention to retail clients that may be holding or trading cryptoassets, and selling these assets may be the source of a customer’s wealth or funds. In a retail context, this may be discovered by, for example, enquiring about the source of a deposit, the regulator notes.

According to the FCA, firms should assess the risks posed by a customer whose wealth or funds derive from the sale of cryptoassets, or other cryptoasset-related activities, using the same criteria that would be applied to other sources of wealth or funds. For example, in the case of retail clients, the criteria they would apply to a property transaction, inheritance, or sale of a valuable artwork or car.

Where a firm identifies that a customer or client is using a state-sponsored cryptoasset which is designed to evade international financial sanctions, we would see this as a high-risk indicator.

Finally, retail customers contributing large sums to ICOs may be at a heightened risk of falling victim to investment fraud, the authors of the letter said.

The tone of the latest “Dear CEO” letter echoes that of the comments made by Mark Carney, Governor of the Bank of England, in a speech delivered in March this year. With regard to regulation, Carney warned that crypto-assets raise a range of issues around consumer and investor protection, market integrity, money laundering, terrorism financing, tax evasion, and the circumvention of capital controls and international sanctions.

Mr Carney emphasized that structural vulnerabilities in cryptocurrencies mean that they are inherently risky compared with traditional financial assets. The risks include extreme price volatility and poor market liquidity due to fragmented markets and highly concentrated holdings, which in turn facilitate manipulation and misconduct. These vulnerabilities are compounded by operational and technological weaknesses, as evidenced by a series of major crypto-asset heists.

“In addition, there is unease that the combination of these vulnerabilities and widening retail participation could damage the reputations of those financial intermediaries connected to crypto-asset markets”, Mark Carney said.

In extreme circumstances, according to him, it could even undermine confidence in the broader financial system itself, particularly if people held an unfounded belief that authorities had legitimised these activities.

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