Understanding the Travel Rule and Its Impact on the Crypto Industry

In the ever-evolving landscape of cryptocurrency, regulatory compliance plays a vital role in ensuring transparency and preventing illicit activities. One such regulation that has garnered significant attention is the Travel Rule. 

FATF Plenary 2023 Takeaways

The Financial Action Task Force (FATF) is implementing the Travel Rule to help virtual asset service providers (VASPs) better facilitate freezing actions, in order to discourage bad actors from using crypto for nefarious purposes. The Travel Rule requires countries to ensure that VASPs in their local jurisdictions share beneficiary real-identity information mandatory, at the time of or prior to transacting. 

• In its recent plenary the FATF however has observed that the implementation of the Travel Rule has been slow, and many member states are lagging behind in compliance. 
• In fact, a survey by FATF found that only 29 of 98 jurisdictions had taken steps towards implementing the Travel Rule. 
• VASPs seem to have been slow to comply for myriad reasons, and most global regulators have not enforced the requirement, with countries at different stages of Travel Rule implementation. 

The FATF has urged countries to implement anti-money laundering (AML) and counter-terrorism financing (CTF) measures on crypto-related activities "without delay" in order to prevent "criminals" from exploiting "significant loopholes" not protected by regulation. The FATF has also called on all member states to implement the Travel Rule "without delay" to close "loopholes" not currently protected. The Travel Rule implementation is one of the top priorities of FATF's virtual asset work.

Introduction

The Travel Rule is highly complex and demands the use of technology to monitor transactions that, until recently, was unavailable. For instance, the FATF recommends that countries adopt a 'de minimis' threshold of 1,000 USD/EUR for VA transfers, while keeping in mind that there would be comparatively fewer risks associated with transfers below this threshold. However, new technology solutions based on predictive and behavior analysis are available that address Travel Rule requirements, so regulators from different jurisdictions are expected to move faster in the implementation. 

What is the Travel Rule?

The Travel Rule, also known as the Funds Travel Rule, is a regulation established by the Financial Action Task Force (FATF), an intergovernmental organization combating money laundering and terrorist financing. Initially introduced in 1996, the Travel Rule required financial institutions to share customer information during cross-border transfers exceeding a certain threshold. Traditionally, this rule applied to banks and other traditional financial entities.

However, with the rapid growth of the cryptocurrency industry which currently sits at a market cap of $1.3 trillion in 2023 and is expected to surpass $5 trillion by 2028, depicting an astounding rise at a CAGR of 30.40%- regulators recognized the need to extend the Travel Rule's reach to include virtual asset service providers (VASPs). VASPs encompass entities such as cryptocurrency exchanges, custodian wallet providers, and peer-to-peer trading platforms.

The Application of the Travel Rule to Crypto

In June 2019, the FATF released updated guidance explicitly outlining the applicability of the Travel Rule to virtual assets. The guidance mandates that VASPs must collect and share customer information, including originator and beneficiary details, for transactions exceeding the prescribed threshold. This information exchange aims to facilitate effective anti-money laundering (AML) and counter-terrorism financing (CFT) efforts within the crypto space.

The Travel Rule requires VASPs to establish secure systems that enable the seamless transmission of customer data alongside cryptocurrency transactions. By enforcing this rule, regulators aim to minimize the risks associated with anonymous transactions, enhance transaction monitoring capabilities, and foster a more transparent crypto ecosystem.

Outcomes FATF Plenary, 22-24 February 2023

There is an ongoing collaboration between the Financial Action Task Force (FATF) and jurisdictions that are currently under scrutiny to address strategic deficiencies in their systems. The primary objective is to combat illicit activities such as money laundering, terrorist financing, and proliferation financing. 

What is Grey list

When a jurisdiction falls under increased monitoring by the FATF, it signifies the country's commitment to promptly rectify the identified strategic shortcomings within agreed timeframes, thereby subjecting themselves to intensified supervision. Externally, this list is commonly known as the "Grey List."

The FATF, together with FATF-style regional bodies (FSRBs), maintains engagement with the listed jurisdictions as they provide progress reports on their efforts to tackle the identified strategic deficiencies. The FATF urges these jurisdictions to diligently execute their action plans within the agreed timeframes.

Jurisdictions under Increased Monitoring 

Periodically, the FATF identifies additional jurisdictions that demonstrate strategic deficiencies in their systems to combat illicit financial activities such as money laundering, terrorist financing, and proliferation financing. While some jurisdictions are yet to undergo review by the FATF or their respective FSRBs, they will be evaluated in due course.

Europe:

• Albania
• Gibraltar
• Türkiye (Turkey)
• Croatia (Newly identified)
  
  

North America:

• Barbados
• Cayman Islands
• Jamaica
• Panama
• Haiti
  
  

Africa:

• Burkina Faso
• Democratic Republic of Congo
• Mali
• Mozambique
• Senegal
• South Africa
• South Sudan
• Uganda
• Nigeria
• Tanzania
• Cameroon (Newly identified)
  
  

Asia:

• Jordan
• Philippines
• UAE (United Arab Emirates)
• Syria
• Vietnam (Newly identified)
  
  

High-Risk Jurisdictions subject to a Call for Action

For countries identified as high-risk, the FATF has emphasised the importance of enhanced due diligence. However, in the most severe cases, more stringent measures are necessary to safeguard the integrity of the international financial system. These measures, known as counter-measures, are implemented to protect against the risks associated with money laundering, terrorist financing, and proliferation financing.

The FATF has identified three jurisdictions which need to improve the strategic deficiencies in their AML/CFT policy. The jurisdictions include Democratic Republic of Korea, Iran and Myanmar. The FATF recommends its member states to uphold the highest level of counterparty due diligence measures to ensure global financial stability.

FATF has recommended multiple due diligence enhancements over the existing comprehensive framework to these three members. These recommendations specifically cater to the lack of strategic deficiencies identified by FATF:

• Demonstrating an improved understanding of ML risks in key areas; 
• Demonstrating that on-site/off site inspections are risk-based
• Ensuring that ML is investigated/prosecuted in line with risks; 
• Demonstrating investigation of transnational ML cases with international cooperation; 
• Managing seized assets to preserve the value of seized goods until confiscation.
• Demonstrating an increase in the freezing/seizing and confiscation of criminal proceeds, instrumentalities, and/or property of equivalent value; and 
• Demonstrating enhanced use of financial intelligence in LEA investigations, and increasing operational analysis and disseminations by the Financial Intelligence Units (FIU).

It is important to note that due to the COVID-19 pandemic, the FATF temporarily halted the review process for Iran and the Democratic People's Republic of Korea (DPRK) from February 2020. However, the FATF's call for countermeasures on these high-risk jurisdictions remains in effect.

Although the statement adopted on 21 February 2020 might not reflect the most recent status of Iran and DPRK's AML/CFT regimes, it underscores the ongoing importance of applying countermeasures and protecting the integrity of the global financial landscape.

Implications for the Crypto Industry

Enhanced AML/CFT Measures:

The scale of illicit use of crypto assets is significant, highlighting the importance of AML/CFT regulation and supervision, as well as law enforcement. Implementing international standards, particularly those issued by the Financial Action Task Force (FATF), should provide a solid basis for effective AML/CFT compliance. For more effective AML programs, crypto companies should consider AML/CFT solutions that include suspicious activity monitoring both on and off the blockchain, streamlined case management, and behavior-based risk management.

Technological Challenges:

The implementation of the Travel Rule has posed a significant challenge for the crypto industry, which was initially designed to allow for pseudonymous transactions. Some of the challenges for consideration include alignment of KYC policies for every VASP globally, ownership of risk, reliance on third parties, enhanced due diligence, building and managing a global team of trained compliance staff, as well as data privacy and data processing requirements. To effectively address the risks that cryptocurrency transactions present, crypto exchanges should seek to establish the identities of their customers and understand their financial activity.

Global Coordination and Standardization:

As the crypto-asset ecosystem moves across the spectrum from centralized to decentralized, the intricacies in identifying the “who”, “where” and “what” of transactions become more complex. The borderless nature of technology means that global coordination is necessary to establish a consistent, coordinated, and effective regulatory framework for crypto assets. The FATF reviewed the opportunities and challenges of new technologies for AML/CFT to raise awareness of relevant progress in innovation and specific digital solutions. The FATF also looked at the persisting AML/CFT measures, as well as the costs of implementing the measures.

Conclusion

The Travel Rule represents a significant milestone in the regulation of the cryptocurrency industry. By extending the rule's application to virtual asset service providers, regulators aim to foster a more secure and transparent ecosystem. While compliance with the Travel Rule poses challenges, it ultimately strengthens AML and CFT efforts and instills greater confidence in the crypto market. As the industry continues to evolve, proactive adaptation to regulatory changes will be crucial for both businesses and individuals operating within the crypto space.

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