By Neha Dhir
The recent issuance of a notification requiring all entities involved in the exchange, transfer, safekeeping and administration of virtual currencies, as well as financial services related to the issuance of virtual currencies, to comply with the Prevention of Money-Laundering Act 2002 is a major step forward in recognizing and regulating the crypto domain in India.
The legalities of this move are that all entities have to comply with Anti-Money Laundering regulations which include conducting thorough know-your-customer (KYC) procedures, keeping records of transactions, and filing reports with the relevant authority. But what are the legal challenges associated? We discuss.
The Enforcement Directorate (ED) had before the issuance of notification dated 07/03/2023 and grant of express power to ED under the Prevention of Money Laundering Act, 2002 (PMLA) for matters concerning Anti Money Laundering (AML) and Countering the Financing of Terrorism (CFT) Virtual Digital Assets (VDA), taken suo moto cognizance of the issues regarding lack of Enhanced Due Diligence and raising Suspicious Transaction Report (STR) against various stakeholders in the Virtual Assets (VA) Industry.
The issuance of the notification goes beyond just a declaration and signature as it strengthens ED’s power to a greater extent and brings forth a certain clarity to the ambiguities present in terms of legal remedy that users of such assets can avail. Furthermore, it provides an opportunity to be heard by the Special Courts established under the PMLA in matters concerning the VDA industry.
The matter of concern is that the pendency of cases before the PMLA and PMLA Appellate Tribunal (PMLA AT) has been unresolved for two years. In this situation, to open the jurisdiction of courts and appellate authority under PMLA to VDA industry matters would be an inefficient implementation of the law, as well as an additional burden on existing judicial courts.Rather than immediately taking this step, a more effective approach would be to first set up a regulator to make a regulatory and licensing framework for the VDA service providers.
This would allow for establishing clear and express laws for the VDA industry, following the model of other jurisdictions such as the United Arab Emirates (UAE) and the European Union (EU). The UAE has taken the progressive step of setting up the Virtual Assets Regulatory Authority (VARA), which has developed a well-defined and legally enforceable regulation with rule books for each activity in the industry, and licensing and compliance requirements.
The applicability of specific requirements imposed by the Prevention of Money Laundering Act with respect to compliance, disclosures, reporting and filing of statements for exchanges, wallets and financial services providers related to the offer and sale of Virtual Decentralized Assets (VDAs) may result in an increase in costs of compliance, audit and due diligence. This could result in the elimination of illegitimate players in the industry, as well as regulation of the VDA industry.
However, this presents a unique challenge, since the decentralised nature of VDAs can be a barrier when it comes to identifying and regulating those involved in buying and selling VDA. Furthermore, many exchanges and wallet providers operate anonymously, making it challenging for authorities to trace transactions and monitor the industry.
By taking proactive measures such as integrating compliance and auditing protocols, it’s possible to ensure that these requirements are met without impinging on the decentralized nature of VDAs. This could benefit the industry in the long term by encouraging only legitimate players in the industry and helping to protect users from fraud and predatory behaviour.
In order to successfully overcome the looming challenges presented by the upcoming introduction of PMLA reporting requirements and the subsequent implications for the VDA industry, the government must work in close partnership with these providers in order to develop effective compliance measures which are both robust and practical.
This approach will enable VDA service providers to comply with PMLA reporting, as well as the additional reporting metrics which, though likely to affect trading volumes and revenues of exchanges, also hold the potential to greatly benefit investigations by the Enforcement Directorate and Income Tax Department.
Furthermore, exchanges will need to invest resources in order to comply with the SPDI Rules of 2011 and Data Protection Laws, which are necessary to protect sensitive personal data. By establishing a collaborative and cooperative relationship between the government and VDA industry, the effective and efficient enforcement of reporting regulations and compliance measures may be achieved, while simultaneously mitigating the financial risks posed to exchanges.
Effect on Indian Crypto Space
The Indian government has taken a proactive stance on VDA industry regulations at the global level, engaging in discussions with G20 finance ministers and central bank governors. India has urged the International Monetary Fund (IMF) and the Financial Stability Board (FSB) to collaborate on a joint paper to help countries create comprehensive crypto policies. However, the inclusion of VDAs within the ambit of the Prevention of Money Laundering Act (PMLA) without providing clear and unambiguous regulations and licensing requirements could potentially hamper the industry’s growth in India.
Without defining the regulatory, compliance and licensing regulations for the industry, this approach to set up a punitive law may be a detrimental step for VDAs, stifling the industry before it has a chance to grow and succeed. The absolute concentration of power in the hands of ED and Income Tax Authorities (ITA) to take cognizance, issue summons, conduct investigation, raids, arrests and freeze proceeds of crime in the presently highly unregulated and largely misunderstood cryptocurrency industry, that is fundamentally based on complex technology and is immensely global and high stake, is far reaching and could potentially lead to witch hunting of innocent parties and companies. Such potential risks therefore make it necessary for said authorities to be delivered sound and fair regulatory and precautionary measures in order to curb any abuse of their powers.
The author is attorney, global digital assets practice, BlockLegal