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MFSA issues Feedback on PIFs investing in VCs

The MFSA has issued a feedback statement in reply to the consultation previously held on Professional Investor Funds (PIFs) investing in Virtual Currencies (VCs).

The Proposed Regulation aims to introduce within the regulatory framework, provisions to safeguard the interests of investors and the integrity of the financial market in the context of virtual currencies.

In view of the feedback received, the MFSA has revised its position on having a separate rulebook applicable to PIFs investing in VCs. The additional requirements pertaining to such PIFs will instead be inserted as supplementary licence conditions applicable to such collective investment schemes (CIS) and not as a standalone rulebook. This is a welcomed decision as it will avoid creating unnecessary confusion and overlapping between the different rulebooks.

Applicability

The proposed framework will be applicable to all CIS investing in VCs, regardless of their exposure to such investments. This therefore means that if a PIF invests only a limited percentage of its assets under management (AUM) in VCs, whether directly or indirectly through trading companies or special purpose vehicles, it would fall under the full scope of the proposed regulatory framework. This does not however include any other type of indirect investment including investment in units of a CIS which itself invests in VCs. Nevertheless, investments in those units of CIS which were created through an ICO, are to be construed as a direct investment in VCs.

Extension of Scope

The MFSA has suggested that it is prone to extend the scope of the proposed framework to apply to AIFs and Notified AIFs (NAIFs) as well. We consider this to be a step in the right direction to facilitate the operations of the VC market.

Legal Structure

In response to the feedback received, the MFSA has also revised its original position on the type of investment models for CIS investing in VCs. This was originally limited to SICAV and INVCO structures as they were considered to have additional governance oversight safeguards since they are required to have a board of directors responsible for the overall conduct of business of the CIS. The MFSA has now extended the regime to include limited partnerships and unit trusts. Cellular structures will also be available under the framework and thus PIFs investing in VCs may be established as Incorporated Cell Companies (ICCs), or Incorporated Cells (ICs) of either a SICAV ICC or a Recognised Incorporated Cell Company (RICC).

Investor Base and Diversification

In view of the specific risks associated with VCs and their underlying technologies, the MFSA has decided that for the time being it will maintain its original position to restrict the proposed regime to Qualifying Investors. Furthermore, in line with the current regulatory regime, PIFs investing in VCs will not be bound by the principle of risk spreading.

Competence

The MFSA has also clarified its position in terms of the competence required by members of a CIS’s governing body. The Authority thus expects the governing body to have a suitable mix of skillsets encompassing financial services, the field of VCs and their underlying technologies. This also applies to the governing bodies of existing PIFs launching sub-funds investing in VCs.

Furthermore, since the Compliance Officer and the MLRO need to be accustomed to the dealings of the business of the PIF, it expects Compliance Officers to have an understanding of the field of VCs and their underlying technologies, whereas MLROs are further expected to remain up-to-date with the various money laundering/funding of terrorism typologies adopted within the DLT ecosystem. This obligation is also to be borne by auditors who are expected to have the necessary knowledge and expertise to identify, review and form an opinion on the respective risks applicable to VCs and any relevant safeguards in place.

Quality Assessment

The Authority in its feedback reiterated that to comply with the quality assessment requirement, investment managers must carry out appropriate research to assess the quality of the VCs in which they are investing. This assessment must be carried out prior to investing in the VC, and it must take into consideration a number of specificities, including liquidity and market capitalisation. The VC investment should remain in accordance with the investment objects, policy and restrictions outlined in the scheme’s offering documents.

Safekeeping and Custody

As a minimum, a PIF investing in VCs is expected to opt for a combination of cold and hot storage. With regards to cold storage, the PIF is expected to use a multi-signature wallet whereby the input of two out of two signatories would be required to access the wallet and transact in VCs. The investment manager (or the investment committee and/or portfolio manager where the PIF is self-managed) is expected to be the first signatory and the custodian the second signatory. Subsequently, the investment manager (or investment committee and/or portfolio manager) may transfer, with the custodian’s mandatory input, VCs from the multi-signature (cold) wallet to the sole-signature (hot) wallet to which the investment manager (investment committee and/or portfolio manager) will have sole access. The adequacy of safekeeping and custody arrangements applicable to PIFs investing in VCs will be assessed by the Authority on a case by case basis.

Service Providers and Governing Body

The MFSA also clarified that, similar to any other asset class, the service providers for CIS investing in VCs will be required to have the same sufficient financial resources and liquidity at their disposal to enable them to conduct their business, and such business organisations, systems, experience and expertise deemed necessary by the MFSA, as reflected in the requirements of the traditional PIF framework already in place. Competence of the relevant service providers in the area of VCs will be assessed by the Authority on a case by case basis.

Furthermore, where an investment manager is authorised in an EU/EEA State or a Recognised Jurisdiction, the requirement for prior approval of the in-house investment committee members by the MFSA shall not be applicable. In such instances, the governing body and the proposed investment manager of the CIS shall be required to submit a declaration confirming the existence of such in-house investment committee together with any required information and documentation evidencing its members’ competence in VCs.

Risk Management

The MFSA has noted that the manner in which the investment manager (or investment committee and/or portfolio manager) performs the Risk Management function, including stress testing procedures, is a business decision that should be taken by the investment manager (or investment committee and/or portfolio manager) of the Scheme.

Liquidity

Similar to any other asset class, PIFs investing in VCs should ensure that the appointed investment manager employs an appropriate liquidity management policy and adopts procedures that enable the investment manager to monitor the liquidity risk of the scheme and to ensure that the liquidity profile of the investments of the scheme complies with its underlying obligations.

The Authority noted that not all VCs can be considered as “liquid” and thus VCs should not be termed as “highly liquid assets”. Hence, similar to other asset classes, the scheme should ensure that the investment manager uses the appropriate liquidity management tools such as, inter alia, the use of side pockets and redemptions in specie, subject to sufficient and appropriate disclosures being included within the offering documentation. Given the liquidity risks associated with VCs and their nascent nature, the requirement on CIS to ensure that the appointed investment manager confirms consistency between the liquidity profile and the redemption policy would further place an additional governance safeguard.

Valuation

Valuation policies and procedures applicable to other asset classes should also be adopted to the valuation of VCs’ exposures and the calculation of the net asset value (NAV) of the scheme. Hence, PIFs investing in VCs should adopt appropriate and consistent procedures so as to ensure proper and independent valuation of the assets as well as proper calculation of the scheme’s NAV.

Listing

Whereas listing on a regulated market shall also be available to PIFs investing in VCs, this possibility shall not include those units which have been created through an ICO until the pertinent regulatory framework of the proposed Virtual Currencies Act is implemented.

Following the issue of this Feedback Statement we now await the issue of the updated Rulebook regulating PIFs investing in VCs as well as awaiting the Feedback Statement following the Discussion Paper on Initial Coin Offerings (ICOs), Virtual Currencies and Related Service Providers.

For more information on Virtual Currencies, ICOs, and Collective Investment Schemes particularly related to VCs, please contact Dr Ian Gauci on igauci@gtgadvocates.com or Dr Cherise Abela Grech on cabelagrech@gtgadvocates.com