Draft regulations implementing 5MLD in Germany seek to extend regulatory perimeter and clarify regulation of crypto activities

The German Federal Ministry of Finance (Bundesfinanzministerium – “BMF“) has recently published a draft law (Regierungsentwurf) (“Draft“) to implement the amending directive (Änderungsrichtlinie) to the Fourth EU Anti-Money Laundering Directive 2018/843 (“4MLD”).

The Draft is intended not only to transpose the current Anti-Money Laundering Directive (EU) 2018/843 (“5MLD“) into national law, but to implement further reform proposals as well. For example, in addition to the necessary implementation under anti-money laundering law, the Draft provides for “cryptographic values” (Kryptowerte) to be regulated as financial instruments (Finanzinstrumente) and wallet-providers to be regulated as financial services providers (Finanzdienstleistungsinstitute).

The Draft has now been sent to the associations concerned for consultation and statement.

Extending the regulatory perimeter

According to the Draft, the scope of application of the GwG will be extended and strengthened to include further obligated parties (Verpflichtete) under anti-money laundering law. For those professional groups, this means that they will have to fulfil due diligence obligations (in particular identification of contractual partners, clarification of beneficial owners, continuous monitoring of the business relationship), set up a risk management system and report suspicions in the future.

1. Extending the range of obligated parties (Verpflichtete) in the financial sector

Exchange platforms that exchange fiat money (EUR, USD, RUB, etc.) for virtual currencies and vice-versa or offer the exchange of virtual currencies among themselves.

According to the administrative practice of the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – “BaFin“), crypto currencies have for some time been deemed units of account (Rechnungseinheiten) within the meaning of section 1(11) sentence 1 no. 7 KWG. Therefore, in BaFin’s opinion (in spite of a different ruling by the higher court, which BaFin did not follow), services relating to crypto currencies may qualify as financial services (Finanzdienstleistungen) and be subject to licensing accordingly.

According to the Draft, cryptographic values are now to be expressly included in the KWG as financial instruments (Finanzinstrumente).

Cryptographic values should therefore be defined as (§ 1 para. 11 sentence 3 KWG Draft)

“digital representations of a value which has not been issued or guaranteed by any central bank or public authority and does not have the legal status of a currency or money but is accepted as a means of exchange or payment by virtue of an agreement or actual practice […]”.

The term “crypto value” is derived from the internationally accepted term “crypto assets”. The term is intended to cover all forms of virtual currencies and digital value units. However, whilst so-called Security Tokens and Payment or Currency Tokens are included, Pure Utility Tokens that serve as electronic vouchers for the purchase of goods or services are not.

Under the law as it currently stands, crypto currencies can qualify as financial instruments – in particular: investment products (Vermögensanlagen), debt instruments (Schuldtitel), shares in an investment fund (Anteile an einem Investmentvermögen) or units of account (Rechnungseinheiten). As an example of a generally known crypto value that qualifies as a unit of account, the Draft cites Bitcoin.

Therefore, the exchange of cryptographic values that qualify as financial instruments within the meaning of the KWG can already be a banking business (Bankgeschäft) or a financial service. Accordingly, the exchange of cryptographic values into legal currency or vice versa as well as into other cryptographic values may qualify as, for example: financial commission business (Finanzkommissionsgeschäft), proprietary trading (Eigenhandel) or the operation of a multilateral trading system (Betrieb eines multilateralen Handessystems). As a result, crypto exchange platforms are already regularly used by credit institutions or financial service providers and are thus regulated under the GwG.

Consequently, the term “cryptographic value” in the KWG would not cover a wider classification of digital value units than the current legal situation and the current administrative practice of BaFin. It can therefore be assumed that the normalisation of the term cryptographic value as a financial instrument is rather intended to clarify the administrative practice of BaFin and thus provide legal security.

Providers of electronic wallets (so-called Crypto Wallet providers) with which virtual currencies (e.g. Bitcoin) are stored

Currently, service providers offering the custody of cryptographic values have generally not been within the regulator’s scope if the cryptographic values do not qualify as securities (Wertpapiere) (if so, possibly custody business – Depotgeschäft) or securities (exclusively) for investment funds (if so, possibly restricted custody business – eingeschränktes Verwahrgeschäft).

In the future, the custody, administration and security of cryptographic values or private cryptographic keys for others, which serve to hold, store and transfer cryptographic values, shall represent so-called crypto custody business (Kryptoverwahrgeschäft).

The crypto custody business is to be introduced into the KWG as a new financial service. Service providers offering crypto custody business would therefore be regulated under anti-money laundering law as financial services providers.

Financial undertakings (Finanzunternehmen)

The Draft provides for the introduction of an independent definition of the financial undertaking in the GwG. This is intended to separate the term ‘financial undertaking’ under GwG from the respective definition in the KWG.

Financial undertakings within the meaning of the GwG comprise companies whose main activity is to acquire monetary receivables against payment with a financing function.

Companies that acquire receivables with a financing function (factoring) generally constitute financial services providers within the meaning of the KWG and are therefore already obligated parties pursuant to the GwG. However, the term ‘financial undertaking’ as defined by the GwG should be broader and will also include those companies that provide maturity factoring (Fälligkeitsfactoring), i.e. the acquisition of receivables without a financing function. At present, these are not obligated parties pursuant to the GwG, which means that the circle obligated parties would be inflated – without any regulatory necessity.

Payment and e-money institutions (Zahlungs- und E-Geld-Institute) with a place of business overseas that operate domestically through agents or e-money agents

Payment and e-money institutions (Zahlungs- und E-Geld-Institute) established abroad are not currently covered by the scope of the GwG. In future, payment e-money institutions domiciled in a member state of the European Economic Area who are operating in Germany through agents (Agenten) or e-money agents (E-Geld-Agenten) shall be covered.

By widening the scope, systemic shortcomings in the implementation of GwG obligations in a network of agents shall be reprimanded and, if necessary, sanctioned directly by the cross-border institution. Such kind of amendment would result in backing away from the “domicile principle” (Sitzprinzip) currently applicable to the GwG, namely that only persons / companies domiciled in Germany are subject to German anti-money laundering obligations.

2. Extending the range of obligated parties (Verpflichtete) in the non-financial sector

Obligations under the GwG are extended under the Draft to cover real estate agents (Immobilienmakler), where they broker rental contracts with a monthly rent of at least EUR 10,000, and art warehouse keepers (Kunstlagerhalter), where they carry out transactions with a value of at least EUR 10,000.

Group-wide duties

Under the new legislation, corporate groups will also be covered where the parent company itself is not obliged under anti-money laundering law, but only the companies, branches and subsidiaries belonging to the group. The new regulation is intended to prevent group-wide obligations from being circumvented. With the new regulation, it shall no longer be possible to set up a parent company with no operational business, which is not an obligated party under the GwG by itself, in order to circumvent the provisions of money laundering law.

However, this does not follow from the provisions amended in the Draft, but only from the explanatory memorandum of the Draft. It is therefore unclear to what extent this scenario will be incorporated in the actual law and which specific constellations will be included.

Who is classed as a politically exposed person?

In order to specify the group of politically exposed persons for whom increased due diligence obligations apply, each Member State must provide the European Commission by January 2020 with a list of the specific functions and offices to be covered. The European Commission will draw up a common list from the lists of Member States, which will then also be referred to in the GwG.

Public access to the transparency register

In future, the transparency register will be accessible to the entire public. However, the existing inspection procedure is to be retained.

Obligated parties and competent authorities shall be obliged to report to the body keeping the register any discrepancies that come to their attention after consulting the transparency register. In addition, a requirement will be introduced to obtain proof of registration or an extract from the register when establishing a new business relationship with registered companies.

Extension of liability for fines

It is envisaged that the catalogue of fines will be extended to include further offences. It is also intended to intensify criminal prosecution by obliging supervisory authorities to inform the prosecuting authorities immediately if there are any indications of criminal offences.

The powers of the German Financial Intelligence Unit (Zentralstelle für Finanztransaktionsuntersuchungen) (including extended data access powers) will also be strengthened. However, such regulations are not yet part of the Draft, but shall be incorporated into the Draft in the course of the legislative procedure.

Comment

The Draft mainly provides for changes that are prescribed by the 5MLD and must therefore be implemented Europe-wide by 10 January 2020. In this respect, the proposals of the Draft are hardly surprising. More surprising are the gold plating amendment proposals, in particular the introduction of a new authorisation in the KWG for Crypto Wallet providers and the definition of cryptographic values as a financial instrument.

Under the Draft, the law will be clarified such that virtual units that correspond to the definition of cryptographic values must always be qualified as financial instruments within the meaning of the KWG. If the Draft is implemented in this way, transactions with cryptographic values are likely to be subject to authorisation in the future. This would lead to legal clarity, in particular by resolving the disagreement between the Berlin Court of Appeal (Kammergericht Berlin) and BaFin. In terms of content, no major change is to be expected from the standardisation of cryptographic values as financial instruments, since the classification of crypto units will not be wider than it currently is, according to BaFin’s administrative practice thus far.

With the planned introduction of the crypto custody business, a new financial service would be created which would likely lead to a great need for adjustment in the industry. It can be assumed that most crypto wallet providers do not hold a licence from BaFin. For wallet providers, this would mean that they would have to meet the (high) capital requirements pursuant to the KWG as well as the minimum requirements for risk management and proper business organisation. On the other hand, they would have to set up a structure that would enable them to meet the requirements placed on obligated parties and, in particular, to fulfil the general duties (allgemeine Sorgfaltspflichten).

The introduction of an own definition of a financial undertaking in the GwG for the first time is intended to facilitate a broad understanding of the term and, in particular, to cover companies that are not covered by the term financial undertaking pursuant to the KWG. This would notably affect companies that provide maturity factoring. This change is questionable though, given that maturity factoring (Fälligkeitsfactoring) is not subject to approval under the KWG.

Since the present Draft is a proposal by the BMF to amend the law, it remains to be seen which of the draft provisions will be contained in the final legislation, following further consultations and hearings with associations.