The Dubai Financial Services Authority (“DFSA”) has published a comprehensive explainer (the “Explainer”) on its approach to regulating financial services in respect of “Crypto Tokens” carried on in or from the Dubai International Financial Centre (“DIFC”). We have set out some key takeaways from the Explainer below.
1. Crypto Tokens and the recognition criteria
The DFSA confirms that Crypto Tokens are tokens that are used or intended to be used as a medium of exchange or for payment or investment purposes. The definition of a Crypto Token does not include an “Excluded Token” (which includes NFTs, utility tokens and CBDCs) or an “Investment Token” (typically referred to as a tokenised investment) or any other type of investment.
With limited exceptions, only Crypto Tokens recognised by the DFSA can be used in the DIFC. This include certain types of “Fiat Crypto Tokens” (commonly referred to as “stablecoins”). Financial services relating to “Unrecognised Tokens” (unless it is the provision of custody and relating to certain type of funds) and “Prohibited Tokens” (including privacy tokens and algorithmic tokens) are not permitted.
Before recognising a Crypto Token, the DFSA will assess its suitability. Additional criteria will apply to Fiat Crypto Tokens. Where an applicant seeks recognition for multiple Crypto Tokens, the DFSA will work closely with them to ensure that there are appropriate timelines for recognising them all. The DFSA also confirms that only authorised persons, applicants to become authorised persons or an issuer or developer of the Crypto Token may apply to the DSFA for recognition in the DIFC.
Notably, as of September 2024, the DFSA has only recognised 5 Crypto Tokens, namely Bitcoin, Ethereum, Litecoin, Toncoin and Ripple. Notwithstanding that these comprise around 80% of the global market capitalisation of crypto assets, this is a highly restrictive policy when compared with regulators in the majority of other jurisdictions internationally.
2. What are the applicable financial services and relevant licensing requirements?
The DFSA confirms that while other financial services may indirectly relate to a Crypto Token, those which apply directly are the activities of dealing, advising, arranging deals, arranging or providing custody, managing assets and operating a clearing house or a multilateral trading facility.
Businesses new to the DIFC must obtain a licence to carry on financial services relating to Crypto Tokens, and businesses authorised by the DFSA must consider whether their licence covers their activities, or if a variation is needed. The Explainer also makes clear that, with limited exceptions, firms carrying on financial services relating to Crypto Tokens must be incorporated in the DIFC. The processing time for these applications varies depending on the nature, scale, and complexity of the transaction in question, but in any case, involves a 6-step process.
3. What are the key conduct requirements related to Crypto Tokens?
The Explainer includes a non-exhaustive list of conduct requirements including the provision of a key features document, custody requirements, technology governance requirements and independent technology audits, and risk warnings, with further obligations applying to firms dealing with retail clients (including appropriateness assessments and a ban on incentives).
4. If a Crypto Token is recognised by the DFSA, is it available for use by all authorised persons?
If a Crypto Token is recognised by the DFSA, it will be available for use by any authorised person provided they have the required authorisation on their licence. However, the DFSA still expects an authorised person to perform sufficient due diligence before offering Crypto Token-related products to clients.
5. Will the DFSA allow self-recognition of Crypto Tokens or remove the recognition process?
At present, self-recognition is not considered appropriate. The DFSA is of the view that self-recognition will rely on the development of a compliance culture and international standards.
6. What is the DFSA’s approach to stablecoins?
As stablecoins, referred to by the DFSA as Fiat Crypto Tokens, are typically marketed as providing a stable value relative to other crypto assets and hence attract broader use cases, they are subject to additional recognition criteria[1].
In the DIFC, recognised Fiat Crypto Tokens are allowed for additional use in certain circumstances in the context of the activities of money transmission and executing payment transactions, clearing and settlement and margining in connection with trading in Crypto Token derivatives.
The DFSA does not regulate the issuance of Fiat Crypto Tokens. However, its recognition criteria are intended to allow the DFSA to recognise Fiat Crypto Tokens issued in other comparable jurisdictions and ensure they maintain a stable value relative to their peg. Even if a stablecoin does not meet the criteria for a Fiat Crypto Token, it may still be a Crypto Token.
7. Does the DFSA impose any limits on trading volumes of Crypto Tokens?
No, there are no trading volume limits.
8. Do DFSA authorised firms require a variation of their licence to carry on financial services with investments relating to Crypto Tokens?
No, providing that the authorised firm has the relevant type of investment specified in its licence, and that investment is indirectly exposed to a Crypto Token. However, the firm must still comply with the specific regime that applies to Crypto Tokens. All other circumstances require a variation of permission.
9. What businesses are prohibited from providing Crypto Token-related services?
The DFSA does not permit representative offices, crowdfunding platforms and branches to carry on Crypto Token related services.
10. What is the DFSA’s approach to funds investing in Crypto Tokens?
The DFSA’s approach depends on where the fund is established or domiciled. In summary:
- funds established or domiciled in the DIFC do not have limitations on investing in recognised Crypto Tokens. They can invest the whole fund property in Crypto Tokens directly or indirectly. If they are a “Qualified Investor Fund” they can have 30% of their gross asset value invested in unrecognised Crypto Tokens (subject to certain requirements).
- external funds (established or domiciled outside the DIFC but managed by a DFSA authorised fund manager) can invest up to 20% of the fund’s gross asset value (“GAV”) in recognised Crypto Tokens. Units in these funds can only be offered to professional clients through private placement at a minimum initial subscription of USD 50,000. Similar conditions apply to units in foreign funds.
The DFSA’s approach to indirect investment by a fund in Crypto Tokens is the same as above.
11. Can a DFSA authorised firm offer foreign spot crypto exchange traded funds (“ETF”)?
Firms cannot offer units in foreign ETFs where the fund’s investment in Crypto Tokens exceeds 20% of its GAV. As most foreign spot Crypto ETFs are likely to be wholly invested in a single Crypto Token, they cannot be offered in the DIFC.
Some transactions, including (but not limited to) execution-only transactions and transactions for the purposes of managing a discretionary portfolio for a client, are not treated as ‘offers’ and therefore do not attract these restrictions.
12. What custodians can be used to safeguard and administer Crypto Tokens?
The DFSA allows the use of non-regulated custodians provided that the fund manager or authorised firm’s due diligence assesses the custodian as having adequate custody and asset safety arrangements.
13. What actions are custodians required to take in case of unauthorised or incorrectly executed transfers?
Custodians must put the client’s account back in the position it would have been in had the transfer not occurred or had been executed properly. This must happen promptly and within three business days. If the situation is not addressed, firms must disclose this to the DFSA. Quarterly reporting to the DFSA is also required.
Commentary
The Explainer provides clarity on the DFSA’s approach to Crypto Tokens, and the procedural and substantive requirements that firms must keep in mind. This clarification emphasises the DFSA’s commitment to fostering innovation while maintaining a robust regulatory approach to ensure financial stability and consumer protection.
Co-Authored by Milo Bates, Trainee Solicitor
[1] Rulebook GEN 3A.3.4
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