Blockchain, Fintech and VFA revolution

The Malta Financial Services Authority (MFSA) last year introduced its FinTech Regulatory Sandbox, which provides a controlled regulatory environment where FinTech operators may test their innovations within the financial services sector under prescribed conditions. The sandbox was launched during a press conference held in July 2020

It aims to be a valuable tool for start-ups and established operators in financial services to identify regulatory gaps and risks before implementing financial innovations in their business models, applications and products. The sandbox is intended to support more sustainable financial innovation while ensuring regulatory certainty and promoting knowledge-sharing between operators and the regulator.

Simply put, Fintech is the application of technology and innovation to solve the needs of consumers and firms in the financial space, for example, one may focus on credit cards, online banking and blockchain-powered cryptocurrencies. A corollary to the Fintech vision encapsulates the use of blockchain technology to drive the systems. Locally, we may be excused to beat our drum for being the first EU country to regulate Blockchain.

Many recall how in 2018, the minister for the economy and industry, Silvio Schembri called a press conference to announce the publication of a consultation document entitled The establishment of the Malta Digital Innovation Authority; the framework for the certification of distributed ledger technology platforms and related service providers; and a virtual currency Act. In a much-hyped Malta Blockchain conference, in 2018, government remarked that after successfully positioning Malta as the “Blockchain Island”, by being the first in the world to regulate DLT (distributed ledger technology) products and services, it now would like to position Malta among the top 10 countries in the world with an artificial intelligence policy and its sister technology – a Fintech revolution.

Then, the good news was announced about a collaboration with SingularityNET, a decentralised marketplace for AI services, in a pilot project to “explore a citizenship test for robots in the process of drafting new regulation for AI”. SingularityNET is working with renowned robot Sonia, built by Hanson Robotics. Sonia was showcased in a presentation attended by local Castille dignitaries and was expected to rubber stamp the birth of the digital age. It is a fact, that our DLT legislation matches the European Parliament resolution of October 2018, which launched directives on distributed ledger technologies and blockchains. Critics pointed out that the MFSA must be careful not to gold plate its own laws in a dirigiste approach to safeguard its reputation.

The regulator tightened the game rules so much that few applications were filed. Regrettably, due to such constraints, the noble aim to help start-up businesses in their quest for funds via ICO was not achieved. SMEs discovered the cost of registration for DLT structures is not proportionate to their size and complexity. In an ideal world, one lauds the potential of Initial Coin Offerings (ICOs) as an alternative investment instrument in funding SMEs and innovative start-ups. It aims to accelerate technology transfer.

Needless to say, in an ideal world, there is an overriding scope to enhance investor protection and tighten obligations for the initiators of ICOs. Having briefly introduced the introduction of a Fintech sandbox and laws regulating Blockchain and Virtual Assets, let us comment on the operation of such laws. Applicants for a VFA license are faced with a stiff finance instrument test (FIT) and other obligations to invest substantial paid-up capital. This test is exclusively administered and signed by accredited VFA agents, of which so far there are about two dozen authorised and fully licensed (the list is not growing). Back to the FIT, this is the starting point, as it is only in the event that the token in question qualifies as a Virtual Financial Asset that subsequent steps for recognition can proceed.

Onerous compliance tasks are heaped on issuers, who are obliged to draw up an annual compliance certificate in relation to business. It is not a walk in the park for any foreign investor who decides to set up an ICO in Malta (over the past three years no blossoms in the ICO garden). The ICO management has to engage a number of functionaries, who are experienced professionals in the field of information technology, DLT assets and have a good understanding of the issuer’s business.

These requisites include inter alia a system IT auditor, a certified VFA agent, a custodian, a statutory auditor and a money laundering reporting officer. Finally, there must be approval of the “White paper” signed by the issuer, who makes adequate disclosures including any deployment of smart contracts. Giving birth to the Blockchain concept has been arduous even though government generously sponsored a number of local conferences, which served as a foundation stone. Some blame a conservative banking structure and the onset of the pandemic as the femme fatale for the Blockchain & Fintech industry. Both are still in their infancy. Comparisons can be odious, yet it is tempting to comment, how three years down the line and Malta has not caught up with the success registered in Estonia. The latter is crowned as the Baltic Blockchain queen, which so far registered over 800 Crypto/Blockchain companies.

A particular blockchain technology used by Estonia – KSI Blockchain by Guardtime – has been proven to work and is today even used by Nato and the US Department of Defence. Today, the Estonian government boasts it is home to a growing cohort of tech unicorns. These private companies each valued at more than $1bn, makes us want to catch up. Estonia with a population of just over one million, now prides itself of 15 to 20 crypto-friendly banks.

Back to Fintech, during the past year one augurs that initial proposals submitted to the MFSA Regulatory Sandbox have progressed to target technologicallyenabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and the provision of financial services.

George Mangion is a senior partner of an audit and consultancy firm and has over 25 years’ experience in accounting, taxation, financial and consultancy services. His efforts have seen PKF instrumental in establishing many companies in Malta and places PKF in the forefront as a professional financial service provider on the island.