By: Kemar A. Roberts, Attorney-at-law
This article will examine the Regulatory Sandbox policy that has been implemented in Barbados and contrast its establishment and subsequent treatment of digital currencies, and other FinTech operations with international attempts to regulate the cryptocurrency phenomenon. In so doing, it is posited that regulators within Barbados are attempting a progressive approach to supervise its FinTech markets. The definition of a Regulatory Sandbox described by The Consultant Group to Assist the Poor (CGAP) – an independent think tank dedicated to financial inclusion – in their October 2017 working paper, written by Financial Sector Specialist Ivo Jenik and Senior Policy Consultant Kate Laurer will be adopted. The definition states that a Regulatory Sandbox is “a framework set up by a financial sector regulator to allow small scale, live testing of innovations by private firms in a controlled environment (…) under the regulator’s supervision.” Therefore, the use of a regulatory sandbox allows for innovative testing in a real market where there is direct communication between innovators and regulators to ideally mitigate any negative impacts.
Regulatory Understanding of Crypto and FinTech Spaces
It is of utmost importance that regulators understand the various industries which they attempt to govern. This understanding is very applicable to the FinTech industry and Crypto spaces if regulators are to achieve practical and sound regulation which caters to the market’s innovative character. In reference to the use of blockchain technology, Associate Professor at St. Mary’s University School of Law, Angela Walch, posits in her paper The Path Of The Blockchain Lexicon (And The Law) published on March 24, 2017 in 36 Review of Banking & Financial Law 713 (2017) that “unsurprisingly, the fluctuating terminology can cause difficulties for global regulators seeking to understand and appropriately govern the technology.” To this end, Professor Walch highlights that understanding the technology, identifying and distinguishing the different variants of it, and creating precise language to regulate it are the main challenges which regulators may face in the crypto space. She further notes that “if regulators can’t figure out what the facts are, or misunderstand them, then they can’t fully identify or quantify the risks posed by the technology and are more likely to make bad decisions about whether and how to regulate.” These sentiments therefore beg the question; do our regulators possess the necessary subject matter expertise to effectively regulate this creative technology?
Regulatory Sandbox for Crypto and FinTech Spaces In Barbados
It is therefore suspected that with an intention to observe and ascertain knowledge on how the crypto space works, the Central Bank of Barbados (CBB) and the Financial Service Commission (FSC) have together launched their Regulatory Sandbox aiming to progressively and appropriately govern this market. Though these entities have produced descriptive material on the FSC’s website which notes that “the rapid evolution of FinTech (…) means that these innovations might not be captured under current financial sector legislation that exists to protect Barbadians,” they have also made their intentions to have a knowledgeable application of crypto regulation. This is noted where their material states “the purpose of this Regulatory Sandbox is two-fold. For businesses it allows them to test the feasibility of their innovators in a real-world, but controlled, environment. For the regulator, it provides an opportunity to better understand the nature of the product or service and by extension to determine whether the existing framework is sufficient or if a new type of legislation is necessary.” It is therefore pellucid that the regulators in Barbados are positioning themselves to be equipped to govern new innovations such as crypto without trying to unnecessarily place them in traditional paradigms. It is further evident from their communication that they have contemplated both sides of the coin; the fact that there is a need for regulation juxtaposed with the realities of innovation and progress.
International Regulation of Crypto and FinTech Spaces
On the other hand, there exist some international regulators who intend to do the exact opposite to our local regulators given their presumptions that pre-existing systems will cater to this type of innovation. A prime example of this is noted in the United States of America’s Securities and Exchange Commission’s (SEC) treatment with the capital-raising method of Crypto Startups (referred to as Initial Coin Offerings). An analysis of the US Supreme Court’s landmark decision of SEC V Howey 328 U.S. 293 (1946) shows the general metric that the SEC will use to determine whether Crypto coin offerings will fit into the parameters of a traditional investment contract, and are therefore subject to the current securities registration requirements of the SEC. This metric has come to be known as the Howey Test. Subsequently, a Crypto coin offering may be considered an investment contract if, from the transactions associated, it can be ascertained that:
- There is an investment of money;
- There is an expectation of profits from the investment;
- The investment of money is a common enterprise; and
- Profits come from the efforts of a promoter or third party.
It must also be noted that different circuit level courts within the United States utilize varying factors (the two most common being the horizontal and vertical approaches) to determine whether the common enterprise aspect of this test is satisfied. Therefore, there is no uniform application to this test.
Critique of International Regulation
Some notable contributors within the innovative and regulatory space have critiqued the use of this antiquated test within the Crypto space. Similar critique has flowed in relation to some of the SEC’s topical decisions where they have employed the Howey Test. One said decision involved the SEC’s investigation of the DAO, a virtual organization referred to as a decentralized autonomous organization, which was executed on a distributed ledger and utilized tokens to hold assets for its customers. On July 25, 2017, the SEC published a report of investigation on the DAO regarding the application of the US federal securities laws to the offer and sale of DAO Tokens, and more specifically, whether the DAO tokens are securities. Illustratively, K. Alexia Hefti (Canadian lawyer and Blockchain Tax Lead for Deloitte) along with Marvin Hichem Coleby (CEO and founder of Raise – a startup within the blockchain industry) have noted within their article SEC Centralization in an Age of Blockchain Decentralization: Why Emerging Markets Continue to Lead Blockchain Innovation that “The SEC’s decision represents a stark contrast to the more regulatory-friendly approach to blockchain technologies taken by many emerging market regulators and governments.” Hefti and Coleby have further stated that the SEC can learn from countries like Barbados “that are exploring creative regulatory environments for blockchain technologies,” where our “regulatory friendly approach encourages cryptopreneurs to reach their innovative potential, while operating within the bounds of today’s corporate limits.”
However, Hefti and Coleby also realistically note that “the SEC’s rigid regulatory approach to blockchain technologies represents a shift in the global technology industry” and that “innovators in this space would be prudent to become familiar with US securities regulation.”
The Duality of Innovation and Regulation
Though it is indubitably glaring that any local innovator who is contemplating US investment would need to have regard to their securities regulation and the SEC’s investment contract classification, it is arguably posited that our very own FSC is focused on investor protection, in tandem with a more creative regulatory environment, which augers well for an innovative market such as Crypto. In an FSC Media Release published on January 11, 2019, it is noted that FSC’s CEO Kerster Guy advised the public to exercise extreme caution when considering investment decisions in the Crypto sphere. He is noted to have said “we are aware that these types of scams will continue to surface from time to time and that with cryptocurrency still being a novel concept to many people, there is a lot of room for misinformation, misunderstanding and misguidance. As a regulator, we want to protect the public from that as far as we are able to.” This therefore shows that as serious as the Barbadian regulators are about learning and embracing innovation, they are still just as serious about investment protection; potentially an oasis where the two worlds can collide. These comments come in a period where the FSC and CBB are still actively embracing a Regulatory Sandbox period thus illustrating that the duality needed in order to regulate this market can exist, and our regulators are currently taking the right steps. This type of focus becomes necessary as more FinTech and Crypto innovators emerge given current global trends, and will auger well when these innovators commence their own locally based initial coin offerings or other capital raising ventures.