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All cryptocurrency exchanges and providers of services related to virtual digital assets (VDAs) would have to determine the true ‘beneficial owners’ of wallets where VDAs are stored, report all VDA receipts worth Rs 10 lakh or more by NGOs and non-profits, and terminate business relationship with ‘politically exposed persons’ if there are hurdles in carrying out ‘enhanced due diligence’ of such dodgy customers.

The service providers must also refrain from alerting or ‘tipping off’ clients about possible suspicious transactions (which are reported to a government agency under the recently amended law), and treat certain VDA flows as ‘cross-border’ transactions or ‘wire-transfers’ of fiat money.

All this has been outlined in a note recently shared by India’s Financial Intelligence Unit with some of the local service providers, two industry persons aware of the proposed guidelines told ET.

Further, entities involved in issuance, book building, underwriting, and placement or sale of initial coin (or token) offerings (ICOs) — similar to IPOs — would have to follow the strict reporting rules of VDA service providers.

The draft note, which sets out measures to spot and curb money laundering, terror funding and proliferation financing, follows the March 7, 2023 finance ministry notification bringing transactions relating to VDAs under the Prevention of Money Laundering Act (PMLA).

The note lays down that service providers should “examine, as far as reasonably possible, the background and purpose of all complex, unusually large transactions, and all unusual patterns of transactions, which have no apparent economic or lawful purpose.”

However, transposing the PMLA regulations which are linked to fiat money and conventional capital assets for framing similar rules for VDAs may need certain clarifications in statutes and regulations. “The PMLA and rules under it contemplate the reporting of cross border transfers above a certain threshold. In the VDA context, what amounts to a cross border transfer is ambiguous. Moreover, in the absence of clarity under FEMA (Foreign Exchange Management Act), platforms face uncertainty in classifying VDA transactions as cross-border,” said Jaideep Reddy, Counsel, Trilegal.

For instance, the note suggests that VDA transfer to or from a service provider, involving a chain of transfers, may be treated as cross-border qualifying transfers. Would it then mean additional reporting for service providers and violations under FEMA by customers who break the rules?

Beneficial owners, in the context of VDAs, are the last natural persons controlling a customer of a crypto exchange or service provider. They could be significant shareholders of a company, beneficiaries of a trust, or a senior management official. Enhanced due diligence, which is prescribed for ministers, politicians, senior bureaucrats and other politically exposed persons, would mean frequent review of customer profile and deals, assessing their source of funds, gathering information from publicly available information, and conducting independent enquiries on details given by the customer.

Eye on unhosted wallets, P2P deals

In the absence of rules, crypto platforms have been allegedly used among others by entities linked to unauthorised loan Apps, backed by Chinese nationals, to transfer funds out of India after converting the money recovered from usurious lending schemes into cryptocurrency. The transactions that came handy were transfers of cryptos to a private wallet owned by the same persons or one belonging to a third-party, or to a wallet of a connected person in an overseas exchange. Such withdrawals of cryptos from wallets hosted by a local exchange to an `unhosted wallet’ beyond the jurisdiction of domestic law enforcement agencies has been a challenge for the Enforcement Directorate (ED).

With an unhosted wallet, also known as cold storage or self-custody in the crypto parlance, a person can hold cryptocurrencies outside of an exchange. In this context it has been suggested that additional limitations or controls may be put in place on such transfers with unhosted wallets.

Also, ‘suspicious transaction reporting’ should involve multiple parties in peer to peer (P2P) deals which are direct purchase and sale of VDAs without intermediaries.

All transactions related to transfer, exchange of VDAs for VDAs or fiat currencies would be construed to be on the lines of wire transfers, says the note. Thus, the compliance burden in an electronic fund transfer would also apply in VDA for VDA, as well as VDA for cash deals.

According to the draft framework, crypto platforms and other intermediaries (while carrying the customary KYC procedures) must take care that wallets are not opened under anonymous, pseudonymous, or fictitious names; have adequate screening procedures for hiring employees; and, report the information in respect of a suspicious transaction within 7 days.

Also, they have to disclose details of bank accounts where they hold funds for their own as well as for clients’ transactions; and appoint a ‘designated director’ and a ‘principal officer’ (not below the rank of head of audit or compliance) to ensure overall implementation and compliance of PMLA rules.

For receipts above the threshold amount, the service provider shall register the details of NGO accounts/ wallets held on the DARPAN Portal of NITI Aayog. Service providers have to preserve all records for five years.

All clients, under the framework, should be categorized as either high risk or low risk — with the risk perception shared by a client’s location, nature of business, trading turnover and manner of making payments for transactions.

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