by Gaming Counsel, May 23, 2013 | 11:57 am

A news report from The Register this past Monday suggested that Canadian anti-money laundering and financial crimes regulations and disclosures will not apply to bitcoin exchanges in Canada. This was based on letters apparently received by some exchanges from the Financial Transactions and Reports Analysis Centre of Canada (FinTRAC). I have not seen the letters, but today I confirmed this position with a spokesperson for the FinTRAC. This posture presents an exciting opportunity for bitcoin exchanges that the Financial Crimes Enforcement Network (FinCEN) recently confirmed are subject to registration, monitoring, and reporting as money services businesses and money transmitters in the United States. On the financial regulatory side, those exchanges may find a more welcoming environment north of the border. However, remember that future changes to the regulatory structure in Canada are possible.

What is FinTRAC?

FinTRAC is an independent agency of the Canadian government that reports into the federal Minister of Finance. It is Canada’s financial intelligence unit for purposes of the Financial Action Task Force’s 40 Recommendations. FinTRAC’s mandate is to facilitate the detection, deterrence, and prevention of money laundering and terrorist financing activities. FinTRAC was set up and is empowered under the federal Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the PCMLTFA) and the attendant regulations, including the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulations (the Regulations).

If you are a casino, life insurer, accountant, securities dealer, or dealer in precious metals in Canada, among others, you will need to report to FinTRAC in certain cases. (FinTRAC-regulated persons are often referred to as reporting entities.) If you are a money services business, you’ll need to register with FinTRAC, name a compliance officer, implement and periodically review your compliance regime, identify your clients, keep various records, and report several types of transactions to FinTRAC, e.g., suspicious transactions and large cash transactions, meaning single transactions of $10,000 or more or structured transactions of $10,000 or more. The ongoing compliance and disclosure requirements are extensive.

One province, Quebec, has its own legislation, the Money Services Businesses Act, with some overlapping requirements with the PCMLTFA and the Regulations.

FinTRAC has many of the same responsibilities and functions as FinCEN, which is the United States’ FIU.

Enter bitcoin

Bitcoin is a virtual decentralized currency that has gained value, interest, and supporters since its introduction in 2009. Bitcoin is also a global payments system. This currency allows value to be stored and transferred anywhere, at any time, potentially anonymously, with little — and oftentimes no — counterparty risk. It’s a revolutionary concept that is changing how we think about everything from money and value to the roles of central banks and governments in issuing currency and coinage. Bitcoin’s decentralized nature and the advent of cryptocurrency trading bots like the ones from immediate connect have reshaped traditional notions of finance, offering new opportunities and challenges for both seasoned traders and beginners alike.

As mentioned above and elsewhere (also here), FinCEN has issued guidance confirming that bitcoin exchanges will be subject to the Bank Secrecy Act and the rules governing money transmitters. Therefore, many have been interested in the position of Canadian and other international regulators when it comes to these types of exchanges. Will Canada regulate them as money services businesses? Or would it take a more laissez faire approach? Could Canada become a zone that could act as a testing lab for startup bitcoin exchanges?

We now have our first answer from FinTRAC. Generally, it views bitcoin exchanges as entities that do not have to register, identify clients, and report under the money services business rules.

Bitcoins aren’t “funds”

Money services business is defined in subsection 5(h) of the PCMLTFA. An MSB is a person or entity “engaged in the business of foreign exchange dealing, of remitting funds or transmitting funds by any means or through any person, entity, or electronic funds transfer network, or of issuing or redeeming money orders, traveller’s cheques or other negotiable instruments except for cheques payable to a named person or entity.” According to the Regulations, “funds means cash, currency or securities, or negotiable instruments or other financial instruments, in any form, that indicate a person’s or an entity’s title or interest in them.” “Negotiable instrument” is left undefined by the Regulations and the PCMLTFA, but I had cautiously expected that FinTRAC might take the view that bitcoin was “[an]other negotiable instrument” such that it would be caught in the definition of funds and money services business.

I was wrong, and here’s the critical takeaway from regulators: FinTRAC does not view bitcoin as funds within the meaning of the PCMLTFA and the Regulations. This means, subject to the scenarios outlined below, that transacting in bitcoin is not transacting in funds, by means of electronic funds transfer, or in “negotiable instruments or other financial instruments.” The only thing left in the MSB definition is money orders and traveller’s cheques, and bitcoin is almost certainly not one of those. FinTRAC simply takes the view that it’s not covered by the existing statute or regulations. (A friend with inside knowledge of FinTRAC believes that it’s only a matter of time before the regulations are amended to include bitcoin exchanges as reporting entities, but the current position is what’s set out in this post.)

Let’s consider this in the context of three different scenarios to see what’s subject to MSB regulation under FinTRAC and what isn’t:

1. Exchanges between participants — If individuals A and B are on a Canadian bitcoin exchange and A sells bitcoins to B and B pays A for those bitcoins in Canadian dollars, there’s no remittance or transfer of funds by the exchange. FinTRAC indicated to me that they see this exchange as the simple purchase of a good, i.e., bitcoin, for money facilitated by the exchange. (As an aside, this may comport with recent comments from the Canada Revenue Agency suggesting that transacting in bitcoin engages the barter rules set out in CRA’s Interpretation Bulletin IT-490.)
2. Exchanges from reserves — If individual A is present on a Canadian bitcoin exchange and buys or sells bitcoins from the reserves of the exchange itself (again, assuming Canadian dollar only transactions), then there’s still no remittance or transfer of funds by the exchange. Again, this is still an exchange of goods for money, at least in FinTRAC’s view. Note that, in both scenarios 1 and 2, if there’s a conversion from Canadian dollars to BTC — or just from BTC — to another non-Canadian fiat currency, then the foreign exchange rules would apply and the exchange would be an MSB within the meaning of the Regulations.
3. Bitcoins as intermediary goods or currency — If the ‘bitcoin part’ of the transaction is solely as an intermediary step between two fiat currencies, then the exchange will be a foreign exchange and subject to the rules. For example, if individuals A and B are on a Canadian bitcoin exchange and A transmits Canadian dollars to B that are converted to BTC and then, as part of the transaction, those bitcoins are received by B in UK pounds sterling, that would be a foreign exchange transaction and the exchange would be subject to the MSB rules. (This last scenario seems odd. One would think that few transactions or contracts would call for exchange in and out of a volatile currency like bitcoin in this manner. Conceptually, however, it might happen, e.g., if a contract between parties in different countries were denominated in bitcoins.)

As with the recent comments of the CRA on bitcoin, I think treating bitcoins as a foreign currency makes more conceptual sense — it would also clearly mean that bitcoin exchanges are reporting entities — but the view now is that BTC-Canadian dollar and vice versa exchanges are generally outside of the ambit of the PCMLTFA and the Regulations.

This may change. The statutory and regulatory structure in Canada was drafted before bitcoins were invented. This posture by FinTRAC can lead to a number of money laundering risks that, if unaddressed, will certainly draw the FATF’s attention. The FATF monitors and periodically reports on every country’s anti-money laundering and counter-terrorist financing regimes. The FATF can bring immense pressure, both through its own moral authority and through its membership, on countries to change laws and curtail practices that present AML and CTF risks.

For now, however, Canada could become an interesting and welcome locale for bitcoin entrepreneurs pursuing exchange or other transactional models, either to confine themselves to the growing Canadian bitcoin market or as a proving ground for further international expansion.