The draft VAITOS Rules Part I: Is the regulatory space now complete?

The Virtual Asset and Initial Token Offering Services Act 2021 (the “Act”) came into force on 07 February 2022. With a view to regulate the AML/CFT risks inherent in virtual assets, the Financial Services Commission Mauritius (the “Commission”) issued, with effect from 28 February 2022, ‘Guidance Notes’ on Anti-money Laundering and Combating the Financing of Terrorism for Virtual Asset Service Providers (“VASPs”) and Issuers of Initial Token Offerings (“ITOs”). The Commission has now published on 03 June 2022 a series of draft rules (the “VAITOS Rules”) for public consultation, namely:

  1. The VAITOS (Capital and Other Financial Requirements) Rules;
  2. The VAITOS (Risk Management) Rules;
  3. The VAITOS (Client Disclosure) Rules;
  4. The VAITOS (Publication of Advertisements) Rules;
  5. The VAITOS (Custody of Client Assets) Rules;
  6. The VAITOS (Cybersecurity) Rules; and
  7. The VAITOS (Statutory Returns) Rules.

Although the VAITOS Rules are not yet in final form, they have been highly anticipated by stakeholders in the virtual assets market.

In this first part of our series on the VAITOS Rules, we will highlight the key features of the VAITOS (Capital and Other Financial Requirement) Rules (the “Capital Requirement Rules”) and the VAITOS (Risk Management) Rules (the “Risk Management Rules”), which make more sense to be read in conjunction with one another.

General principle of the Capital Requirement Rules and the Risk Management Rules

Section 20 of the Act states that a VASP must maintain a minimum stated unimpaired capital and such other financial requirements as prescribed in the FSC Rules, which is now set out in further detail under the Capital Requirement Rules.

Rule 4 of the Capital Requirement Rules lays down the general principle that a VASP must ensure in order for it to meet the unimpaired capital and liquidity resources test, taking into account the nature, scale and complexity of the activities and risks to which the VASP is or could be exposed. The same rule further expands on other additional factors for the VASP to consider in determining the adequacy of its unimpaired capital and liquidity resources.

Particularly, the Capital Requirement Rules also allow for a judgment call by providing that, in determining its minimum unimpaired capital and resources threshold, the VASP should also have regard to its risk management assessment, pursuant to Rule 4 of the Risk Management Rules.

In turn, Rule 4 of the Risk Management Rules imposes on a VASP the obligation to maintain “effective and comprehensive strategies, processes and risk management systems” in place “that it considers adequate to cover”.

We again see a discretionary element that is applied to both the Capital Requirement Rules and the Risk Management Rules that outlines the fundamental prerequisite that the VASP should possess – a robust and effective risk management architecture which is able to assess all those important requirements on the go.

Our take on the capital and financial requirements.

In terms of specific requirements, Rule 5 of the Capital Requirement Rules takes out of the equation intangible assets (such as goodwill) in calculating the unimpaired capital and liquidity resources test (the “Unimpaired Capital Test”), which we believe, should be rightly so.

While we do appreciate that the Rule 5 stands on a twin-axis of either “Own Funds Requirement” or “Prudential Requirement”, we hope that in its final form, the Commission will clarify how the discretionary element set out in Rule 4 of the Capital Requirement Rules will be counterbalanced against the aforementioned requirements of own-funds and prudential requirements.

It is interesting to note that, in contrast to the minimum unimpaired stated capital applicable to licencees under the Securities Act 2005 (which refers to set figures)[1], the Capital Requirement Rules therefore do not cater for set figures, but rather refer to a detailed yet somewhat more flexible explanation on how to calculate the minimum capital requirements applicable to holders of licences under the Act.

We now take a closer look at both the Capital Requirement Rules and the Risk Management Rules, relating to certain specific items as they have been set out in the respective rules.

The four takeaway points of the Capital Requirement Rules and the Risk Management Rules are as follows:

1. Minimum unimpaired capital

Among other financial obligations imposed on a VASP, the Capital Requirement Rules provide that a VASP should at all times maintain a minimum unimpaired capital and sufficient liquidity resources, which should be the greater of (i) the own funds requirement, OR (ii) the prudential requirement.

(i) Own funds requirement

The own funds requirement applicable to ITOs and to the different VASP licencees as per rule 6 of the Capital Requirement Rules are set out as follows:

Virtual asset service provider

Amount

Issuer of ITOs

Sufficient working capital to be capable of meeting its debts as they fall due.

Virtual Asset Advisory Services (Class I)

Sufficient working capital to be capable of meeting its debts as they fall due.

Virtual Asset Broker-Dealer (Class M)

2,000,000 Mauritian Rupees.

Virtual Asset Wallet Services (Class O)

Sufficient working capital in fiat currency to continue business for a period of 12 months, based on realistic forecasts for the business in different market conditions (both negative and positive scenarios).

Virtual Asset Custodian (Class R)

5,000,000 Mauritian Rupees.

Virtual Asset Market Place (Class S)

6,500,000 Mauritian Rupees.

A VASP having multiple licences would be subject to the combined capital requirement of each licence held by it.

(ii) Prudential requirement

Should a VASP choose the prudential requirement route, Rule 7 of the Capital Requirement Rules provides that a VASP should always have prudential safeguards equal to an amount of capital, which is at least the higher of:

  • One quarter of its fixed overheads from the preceding year, reviewed annually; and
  • The financial resources requirements as per the Risk Management Rules.

One will note that the ‘higher of’ test above should espouse either the ‘one quarter of fixed overheadsor the ‘financial resources requirements’ test. We expect that the Commission will make the necessary amendments in the final version of the Rules.

It is worth underlining that Rule 8 sets out, in some degree of detail, the general architecture of how fixed overheads should be calculated. Although we shall not focus on the particulars of how the fixed overheads are calculated, it is rather obvious to us that Rules 8, 9 (Deductible Items) and 10 (Third-Party Expenses) should be read in-tandem with Rule 5 of the Risk Management Rules, which paints a broad canvas of the risk-based approach that VASPs are expected to have in place.

(a) Calculation of Fixed Overheads

The fixed overheads of the VASP must be calculated according to a prescribed formula under rule 8 of the Capital Requirement Rules:

Fixed overheads = Total expenses after distribution of profits to shareholders + Third-party expenses (Rule 10) – Deductible items (Rule 9).

The Capital Requirement Rules do not prescribe what is accounted for in total expenses but make provision for what is taken into account for third-party expenses and deductible items.

(b) Financial resources requirements

The other limb of the Prudential Requirement lays down a financial resources requirement test, as set out in Rule 7 of the Capital Requirement Rules. Although Rule 7 then refers to the Risk Management Rules, we expect that the Commission will publish specific pointers, on the basis of a clearly articulated test, in order to address the financial resources requirement aspect.

2. Recalibration of the minimum unimpaired capital requirement

Rules 13, 14 and 15 of the Capital Requirement Rules cater for a situation where there has been either a material increase or decrease in the projected relevant expenditure of a VASP during the year.

Such materiality principle is explained via either:

  • a 30% increase or decrease in the VASP’s projected relevant expenditure for the current year; or
  • an increase or decrease of 100,000,000 Mauritian rupees (or equivalent amount in another fiat currency) or more in the VASP’s fixed overheads requirement based on projected relevant expenditure for the current year.

While a material increase should be immediately recalculated in relation to the fixed overheads and basic liquid assets requirements, there is no such obligation on the VASP when there is a corresponding material decrease in relation to the same requirements.

3. Insurance

A VASP may make use of an insurance policy covering the relevant services to mitigate its risks. Rule 6 of the Risk Management Rules lays down a few parameters that a VASP may likely consider in choosing the insurance service provider. We need to highlight the fact that the insurance policy is only optional here.

4. Proper record keeping

As per rule 12 of the Capital Requirement Rules, a VASP must maintain adequate systems and controls to ensure the integrity and accuracy of its books and records. Furthermore, the VASP should also ensure that its books, records and accounts comply with internationally recognised accounting standards as applicable.

[1] For example, the holder of an investment dealer (broker) licence and an investment adviser (corporate finance advisory) licence should maintain an unimpaired stated capital of 700,000 Mauritian Rupees and 1,000,000 Mauritian Rupees respectively.