As early as March 2014 the Cyprus Securities and Exchange Commission ("CySEC") alerted potential investors to the risks associated with investment in virtual currencies or contracts for difference linked to them.
CySEC has recently issued a circular (C244 dated 13 October 2017) to Cyprus Investment Firms ("CIFs") regarding the conditions they must satisfy in the event that they provide investment services in respect of such products, in order to safeguard investors' interests.
The circular points out that there is no specific EU regulatory framework governing trading in these products and that there has been no official decision by European regulatory authorities regarding whether trading in CFDs relating to virtual currencies falls under paragraph 9, Section C, Annex 1 of Directive 2004/39/EU on markets in financial instruments ("MiFID"). Pending a decision and guidance from the relevant European body, CIFs which have obtained the prior approval of CySEC and are currently permitted under section 6(9)(b) of the Investment Services and Activities and Regulated Markets Law to provide services in virtual currencies or in CFDs relating to virtual currencies must adhere to the following requirements.
- They must comply with the provisions of the Investment Services Law and guidance issued by CySEC regarding organisational requirements (including safeguarding of clients' assets, compliance function and internal audit function), conduct of business rules (including marketing communication, appropriateness and best execution), record keeping and capital adequacy.
- Before providing any services to clients in virtual currencies
or derivatives linked to them, CIFs must warn their clients that:
- there is no specific EU regulatory framework governing the trading in such products,
- trading in such products is not covered by MiFID and therefore falls outside the scope of the CIFs' MiFID-regulated activities,
- particular risks are associated with these products, which should be set out in a specific risk warning,
- such products are complex and high risk and carry a high risk of losing all the invested capital,
- virtual currencies values can fluctuate substantially in value and may result in significant loss over a short period of time;
- virtual currencies are not appropriate for all investors and should be avoided by investors who do not have the necessary knowledge and expertise and who do not have a complete understanding of the specific characteristics of the products and the risks related to them,
- trading in such products does not entitle the investors to any protection under the Investors Compensation Fund, and
- they have no rights to resort to the Cyprus Financial Ombudsman in the event of a dispute with the CIF.
- CIFs must ensure that all risks associated with the activity are identified, assessed, recorded, monitored and adequately managed.
- Any feed providers such as virtual currency exchanges and liquidity providers used by CIFs must be properly licensed and regulated in their home jurisdiction.
- The CIF must carry out appropriate due diligence on feed providers and counterparties before establishing a relationship, followed by regular periodic due diligence.
- CIFs should use more than one feed provider and should cross-check with other feed providers in order to ensure that best execution principles are followed. Where only a single feed provider is used, CIFs must be able to determine and record how their best execution obligations are met.
- CIFs must clearly disclose to the public the methodology used to calculate the bid and ask prices.
- For all retail clients the leverage limit should be set at 5:1 for trading on CFDs relating to virtual currencies.
CySEC has also posted a warning to investors on its website drawing attention to the high risks associated with investment in virtual currencies and financial products based on them. It identifies several additional warning signs as a reason for exercising even greater caution, such as claims of guaranteed high investment returns with little or no risk, unsolicited offers without a full analysis of the risks involved and high-pressure sales techniques.
The warning also draws attention to the risky nature of investment in Initial Coin Offerings, which should only be undertaken by investors who have the necessary experience and knowledge, are confident of the quality of the ICO project itself and are prepared to lose their entire funds.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.