Winston WONG, GOH Jun Wei
21 December 2022 – The Monetary Authority of Singapore (MAS) issued Consultation Paper P008-2022: “Proposed Regulatory Measures for Digital Payment Token Services” (Consultation Paper), which seeks to address the risky nature of Digital Payment Tokens (DPTs) and proposes various regulatory measures for DPT services. The following are Flint & Battery LLC’s comments, and feedback on some of the points set out in the Consultation Paper by the MAS. We acknowledge that DPTs and the exchanges and markets on which they are traded today require appropriate regulation on service providers to protect customers’ interests. It is felt that the business conduct of the service providers in the DPT market needs to be adjusted in the interest of fairness with other market participants. We had submitted responses to MAS for certain questions and reproduced the same herein.
Question 1: MAS seeks comments on the proposed scope of “retail customer” for customer access measures
We agree that there should be customer categorisation prior to allowing them to engage in the services provided by the service providers. Firstly, we agree that institutional investors that transact DPTs will not receive any protection as a customer. We further propose for all businesses to be included in this category that receives no protection. Second, we agree that customers with stronger financial ability should be given less protection than those with less financial ability. Thus, we agree with the proposal to categorising customers into “retail customers” and “non-retail customers”.
On principle, we disagree that this “protection” conferred to retail customers should be in the form of access measures as this is a form of discrimination. Instead, all DPT Service Providers (DPTSPs) intending to serve retail customers should be subject to stringent supervision by MAS in the form of disclosures, audits, liquidity ratios, etc.
However, we note that MAS has not defined the nature of access measures. As such, it is difficult for us to propose an exact mechanism for categorizing customers into retail and non-retail customers. Subject to the exact protective measures being defined by MAS, we agree that the use of the definition for Accredited Investors (AI) to categorise customers into retail and non-retail is suitable.
We disagree that single-currency pegged stablecoins, or any stablecoins, should be treated differently as DPTs with less risk unless they are issued by a country and exempted by MAS on a case-by-case basis. It is our view that it is not the peg but the issuer that determines the risk of a DPT. We surmise that this list would include all national currencies, with certain currencies excluded because such currencies experience instability, such as political instability or experience high inflation.
In line with our views and proposals above, it is our opinion that the definition of DPT under the Payment Services Act 2019 should be revised as follows:
(a) The reference to a representation of value should be removed, i.e., to replace the words “digital representation of value” with “digital fungible token”. The relevant consideration and prerequisite for qualification and regulation is not whether a token represents value, because many tokens have no underlying value and hence do not necessarily represent value. Instead, such token is fungible in nature and has the potential of being traded (whether speculatively or otherwise) when listed on an exchange as an item representing apparent value, and in our view, sometimes exclusively upon the premium of a popular speculative tradable item.
(b) The definitional link to the intended purpose of a DPT being a medium of exchange accepted by the public, or a section of the public, as payment for goods or services or for the discharge of a debt, should be removed, i.e., to delete subsection (c) in its entirety. It is irrelevant whether the DPT is created intended for a medium of exchange and the relevant consideration is that set out in item (a) above.
The definitional link to a DPT’s denomination to currency or being pegged to currency should be removed, i.e., to delete subsection (b) in its entirety. It is irrelevant whether the DPT is denominated or pegged to currency. However, we propose that the MAS may prescribe exemptions where a country issues a DPT denominated or pegged to its currency. It is our opinion that MAS should regulate a DPT irrespective of its link to currency but rather, on the basis of who its issuer is.
Question 2: MAS seeks comments on the options for the treatment of DPT holdings for the purpose of determining a customer’s eligibility as an Accredited Investor (AI).
We agree that DPT holdings shall be excluded from the valuation of a person’s net worth in determining whether such person is an AI. We further propose that DPT holdings shall be excluded from the valuation for all other purposes where an individual or entity’s value needs to be calculated unless there is some particular reason otherwise.
Question 3: MAS seeks comments on the proposal to assess the retail customer’s knowledge of the risks of DPT services, as well as the risks to be covered by the assessment. MAS also seeks comments on possible next steps for DPTSPs, should the retail customer be assessed not to have sufficient knowledge of the risks of DPT services.
Use of knowledge as a basis to segregate categories of customers of DPT services
We agree that “many retail customers may not have sufficient knowledge of the risks of trading DPTs, leading them to take on higher risks than they would otherwise have been willing, or are able, to bear” and that a customer’s lack of information on the DPT market is one of the main concerns that put such customer at a high risk of financial loss. We agree that there should be an assessment to categorize customers into distinct groups, using the concept of Accredited Investors as defined in the Securities and Futures Act 2001 (SFA). However, we disagree with MAS’s view that customers should be further segregated based on an assessment of their level of knowledge.
The knowledge gap
It is our opinion that there is a knowledge gap of customers resulting in two key consequences that should be of concern to MAS:
(a) Not fully understanding the risks of owning DPTs: This could result in customers employing trading strategies that result in larger than expected financial losses.
(b) Not fully understanding the risks of using DPTSPs: This could result in customers not appreciating the following:
i. the position of conflict that the DPTSPs have vis-à-vis its customers;
ii. whether applicable regulation provides sufficient safeguards to address the abovementioned conflicts;
iii. whether DPTSPs that hold customer assets have other business operations that are likely to endanger customer assets, like a lending business;
iv. whether DPTSPs that hold customer assets have in place sufficient safeguards like the use of an independent custodian, the existence of capital reserves and liquidity ratios; and
v. whether there is an effective audit or verification of the abovementioned safeguards.
The above knowledge gap could result in customers underestimating the risk of using a particular DPTSP.
The use of knowledge-based v. financial ability-based categorisation of customers
We are not aware of any similar customer trading activity regulated based on the customer’s level of knowledge. Even outside of activity of trading on an organized market, the prevailing mode of regulation for any form of a risky purchase of goods or services is a combination of information campaign, regulation of the service provider, and police enforcement for nonspecific offences such as cheating, and other white-collar crimes.
It is prevalent, on the other hand, that service providers are subject to knowledge requirements. For example, financial advisors, fund managers, and capital market professionals are all subject to knowledge-related certification. As a side note, categorisation based on knowledge may even be considered an undesirable form of discrimination against customers to certain interest groups, though we express no opinion on this point.
For example, customers of broking service providers and exchanges are protected instead by a combination of rules that regulate the level and timeliness of disclosures, matters that require to be disclosed, conflict of interest, and capital requirements. For example, the SGX requires listcos to immediately disclose matters that may influence share prices and to halt trading, where appropriate. Brokers are subject to rules that diminish the risk of conflicts of interest between the broker and the customer. Also, all market participants, whether broker, exchange, customer, and even a non-participant, are subject, to a differing extent, to rules that target insider trading, and market manipulation.
It is our opinion that the basis of financial ability should be used to segregate customer type and the level of protection that MAS will prescribe to a particular category of customers. We agree with the use of AI as a way to categorise customers of a regulated DPT exchange.
Proposed measures to reduce the knowledge gap
Instead, we propose the following measures to reduce the knowledge gap between customers and service providers. MAS should identify and publish advisories periodically, the risks of:
(a) owning DPTs;
(b) Trading DPTs and the use of leverage in this regard; and
(c) engaging and using a DPTSP, and especially the use of a DPTSP that holds customer assets.
In particular, we identify the following as risks that MAS should specifically warn the public about:
(a) Clarifying that cryptocurrencies and DPTs are not currencies, and in particular, the following:
i. whether the DPTs are backed by assets, and if so, whether a holder can exchange a DPT for the underlying asset;
ii. that there is no central bank to make prudent fiscal policies;
iii. the extent to which the number of DPTs may be increased by the issuer or otherwise;
iv. that even where there are clear published policies governing the dilution of the DPTs, there is no guarantee that the issuer or creator of the DPTs may not otherwise dilute the DPT beyond the level promised; and
v. that the MAS has not audited any DPTs to verify that the manner to which DPTs are promised to function will be, in fact, the manner in such DPTs function.
(b) Clarifying the differing regulatory regimes that apply to DPTSPs on the one hand, and other financial institutions/intermediaries like banks, exchanges, securities brokers, etc. on the other hand. It is proposed that this be provided clearly in a table and list, at a minimum, the following categories:
i. Capital requirements, liquidity ratio requirements;
ii. Rules that address conflicts of interest between the customer and the DPTSP and;
iii. Audit obligations.
We propose that MAS should, in addition to publishing its advisories, work with the Singapore-based media to ensure this knowledge is well circulated.
Question 5. MAS seeks comments on the proposed restrictions on debt-financed and leveraged DPT transactions
We disagree that MAS should restrict DPTSPs to permit retail customers to use debt to finance their DPT transactions, purchases, and holdings, or allow leveraged DPT transactions.
In respect of MAS’s proposals in para 3.2 of the Consultation Paper, we propose to import the rules that apply to retail investors that presently trade shares, and CFDs in terms of debt financing, and leveraged transactions, for use in the context of retail customers in the DPT market.
It is suggested that a DPTSP engaging in the business of debt-financing and leverage DPT transactions cannot also engage in the business of an exchange facilitating non-debt financing and leverage DPT transactions, to reduce the risk of failure of the non-debt financing and leverage DPT transaction. However, if an exchange is required to use an independent custodian for its customers, and it is recognised by law that DPT ownership of deposits belongs to the customers and not to the DPTSP, then this measure may not be necessary.
Question 6. MAS seeks comments on the proposed segregation measures relating to customers’ assets.
We agree that there should be a clear segregation of customer’s assets (whether retail or non-retail) from the service provider’s assets. Further, we propose that MAS mandates that all DPTs received from customers continue to be owned by the customers and that such DPTs are held on behalf of such customers, unless there is a clear reason, for example, that the DPTSP is in the business of lending out the customer’s DPT, and even so, obtained clear and unambiguous consent and also made the requisite risk disclosures. To be clear, the law should recognise that where the DPTSP is sued by third parties, such third parties cannot claim these customer DPTs to satisfy a judgment against the DPTSP.
In addition to the above, and on a related note, we have also proposed, in Question 10, that if a DPTSP engages in the lending of a customer’s DPT, that should be its only business. For example, such a DPTSP cannot also operate the business of being an exchange. This reduces the risk that a DPTSP functioning as an exchange will also concurrently suffer the risk of a DPTSP in the lending business segment.
Question 7. MAS seeks comments on whether DPTSPs should be required to appoint an independent custodian to hold customers’ assets. MAS also seeks comments on other control measures that would help to minimise the risk of loss or misuse of customers’ DPTs.
We agree that DPTSPs should be required to appoint an independent custodian to hold all customers’ assets (whether retail or non-retail) and that the rules applicable to the fund management industry should be imported, subject to fine-tuning.
Question 8. MAS seeks comments on whether the proposed disclosure and reconciliation measures are appropriate and adequate, and whether any other disclosures would be useful
We agree that customers should be adequately informed of the arrangements and risks involved in having their assets held by DPTSPs. We agree with the proposed disclosures and reconciliation measures. However, we further propose that:
(a) DPTSPs shall disclose whether customer assets are used for anything other than transactions specifically instructed by customers.
(b) The reconciliation of DPT holdings of customers shall be available on a real-time basis for all customers not just on a daily basis.
Question 10. MAS seeks comments on the proposed restriction on DPTSPs not to lend out retail customers’ DPTs. MAS also seeks comments on any other measures to protect customers’ DPTs from the risks of unregulated borrowing and lending by DPTSPs.
We express no view on the restriction on DPTSP’s not to lend out retail customers’ DPT but may lend out only non-retail customers’ DPT. It is our opinion that if a DPTSP engages in the lending of a customer’s DPT, that should be its only business. For example, such a DPTSP cannot also operate the business of being an exchange.
MAS should conduct a study into at what point a DPTSP will pose systemic risks to the financial market by conducting activity similar to that of a traditional bank or digital bank. Where such risks are present, we propose that regulation similar to that governing a bank should apply: e.g. capital requirements, audit, liquidity ratios, IT redundancy, etc.
The legislation regulating the DPTSP should include a statement clarifying that it makes no statement on whether a DPT is an asset.
Question 11. MAS seeks comments on the proposed measures to identify and mitigate conflicts of interests. MAS also seeks comments on any other measures to identify and mitigate conflicts of interest.
We agree with MAS’s proposal in para 4.16 of the Consultation Paper. However, it is our opinion that MAS mandates that all DPTSPs specifically address the conflict situations in para 4.15 of the Consultation Paper and what procedure or measure the DPTSP should take to eliminate or reduce these conflicts. Further, all DPTSPs should be required to comply with the measures in paras 4.16 to 4.19 of the Consultation Paper. To the extent that the conflicts in para 4.15 of the Consultation Paper are not eliminated, or the measures in 4.16 to 4.19 of the Consultation Paper are not implemented in full, MAS exemption should be sought and the DPTSP is required to disclose the extent of non-compliance.
Question 12. MAS seeks comments on the proposal for DPT trading platform operators to publish its policies and procedures on the process for selecting, listing, and reviewing DPTs, as well as the relevant governance policies. MAS also seeks comments on any other measures or disclosures to enhance market discipline on DPT trading platform operators, with regard to DPTs traded on their trading platforms.
We disagree with MAS’s point in para 4.23(a) of the Consultation Paper that DPTSPs need to justify the selection of DPTs available for trading and explain to customers why a particular DPT is suitable for trading. We propose that the starting point should be that all DPTs are inherently risky and speculative. The further issue is that such an explanation can be easily misunderstood, especially by retail customers, that a DPT has sound fundamentals.
We agree with MAS’s proposals in para 4.23(b) to (d) of the Consultation Paper. We feel that, especially for retail customers trading on finance or utilizing leverage, the suspension or removal of a DPT from trading can adversely and seriously harm such retail customers’ financial position. However, MAS needs to consider further if they should regulate the DPTSP’s decisions to suspend trading. If not, all retail customers utilizing finance or leverage must be specifically warned of the risk of DPTs being suspended and them not being able to withdraw their DPTs after suspension.
We propose that, with respect to para 4.24 of the Consultation Paper, the MAS is empowered to require DPTSPs to clarify or elaborate on disclosures made in respect of the above and such clarification and elaboration shall be prominently displayed on the DPTSP’s platform and that such requests, clarifications, and elaborations to be published on MAS’s portal.
Question 16. MAS seeks comments on effective measures, including the implementation of market surveillance mechanisms, to detect and deter unfair trading practices
We considered whether DPTSPs should be regulated under an existing regulatory regime, e.g., Banks, SFA, etc.
On the external, it may seem persuasive that DPTs may resemble commodities, and by parity, its treatment and regulation should be based on that applicable to commodities. However, it is felt that DPTs are dissimilar to commodities for the reason that the property and nature of a traded commodity, like crude oil, or silver, or else, is known and trite. In contrast, the property of a DPT is comparatively complex and obscure. The complex nature of DPTs suggests that the disclosure-heavy regime of securities should be preferred, as are shares of traded companies. However, it is not feasible to enforce this disclosure obligation upon a DPT’s issuer.
We considered whether DPT exchanges should be regulated under the same regime as “organized markets” under the SFA. We note that the present prohibition for operating as an “organized market” as defined in the SFA does not expressly include exchanges for DPTs. It is our opinion that MAS’s concern in respect of the regulation of such entities includes whether the inevitable eventual failure or malfunction of an apparatus resembling an organized market for DPTs will create a contagion to the wider financial system that would adversely disrupt the Singapore financial system, and whether the participation of retail customers in such a malfunction is an issue.
We further opine that irrespective of whether DPTs are endorsed by MAS, considered “currency” or else, that its trading be subject to the laws of market manipulation, insider trading, and other crime. A purposive application of such offences mandates that they should apply uniformly to any tradable digital token to address issues relating to the conflict of interest and disclosure.
We propose MAS amends the SFA to achieve the following:
(a) To include DPTs as a class of instruments regulated under the organized markets regime.
(b) To expressly bring DPTs under the regulation of market manipulation, insider trading, and related white-collar crimes.
(c) The legislation extending the reach of regulation as stated above expressly clarifies that it makes no statement on whether DPTs are assets.
Question 17. MAS seeks comments on the proposed transition period of 6-9 months. MAS also seeks other comments to facilitate the transition towards the implementation of the regulatory measures.
We agree that a transition period of 6-9 months will be sufficient for the implementation of the regulatory measures on DPTs.
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