The nine Policy Recommendations aim to address market integrity and investor protection concerns arising from DeFi by supporting greater consistency of regulatory frameworks and oversight in member jurisdictions.
The Recommendations cover six key areas: (1) Understanding DeFi Arrangements and Structures, (2) Achieving Common Standards of Regulatory Outcomes, (3) Identification and Management of Key Risks (4) Clear, Accurate and Comprehensive Disclosures (5) Enforcement of Applicable Laws, and (6) Cross-Border Cooperation.
With delivery of these Recommendations, IOSCO is now shifting attention towards implementation monitoring, capacity building and technical assistance needs of its members.
IOSCO recognises that jurisdictions are at different stages of tackling the risks presented by crypto-asset markets and decentralized finance. Some have existing regimes in place while others must develop new, bespoke frameworks.
Jean-Paul Servais, IOSCO Chair said:
I am pleased that IOSCO has delivered on the policy ambitions outlined in our Crypto-Asset Roadmap in less than eighteen months. The risks of crypto-asset markets are real and we are tackling these in a coordinated manner, seeking consistent implementation of these IOSCO Recommendations across our membership to best protect investors globally.
Tuang Lee Lim, Chair of the IOSCO Board-Level Fintech Task Force, set up to develop the policy measures, said:
The two sets of policy recommendations on CDA and DeFi provide a coherent and robust policy framework to tackle the core risks posed by crypto-asset markets. This will help facilitate a fair and transparent playing field where responsible innovation can occur while ensuring investor protection and market integrity outcomes.
Revised FSB Recommendations and IOSCO Guidance on Anti-Dilution Liquidity Management Tools (LMTs) aim to achieve a significant strengthening of liquidity management by open-ended fund (OEF) managers compared to current practices.
Measures aim to provide greater clarity on the redemption terms that OEFs could offer to investors, based on the liquidity of their asset holdings, and to ensure greater use and consistency in the use of anti-dilution LMTs.
FSB and IOSCO will review implementation progress and, by 2028, assess whether the implemented reforms have sufficiently addressed financial stability risks.
The Financial Stability Board (FSB) on 20 December 2023 published revised policy recommendations to address structural vulnerabilities from liquidity mismatch in OEFs (Revised FSB Recommendations). Concurrently, to support the greater use and greater consistency in the use of anti-dilution LMTs by OEFs, the International Organization of Securities Commissions (IOSCO) has published final Guidance on Anti-Dilution LMTs (LMT Guidance) for the effective implementation of the Recommendations for Liquidity Risk Management for Collective Investment Schemes.1
The Revised FSB Recommendations are addressed to financial regulatory and supervisory authorities. They set out the key objectives for an effective regulatory and supervisory framework to address vulnerabilities arising from liquidity mismatch in OEFs. Combined with the LMT Guidance, these recommendations aim to achieve a significant strengthening of liquidity management by OEF managers compared to current practices.
To address structural liquidity mismatch in OEFs, the Revised FSB Recommendations provide greater clarity on the redemption terms that OEFs can offer to investors, based on the liquidity of the OEF asset holdings. This would be achieved through a categorisation approach, where OEFs would be grouped depending on the liquidity of their assets (e.g., liquid, less liquid, illiquid). OEFs in each category would then be subject to specific expectations in terms of their redemption terms and conditions. Authorities should set expectations for OEF managers to use a mixture of quantitative and qualitative factors when determining the liquidity of OEF assets in normal and stressed market conditions within the context of the domestic liquidity framework set out by authorities. The Revised FSB Recommendations seek to achieve (i) greater inclusion of anti-dilution LMTs in OEF constitutional documents and (ii) greater use of, and greater consistency in the use of, anti-dilution LMTs in both normal and stressed market conditions.
To support these objectives and ensure more effective liquidity risk management practices, IOSCO’s LMT Guidance provides detailed guidance on the design and use of anti-dilution LMTs by OEF managers. The LMT Guidance aims to support the greater use of anti-dilution LMTs by OEFs to mitigate investor dilution and potential first-mover advantage arising from structural liquidity mismatch in OEFs.
The LMT Guidance sets out key operational, design, oversight, disclosure and other factors and parameters that responsible entities should consider when anti-dilution LMTs are used, to promote greater, more consistent, and more effective use of these tools. For example, responsible entities should have appropriate internal systems, procedures and controls in place at all times in compliance with applicable regulatory requirements for the design and use of anti-dilution LMTs as part of the everyday liquidity risk management of their OEFs. Furthermore, anti-dilution LMTs used by responsible entities should impose on subscribing and redeeming investors the estimated cost of liquidity. This encompasses the explicit and implicit transaction costs of subscriptions or redemptions, including any significant market impact of asset purchases or sales to meet those subscriptions or redemptions.
Looking ahead, IOSCO will consider how to further operationalise the Revised FSB Recommendations through amendments to the 2018 IOSCO Recommendations and supporting good practices, as needed.
The FSB and IOSCO will both review progress by member jurisdictions in implementing their respective revised Recommendations and guidance. This will begin with a stocktake, to be completed by the end of 2026, of the measures and practices adopted and planned by FSB member jurisdictions. IOSCO will aim to coordinate a stocktake of its recommendations and guidance with the FSB’s stocktake to provide a comprehensive picture. The FSB and IOSCO will, by 2028, assess whether implemented reforms have sufficiently addressed risks to financial stability. This will include, if appropriate, assessing whether to refine existing tools or develop additional tools for use by fund managers or authorities.
Klaas Knot, Chair of the FSB, said “The combined efforts of the FSB and IOSCO aim to mark a step change to liquidity risk management within OEFs. A key part of this is a strengthening of the framework around the use of LMTs at a global level. Swift and consistent implementation of these recommendations is critical to addressing financial stability risks arising from liquidity mismatch in OEFs.”
Jean-Paul Servais, Chair of IOSCO, said “The FSB and IOSCO have worked closely together to deliver a comprehensive policy package designed to strengthen open-ended fund managers’ liquidity management to improve investor protection and support financial stability. I commend Christina Choi, Chair of IOSCO’s Committee on Investment Management, on developing IOSCO’s guidance, which provides a robust supplement to the Revised FSB Recommendations, enabling effective adaptation by OEFs on a global scale.”
The International Organisation for Securities Commissions (IOSCO), the global standard setter for securities market regulators, on 14 December 2023 published its Consultation Report on Market Outages.
Operational resilience remains a key global priority for securities regulators, as the resilience of trading venues is vital for the smooth operation of global capital markets.
Recent market outages have shown that trading venues can take different approaches regarding the coordination and communication of recovery pathways for the impacted market participants and the general public.
Building from previous IOSCO reports and new information gathered through a members’ survey, this Consultation Report identifies key findings from recent market outages and puts forward five good practices for trading venues to consider improving market-wide resilience during an outage:
Establish and publish an outage plan with clearly defined roles and responsibilities;
Implement a communication plan, which provides, through an appropriate communication channel, initial notice (as soon as possible) of the outage, and, thereafter, with regular updates on the status of the outage and the recovery pathway;
Communicate information relevant to the reopening of trading in a timely and simultaneous manner to all market participants, providing clarity on the status of their orders and ensuring they receive an adequate period of notice before the resumption of trading;
Ensure the processes and procedures that trading venues will follow to operate a closing auction and/or to establish alternative closing prices are published in the outage plan and communicated to all market participants during an outage; and
Conduct and share with the relevant regulators a lessons-learnt exercise of the market outage and adopt a post-outage plan, with clearly defined timelines and allocation of responsibilities for remediation, designed to reduce the likelihood of future incidents and to improve the ability of the trading venue to effectively respond to outages.
These good practices aim to assist regulators, trading venues and market participants in preparing for, and managing, future market outages and thereby helping improve market-wide resilience.
While the Consultation Report focuses on equities listing trading venues, the findings are also relevant to other trading venues, including non-listing trading venues and derivatives trading venues.
“Market outages – particularly if they occur on a listing trading venue – can be highly disruptive. The proposed set of good practices are an important step towards enhancing market-wide resilience in the event of a market outage. We strongly encourage market participants to actively participate in the consultation process.”
The New Crypto-Asset Reporting Framework is a step towards International Coordination in Regulating the Crypto Industry
Daniel Makina, University of South Africa
The emergence of cryptocurrencies in the early 21st century raised a debate on whether they can be regarded as money. Money is best defined by its five functions as a unit of account, medium of exchange, means of payment, standard for deferred payments and store of value. Generally, cryptocurrencies can somehow satisfy the first three functions. Largely, due to their volatility they can hardly satisfy the functions as a standard for deferred payments and store of value. Hence, in almost all jurisdictions save for El Salvador, cryptocurrencies are not regarded as money or legal tender. However, there is consensus that they can be regarded as an asset class. In South Africa a cryptocurrency is regarded as a private digital asset. While the South African Reserve Bank does not recognise it as legal tender, it acknowledges its legality and supports its development. In October 2022 the Financial Sector Conduct Authority (FSCA) classified cryptocurrency a financial product and brought it under its regulatory framework. The regulatory framework requires cryptocurrency service providers to register with the Financial Intelligence Centre (FIC) and comply with Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) requirements in addition to the normal KYC requirements. By the end of 2023 over ninety (90) financial services providers had applied for licenses with FSCA to offer crypto-related services.
The Cockroach Theory of Crypto
The crypto industry has over the years given regulators and central banks headaches because the high potential for cross-border reach and swift trading among different cryptocurrencies, makes them prone to being used for illicit transactions such as money laundering, terrorism financing, tax evasion, financial scams and other crimes, without being linked back to the illicit activity[1]. Cryptocurrency trading that happens through decentralized peer-to-peer transactions may not reveal any customer identity information, making it impossible to trace who controls the traded cryptocurrencies if illicit activity is involved. Even if the trading is done on centralized platforms, relevant crypto-service providers need not disclose their customers’ identity information, nor must they perform KYC in customers’ registrations. Moreover, the ability to trade rapidly among different cryptocurrencies enables multiple transactions of illicit funds in a short time to effectively hide the trail of funds. Furthermore, if illicit transactions are cross-border, which is often the case, supervision and enforcement will be impossible without coordinated international regulatory collaboration. Because of these underlying risks there have been efforts to try to kill it. The Economist issue of 18 December 2023 aptly likened the crypto industry to cockroaches as follows: “Chopping of their heads does not work: cockroaches can live without one for as long as a week. Whacking them is no guarantee either: their flexible exoskeletons can bend to accommodate as much as 900 times their body weight. Nor is flushing them down the toilet a solution: some breeds can hold their breath for more than half an hour”.
In other words, crypto can be regarded by some as an unwelcome pest just as a cockroach because cryptocurrencies can be used for money laundering, financing terrorism and are generally created for speculative activities. More so, their values have no underlying assets, and cryptocurrencies are difficult to regulate. And just like cockroaches they are difficult to kill. They have endured against all odds because they underpinned by the innovative blockchain technology that has since found various important applications. It can be argued that a cockroach is even easier to kill than crypto because innovative technology like a chemical pesticide can instantly kill it.
Crypto Assets go Mainstream
Since bitcoin, the world’s largest cryptocurrency, achieved its highest price of almost $69,000 on 10 November 2021, it has been on downward trend reaching $16,600 by the beginning of 2023. The fall of crypto prices has been attributed to higher interest rates and a spate of scandals that beset the crypto industry. The founders and bosses of the two world biggest crypto exchanges – Binance and FTX – were convicted for breaking anti-money laundering laws and fraud in 2023. It is noteworthy that the financial crimes they committed are not unique to the crypto industry but are also common in the traditional financial sector.
The year 2023 saw crypto assets establishing themselves as a serious asset class. The dramatic change started when in the USA a court ordered the Securities and Exchange Commission (SEC) to reconsider the application by Grayscale, an investment firm, to convert a $17 billion bitcoin trust into an exchange-traded fund (ETF). BlackRock and Fidelity, the biggest fund managers in the USA, have also applied to launch their crypto asset ETFs. These developments brightened the prospect of crypto assets being approved as an asset class by the SEC in the course of 2024. Consequently, the last quarter of 2023 witnessed a significant increase of the price of bitcoin which touched a two-year high of nearly $45,000 on 11 December 2023, an almost 150% increase in a year.
Towards International Coordination in Reporting Crypto Assets
Countries have taken different regulatory approaches towards cryptocurrencies. For example, China banned the cryptocurrency trading and mining activities within the country in 2021[2], while Hong Kong, a special administrative region of China, has taken a more open regulatory stance, as seen in its policy statement, issued in October 2022[3], aiming to establish a consistent, predictable and clear regulatory framework and a facilitating environment for promoting sustainable and responsible development of the crypto sector in Hong Kong. US President Joe Biden issued an executive order in March 2022 outlining a policy approach for addressing the risks and harnessing the potential benefits of digital assets, including cryptocurrencies across six areas: consumer and investor protection, financial stability, illicit finance, international cooperation, financial inclusion and responsible innovation[4]. In September 2022, the US government released a framework composed of a series of reports for the responsible development of digital assets[5].
South Africa has taken a positive stance on cryptocurrencies. South Africa’s financial sector regulators have published a policy position paper on cryptocurrencies (named “crypto assets” in the paper) through the Intergovernmental Fintech Working Group (IFWG)[6]. The IFWG paper provides specific recommendations on developing a regulatory framework for cryptocurrencies, including confirmation of cryptocurrency legal status and tax application along with regulatory framework implementation for AML/counter-terrorist financing (CFT), monitoring and analysis programme, licensing and supervision, cross-border regulation, payment system providers, initial coin offerings, use in alternative investment and cryptocurrency market support services.
At the global level, in 2014 the OECD published the Common Reporting Standard (CRS) to promote tax transparency bringing its scope certain electronic money and Central Bank Digital Currencies (CBDCs). Since the CRS was adopted over 100 jurisdictions have implemented it. Cognisant of the emergence of crypto assets in the global tax space and realization that these assets can be transferred and held without interacting with traditional financial intermediaries or any central administrator and hence lack full visibility, in August 2022, the OECD, working with the G20 countries adopted the Crypto-Asset Reporting Framework (CARF), a dedicated global tax transparency framework. The CARF provides for the automatic exchange of tax information on transactions in crypto assets in a standardized manner. It consists of rules and commentary which can be incorporated into domestic law to collect information from Reporting Crypto-Asset Service Providers that are designed around four key building blocks.
The Scope of Crypto Assets to be covered
Crypto assets targeted by the CARF are those assets that can be held and transferred in a decentralised fashion using cryptographically secured distributed technology without the in the use of traditional financial intermediaries. These crypto assets also include: stablecoins, derivatives issued in the form of crypto assets and certain non-fungible tokens (NFTs). Notably, assets covered under the CARF also fall within the scope of Financial Action Task Force (FATF) Recommendations to ensure that due diligence requirements build on existing AML/KYC obligations.
Entities and Individuals subject to Data Collection and Reporting Requirements
Reporting crypto-asset service providers under the CARF include entities and individuals whose business is to provide effecting exchange transactions in relevant crypto assets for or on behalf clients. Such financial intermediaries and other service providers would also ordinarily fall within the scope of FATF and hence they are in a position to collect and review their clients’ documentation ensuring it complies with AML/KYC requirements.
Reporting Requirements
Three types of transactions regarded as relevant transactions reportable under the CARF include:
Exchanges between relevant crypto assets and fiat currencies;
Exchanges between one or more forms of relevant crypto assets; and
Transfers of relevant crypto assets.
The Due Diligence Procedures
Reporting crypto asset service providers are required follow due diligence procedures provided by the CARF. These due diligence procedures build on the self-certification process of the Common Reporting Standard (CRS) and existing FATF AML/KYC obligations. They are designed to allow service providers in crypto to efficiently determine the identity and tax residence of crypto asset users.
At the same time the CARF was adopted, the OECD, working with G20 countries, conducted a comprehensive review of the CRS in consultations with participating jurisdictions, financial institutions, and other stakeholders. The result was a set of amendments made to the CRS. Amendments were made in the light of CARF to ensure that indirect investments in crypto assets through derivatives and investment vehicles are covered by the CRS as well as to improve the operation of the Standard based on the experience gained by over 100 jurisdictions since the CRS was adopted. Since the CARF is a separate and complementary framework, there are going to be some entities reporting under both the CRS and the CARF. To lessen the burden of duplicate reporting, the CARF permits reporting crypto asset service providers also subject to the CRS to rely on the due diligence performed for CRS purposes.
South Africa is one of 48 jurisdictions so far that have pledged to adopt the new CARF. The list of countries that have pledged also include all 38 OECD countries and traditional financial offshore hubs such as the UK’s overseas territories – Cayman Islands, Gibraltar, among others. However, key markets such as China, Hong Kong, the UAE, Russia, and Turkey are excluded. The 48 countries adopting the standard have set a 2027 deadline for implementing it in their laws.
The South African Revenue Services (SARS) intends to work towards ensuring that the CARF is incorporated in the domestic law. It recognizes that lack of transparency makes it challenging for tax authorities to gain insight into crypto transactions or the location of crypto assets. Hence, the CARF new international standard will facilitate automatic exchange of information between tax authorities. Already crypto exchanges in South Africa were required to register for licences with the FSCA before the end of 2023. They are excited by the developments because they believe that regulatory oversight will increase public trust in crypto.
Going Forward
Perhaps the cockroach is a necessary evil in the natural ecosystem. By virtue of being an omnivore, it feeds on other pests and plants, some of which are harmful to humans. Similarly, crypto assets could turn out to be a useful diversification tool in the asset manager’s toolkit. Portfolio theory advises us to develop portfolios of assets that are either negatively correlated or not correlated at all. Crypto assets appear not to be correlated with other assets except among themselves. Although, going forward, crypto assets might constitute a worthy asset class for investment just like stocks, bonds, real estate, and other asset classes, countries should prioritize targeted implementation of existing global regulatory standards and recommendations on cryptocurrency put forth by international organizations and standard-setting bodies based on the country-specific context, with coordinated mechanisms that allow for rapid review and adaptation to new developments of cryptocurrencies and their risks. Such international standards[7] can be seen in the FATF’s standards for mitigating the AML/CFT risks of cryptocurrency, the Bank for International Settlements (BIS) proposal for the prudential treatment of banks’ crypto exposures, the Financial Stability Board (FSB) recommendations on the regulation of global stablecoin arrangements and cryptocurrency activities and markets, and others.
[1] See IMF (2021). Global Financial Stability Report—COVID-19, Crypto, and Climate: Navigating Challenging Transitions. Washington, DC, October. https://www.imf.org/en/Publications/GFSR/Issues/2021/10/12/global-financial-stability-report-october-2021; and He, D., Habermeier, K.F., Leckow, R.B., et al. (2016). Virtual Currencies and Beyond: Initial Considerations. IMF Staff Discussion Notes No. 16/3. https://www.imf.org/en/Publications/ Staff-Discussion-Notes/Issues/2016/12/31/Virtual-Currencies-and-Beyond-Initial-Considerations-43618.
[2] See https://www.coindesk.com/learn/china-crypto-bans-a-complete-history/.
[3] See the Policy Statement on Development of Virtual Assets in Hong Kong by the Financial Services and the Treasury Bureau of Hong Kong: https:// www.info.gov.hk/gia/general/202210/31/P2022103000454.htm.
[4] See https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.
[5] See https://www.whitehouse.gov/briefing-room/statements-releases/2022/09/16/fact-sheet-white-house-releases-first-ever-comprehensive-framework-for-responsible-development-of-digital-assets/.
[6] South African Intergovernmental Fintech Working Group (IFWG), Crypto Assets Regulatory Working Group (2020). Position Paper on Crypto Assets (updated in 2021). https://www.sars.gov.za/wp-content/uploads/IFWG-CAR-WG-Position-paper-on-crypto-assets.pdf.
[7] See more details in: FATF (2021). Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers. Paris: Financial Action Task Force (FATF): https://www.fatf-gafi.org/publications/fatfrecommendations/documents/guidance-rba-virtual-assets-2021.html; Basel Committee on Banking Supervision (2021). Prudential Treatment of Cryptoasset Exposures. Basel: Bank for International Settlements (BIS): https:// www.bis.org/bcbs/publ/d519.htm; FSB (2020). Regulation, Supervision and Oversight of ‘Global Stablecoin’ Arrangements. Basel: Financial Stability Board (FSB): https://www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements/; and FSB (2022). Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: Consultative Report. https://www.fsb.org/2022/10/regulation-supervision-and-oversight-of-crypto-asset-activities-and-markets-consultative-report/.
The Report provides an overview of initiatives undertaken in various jurisdictions to address greenwashing, in line with IOSCO recommendations published in November 20211,2 and the subsequent Call for Action3 in November 2022. The Report presents the challenges hindering the implementation of these recommendations, including data gaps, transparency, quality, and reliability of ESG ratings, consistency in labelling and classification of sustainability-related products, evolving regulatory approaches, and capacity building needs. While some of these challenges are currently being addressed, greenwashing remains a fundamental market conduct concern that poses risks to both investor protection and market integrity.
Jean Paul Servais, IOSCO Board Chair said “In recent years, there has been a growing recognition of the economic and financial materiality of climate change and ESG considerations. But there is also a growing concern against misleading claims about ESG risks, opportunities, and impacts. Internationally, industry participants, investors, regulators, and policy makers have stepped up their efforts to address such risks of greenwashing. It is key to promote cultures that support good practices aimed at protecting investors and fostering market integrity. The Report supports regulators address greenwashing by outlining current regulatory best practices from around the world.”
Rodrigo Buenaventura, IOSCO Sustainability Task Force Chair and Chairman of CNMV Spain, said: “Greenwashing can occur throughout the investment value chain, and any market participant – from issuers to asset managers to ESG ratings and data products providers – can engage in this behaviour. Taken more broadly, greenwashing undermines the fundamental trust in sustainable finance. To ensure a healthy global sustainable finance market, there is a need for reliable, consistent, and comparable sustainability related information, while related ESG products should be marketed and managed in a way that does not undermine investors’ trust.”
The Report notes that most jurisdictions have in place supervisory mechanisms to address greenwashing in the area of asset management. Educational and capacity building activities are also used as proactive tools to prevent greenwashing. Furthermore, the Report refers to some enforcement measures which have been taken on a few greenwashing cases. The Report also notes that while the ESG ratings and data products market remains largely unregulated, some jurisdictions are currently developing policy frameworks for ESG ratings and data products providers. Finally, the Report refers to the cross-border nature of sustainability-related investments which requires adequate cooperation. Such cross-border cooperation, including sharing experiences and knowledge, as well as exchanging relevant information and data, is therefore necessary in ensuring market integrity and investor protection.
Grant Vingoe, CEO of the Ontario Securities Commission, Canada and STF Promoting Good Practices Co-Chair, said: “Whether intentional or not, greenwashing negatively impacts investor confidence. Supervisors have a key role to play by ensuring that there are responsible risk monitoring and management processes in place, and by promoting decision-useful information for investors. In doing so, supervisors can help foster a culture that will prevent harm and promote investor confidence in sustainable finance.”
Dr Mohamed Farid Saleh, Executive Chairman, Financial Regulatory Authority, Egypt and STF Promoting Good Practices Co-chair, said: “The ability to address greenwashing is also a matter of capacity. Jurisdictions, notably from emerging markets, will require assistance for both designing and executing their action plans towards any net zero commitment, and more concretely, for implementing new corporate sustainability requirements and new or enhanced supervisory practices. Greenwashing will remain to pose risks to the global sustainable finance markets until the quality and reliability of information available to investors improve. All stakeholders will therefore need to act in concert to combat greenwashing, building a more reliable ecosystem to ensure trust in sustainable finance markets.”
These recommendations are central to the delivery of a coordinated global regulatory response to the significant investor protection and market integrity risks posed by centralized crypto-asset intermediaries called crypto asset service providers (CASPs).
IOSCO’s detailed and targeted recommendations elaborate the regulatory expectations, either through application of existing rules or development of new rules, depending on the jurisdiction, to address the key areas of harm observed in these markets.
The CDA Recommendations set a clear and robust international regulatory baseline to ensure that CASPs meet the standards of business conduct that apply in traditional financial markets.
The Recommendations cover six key areas, consistent with the IOSCO Objectives and Principles for Securities Regulation and relevant supporting IOSCO standards, recommendations, and good practices:
Conflicts of interest arising from vertical integration of activities and functions,
Market manipulation, insider trading and fraud,
Custody and client asset protection,
Cross-border risks and regulatory cooperation,
Operational and technological risk, and
Retail distribution.
Jean-Paul Servais, IOSCO Chair said:
As IOSCO chair, I am pleased with the publication of the IOSCO Report on Crypto and Digital Asset Markets which is the first and important step to ensure investors are protected and crypto-asset markets operate fairly, efficiently and transparently. This report is a key component of the international framework for these markets envisaged by the G20 and FSB.
Next, our attention turns to ensuring the adoption and implementation of the recommendations to support optimal consistency in the way crypto-asset markets and activities are regulated across IOSCO member jurisdictions.
Tuang Lee Lim, Chair of the IOSCO Board-Level Fintech Task Force, set up to develop the policy measures, said:
The activities of CASPs and their associated risks frequently mirror those observed in traditional financial markets. The regulatory approach taken is therefore consistent with IOSCO’s Principles and associated standards for securities markets regulation.
These 18 recommendations for crypto and digital asset markets are outcomes-focused and based on the principle of “same activity, same risk, same regulatory outcome”.
By Lydia Shadrach-Razzino, Partner, Co-head of the Corporate/M&A Practice, Tanya Seitz, Director Designate, and Shamila Mpinga, Candidate Attorney, Corporate/M&A, Baker McKenzie Johannesburg
The Johannesburg Stock Exchange (JSE) has seen listings halve in the past two decades, from 616 in 2000 to just below 300 in 2023. This is likely a result of reduced foreign investments in the country due to the unfavourable global macroeconomic climate. However, some analysts have noted that the JSE’s listing requirements are onerous and have arguably led to increased compliance costs and an unprecedented number of delistings in the past five years. While delistings are an ordinary part of capital markets, the scarcity of new listings is a cause for concern.
One of the main reasons companies list on the main board of the JSE is to raise capital. However, issuers have been less optimistic about the prospects of raising capital on the JSE, as many have been trading at double-digit discounts to their net asset values. This has significantly reduced the attractiveness of the JSE to private companies, hence its current efforts to encourage listings. The JSE has announced numerous changes to its listing requirements to encourage new entrants and prevent delistings, with the most recent of these changes becoming effective as of 17 July 2023.
The changes to its listing requirements include (i) the introduction of dual-class share structures; (ii) the reduction of free float for new listings; (iii) changes to free float assessments for institutional investors; (iv) changes to the listing requirements for special purpose acquisition companies (SPACs); and (v) making financial reporting disclosures less onerous. Although the changes have been well received by market participants as a means to encourage new listings, they appear to be more geared towards attracting IPOs rather than adding significant value for existing issuers. Finally, in September 2023, the JSE announced its intention to completely overhaul the JSE Listings Requirements (Requirements) in an attempt at simplifying the Requirements and cutting red tape, which is welcomed.
Dual-class shares
In essence, dual-class share structures exist where a shareholder’s voting control over a company is disproportionate to their economic interest in that company. A dual-class share structure typically involves a company having two classes of shares that are identical in every respect except for voting rights. One class of shares is a “low vote” share, carrying one vote per share (typically Class A shares), while the other class of shares is a “high vote” share, typically carrying 10 or 20 votes per share (typically Class B shares). Prior to the current amendments, the JSE did not allow companies with dual-class shares to list on the exchange. It also prohibited existing listed companies from issuing dual-class shares. An exemption applies to companies with dual-class shares that were listed before 1999. These exempted companies were allowed to issue additional shares of that class. The amendments relating to dual-class shares are forward-looking and apply to new listings. They do not affect companies that are already listed.
A major concern associated with dual-class share structures is the concentration of power in the hands of management with little to no shareholder oversight. This could lead to dubious corporate governance practices, which makes it important for shareholders to maintain a watchful eye over these companies.
The JSE’s introduction of dual-class shares as “weighted voting shares” has been widely accepted, subject to guardrails to mitigate the abovementioned risks. These include (i) requiring a maximum weighted ratio of 20:1; (ii) requiring that dual class shares be held only by directors of the company; and (iii) capping all shares to one vote regardless of the class for certain matters, such as changes to independent directors and auditors, variation of rights attaching to any class of shares, a reverse takeover, liquidation, or delisting. Dual-class share structures are commonplace on stock exchanges globally, as seen on the New York Stock Exchange, the Nasdaq, and the Toronto Stock Exchange. What remains to be seen is whether there is investment appetite for companies with dual-class share structures on the JSE.
Free float and new listings
Free float refers to a company’s issued share capital that is held by public investors. Prior to the amendment, the JSE required main board issuers to have a free float of 20%. To keep abreast of international developments in Europe and to encourage new listings, the JSE has reduced the free float requirement to 10%. Making a large portion of the company’s shares freely tradeable can be unsettling, particularly for large companies where there are few shareholders willing to sell their shares. Therefore, this is great news for high-growth companies and those with private equity and venture capital investors, which consider free-float requirements a strong deterrent when considering where to list.
Reducing the free float requirement to 10% will allow new issuers flexibility to structure their IPOs and open markets to issuers wishing to initially raise smaller amounts of equity. The requirement to float 10% is in line with other local exchanges, such as the Cape Town Stock Exchange, thereby making the JSE competitive in the local market. The fact that the free float requirement has been largely unchanged for over 20 years has been detrimental for Africa’s largest exchange. It has impacted the JSE’s competitiveness as a primary and secondary listing jurisdiction. For instance, it is strange that companies that were compliant on premier international exchanges would fall short of qualifying for a secondary listing on the JSE for failing to float 20% of their shares. Therefore, this change is a move in the right direction as it reduces the burden of shareholder dilution.
Institutional investors and free float assessment
There are limited security holdings that qualify as free float. One type of holding that previously did not qualify was a shareholding of 10% or more. This was not ideal given that it is common for institutional investors, such as fund managers and portfolio managers, to hold more than 10% of an applicant issuer on listing. As an exception, the JSE allowed institutional investor holdings of more than 10% to qualify as free float. The exemption applied where the interest held was in more than one fund and each fund held less than 10% of the shares in the applicant issuer. This exemption was not the saving grace that it set out to be, as it was rather limited and complex to apply. Therefore, the JSE has resolved to change the rules to recognize institutional investors for free float purposes, provided they have no relationship whatsoever with the directors and family of the applicant issuer.
The JSE has widened the scope for free-float assessments in two major ways. Firstly, the JSE has removed the 10% exclusion altogether, provided there is a minimum number of shareholders. Requiring a minimum number of shareholders will ensure that the floated shares are not held by only one shareholder and will encourage a competitive share price. The JSE’s second amendment is to exclude shareholders who exercise control (>35%) from the free float assessment. Given that 90% of monthly trades on the JSE are driven by institutional investors, they will benefit significantly from this amendment.
Additional amendments: SPACS and Financial Reporting Disclosures
In its efforts to retain and attract listings, the JSE has amended its requirements relating to financial reporting disclosures and SPACS, respectively.
The JSE introduced SPACS in 2013. This type of company is primarily incorporated to raise capital to acquire viable assets with the aim of listing on an exchange. Viable assets are those that qualify for a listing on an exchange. SPACS are a viable investment vehicle and become more attractive in a volatile economic environment when traditional listings become riskier. We witnessed this SPAC boom in 2020 and 2021, when the markets became volatile during the COVID-19 pandemic. Global interest in SPACS has since dwindled. Despite the reduced interest, the JSE has amended its requirements to make SPACS more attractive for listings, should the demand for SPACS increase.
To retain listings, the JSE has reduced the compliance burden for issuers. Issuers will no longer have to produce an abridged version of their financial results along with their audited annual financial statements. Furthermore, issuers’ interim results will no longer have to include an auditor’s opinion, where the previous set of annual results were accompanied by a modified opinion. The JSE has admitted that the previously mandated financial reporting disclosures added no regulatory value or benefit to investors. As such, these amendments have received overwhelming support.
Simplification project
The JSE has announced its intention to simplify the Requirements. Essentially, the JSE plans to rewrite the Requirements using plain language for the benefit of all stakeholders. This process will include a substantial reduction in the volume of the Requirements and cutting red tape to ensure that only rules that are fit for purpose survive the purge. The JSE has created a dedicated portal for this project, which will run in stages over 18 months, including public participation throughout the process. We look forward to reviewing the suggested amendments.
Final thoughts
The JSE certainly has its work cut out for it, particularly given the rise of other exchanges locally and the success of private equity and venture capital financing in South Africa. With less stringent compliance burdens, competitor exchanges and alternative forms of financing have become more attractive methods of raising capital, thus posing a challenge for the JSE.
In its efforts to encourage new listings and curb delistings, the JSE, through its initiatives to cut red tape, must find a balance between reducing compliance burdens and protecting investors. The previous listing requirements had been in place for over 20 years. Therefore, the recent changes are testament to the JSE’s commitment to self-assessment and improvement to encourage capital market reform.
Coupled with the recent amendments to the Requirements, the complete overhaul of the Requirements presents an opportunity for the JSE to reform and regulate listings in a manner that accommodates potential issuers, listed companies, sponsors, shareholders and investors. Balancing these interests is no small feat, but by engaging market participants, the JSE can allay such challenges and pave the path for a renewed JSE that can withstand the cyclical nature of global economic conditions.
A Dispute Resolution team from Baker McKenzie in Johannesburg, including Darryl Bernstein, Kylie Slambert, Cameron Jeffrey and Landise Banzana, successfully represented the Rosebank Rotary Club (RRC) on a pro bono basis in a precedent-setting case relating to the conduct of financial service providers (FSPs) and their duty of care to safeguard their clients’ finances and protect them against cybercrime. The case involved an ongoing dispute involving the RRC and a financial investment firm, Brough Capital (Brough), and its director, Chris Botha (Botha). The decision, which was delivered in the Commercial Court, has implications for all accountable financial institutions.
Botha is a director, Representative and Key Individual of Broughas defined by the Financial Advisory and Intermediary Services Act (FAIS). According to the FAIS Act, Key Individuals have a fiduciary responsibility to ensure that they perform their duties with the necessary care, skill and diligence. FAIS, as well as the General Code of Conduct for Authorised FSPs, requires that FSPs have appropriate technological systems in place that eliminate, as far as reasonably possible, the risk that clients and other FSPs will suffer through, amongst other things, fraud, negligence, or professional misconduct.
The dispute arose out of the misappropriation of funds, totalling ZAR 3.1 million, invested by the RRC via Brough and Botha. The funds were misappropriated as a result of a business email compromise in the form of fraudulent emails sent by unknown hackers purporting to be withdrawal instructions from RRC, to Brough. The Court, in considering the matter, found that Brough did not take adequate measures to prevent the misappropriation from occurring, nor did Botha, both being bound by the legislation and guidelines governing the conduct of intermediary service providers. It was decided that the defendants failed to comply with the duties of an FSP and were guilty of gross negligence, flowing from the manner in which they dealt with the withdrawal instructions from the unknown hackers. Of particular relevance was the fact that the defendants:
Ignored errors on the change of bank account letters, including that RRC’s name was not written in full and that the logo of the respective bank was missing from the letter; and
Ignored the unusual nature of the withdrawals, which were large sums of money drawn in short succession and without notice.
The Court considered the fact that had Botha paid careful attention to the purported letter from the bank, it would have revealed that it was not the plaintiff’s bank account but that of a “Rotary Club” with no name. Further, the Court noted that Botha should have considered the history of the withdrawals from his client and taken time to understand their business insofar as enquiring what the funds were for. The judgment noted that the defendants had failed to exercise the necessary skills, care and diligence, as well as their contractual obligation to be vigilant. The Court found that they had been grossly negligent.
The defendants were found jointly liable to pay the plaintiff ZAR 3.1 million at 10.5% interest per annum, plus costs.
Darryl Bernstein, Partner and Head of the Dispute Resolution Practice in Johannesburg, noted, “This judgment highlights the importance of the responsibility placed on FSPs, as well as those individuals under the supervision of the respective FSPs, to be extra vigilant in an era where cybercrime is rife. It further places great importance on functioning internal controls, such as two-step verification processes, to avoid, as far as possible, the promulgation of cybercrimes and to prevent gross negligence. The judgment is also a reminder to intermediary service providers that, even in instances where the funds are administered by a third party, the proverbial buck stops with the FSP with whom the client has a contractual relationship.”
Businesses have anxiously been seeking clarity on the application of public interest conditions in merger transactions. It is anticipated that the Competition Commission’s draft public interest guidelines for mergers will provide some clarity on its approach to public interest considerations in the context of merger regulation.
The South African Competition Commission (the Commission) released the Draft Revised Public Interest Guidelines (draft guidelines) on the first day of its 17th Annual Competition Law, Economics and Policy Conference. These draft guidelines are intended to indicate the approach that the Commission may adopt and the type of information the Commission may require when evaluating the public interest factors in section 12A(3) of the Act.
Merger control
Since the amendment of the Competition Act (89 of 1998) a few years ago, the public interest component of merger regulation has achieved prominence. Over the 2021/22 financial year, at least a quarter of all mergers were approved subject to public interest conditions. As a result, businesses have been eager for clearer guidance from the competition authorities on when public interest conditions will be applied and how these conditions should be structured.
Merger control in South Africa is, in part, governed by the public interest considerations set out in section 12A(3) of the Competition Act. These considerations must be read alongside and given equal weight to the traditional assessment of a merger’s effect on competition in the relevant market. Section 12A(3) provides that, when determining whether a merger can be justified on public interest grounds, the competition authorities must consider the effect that the merger will have on:
a particular industrial sector or region;
employment;
the ability of small and medium businesses, or firms controlled by or owned by historically disadvantaged persons, to effectively enter into, participate in or expand within the market;
the ability of national industries to compete in international markets; and
the promotion of a greater spread of ownership, to increase the levels of ownership by historically disadvantaged persons, workers and firms in the market.
HDP requirement
The section 12A(3)(e) requirement, introduced via a legislative amendment in 2019, that a merger must promote a greater spread of ownership by historically disadvantaged persons (HDPs) and workers, has been the subject of much scrutiny. HDPs are defined in the Act as a category of individuals who were disadvantaged by unfair discrimination based on race, prior to the enactment of the Interim Constitution, including organisations that are controlled by HDPs.
While the draft guidelines discuss the Commission’s approach to each public interest consideration, potential merger parties will be particularly interested in the Commission’s interpretation of section 12A(3)(e), and how it interacts with the rest of the considerations.
At the outset, the Commission makes it clear that section 12A(3)(e) enjoys a unique status amongst the other public interest considerations as it is the only consideration to impose a positive obligation on merging parties. Accordingly, the starting point of the Commission’s merger assessment will be that all mergers are required to promote a greater spread of ownership. The Commission is explicit in noting that “a lack of promotion of ownership levels will not be considered to be responsive to this provision”.
The applicability of section 12A(3)(e) to mergers with a neutral effect on HDP and/or worker ownership (particularly foreign-to-foreign mergers) has been a grey area in the Commission’s application of section 12A(3)(e). The draft guidelines seek to provide clarity by stating that the obligation to promote or increase a greater spread of ownership pertains to all mergers having an effect in South Africa. This suggests that mergers between two foreign-owned firms with limited South African operations may be required by the Commission to promote a greater spread of HDP and/or worker ownership.
Comment
Although the Commission’s guidelines, once adopted, will not have the status of enforceable legislation, they nevertheless provide a clear indication of how the Commission is likely to approach the public interest element of merger regulation in South Africa, and how it intends to marry the transformational imperatives that underscore the Competition Act with the requirement for greater certainty in merger regulation.
Interested parties have until 17 November 2023 to submit comments on the draft guidelines.
Enrica Schaefer, Jenny Leahy, Rikki Haria and Jennifer Mellott
The 2024 edition of Getting the Deal Through: Merger Control has been published. This annual overview of global merger control has been led by Freshfields in partnership with Law Business Research for the past 28 years. The current edition covers the basic principles of merger control regulation in 59 jurisdictions worldwide. In this blog, we introduce the opening chapter which considers the key developments in the recent global shift towards tougher merger control enforcement—a trend that looks set to continue into 2024.
Over the past year, competition authorities globally have continued to make a move towards more stringent merger control enforcement. This follows an increasingly shared view among authorities and politicians across multiple jurisdictions that excessive consolidation in certain industries has been exacerbated in the past by a lenient approach to merger control enforcement. This overall trend has manifested itself in an increasing number of transactions being blocked, requiring remedies, or being abandoned by the merging parties.
