Regulation of Crypto-Asset Activities in Abu Dhabi Global Market (ADGM)

Apr 13, 202410 min read

Introduction

The Abu Dhabi Global Market (ADGM), a finance-focused free zone within the Emirate of Abu Dhabi, administers a distinct and comprehensive regulatory framework for crypto-asset activities. Established by the Financial Services Regulatory Authority (FSRA), this framework governs the operations of entities engaging in crypto-asset spot transactions from within ADGM since June 2018.

Regulatory Framework Overview

Entities wishing to undertake regulated crypto-asset services must comply with regulatory requirements, including Anti-Money Laundering and Counter-Terrorism Financing (AML/CFT) rules, Know Your Customer (KYC) regulations, market surveillance protocols, and specific licensing mandates. Central to this regulatory approach is acquiring a Financial Services Permit (FSP), compulsory for conducting Regulated Activities concerning Virtual Assets in or from ADGM.

Application Process for Financial Services Permit

The process for obtaining an FSP is structured into five principal stages:

Due Diligence and Initial Discussions: Prospective entities engage in preliminary discussions with FSRA teams. This stage involves explaining their business models, demonstrating compliance with established regulations, and providing technological demonstrations.
Formal Application Submission: Entities submit a detailed Virtual Asset Application Form, requisite supporting documentation, a comprehensive launch plan, and the associated fees. FSRA commences a formal review after receiving these submissions.
In Principle Approval (IPA): This approval is granted after reviewing the application and supporting documents, contingent on the applicant's adherence to all regulations. Certain conditions must be fulfilled before receiving final approval.
Final Approval: Final approval is granted conditional upon satisfactory completion of operational testing and capabilities, as well as third-party system verifications if necessary.
Operational Launch Testing: This is particularly crucial for Multilateral Trading Facilities (MTFs) and Virtual Asset Custodians; this phase involves operational testing to ensure compliance with FSRA's standards, potentially including third-party system verifications.

Corporate Establishment and Location Requirements

To be eligible for an FSP, an entity must establish a corporate presence within ADGM. The regulatory requirements stipulate that an Authorized Person, Recognized Body, or Applicant must have their head office and registered office within ADGM to conduct any Regulated Activities or Activities under a Recognition Order. Applicants can be either a Body Corporate or a Partnership, depending on the nature of the Regulated Activities envisaged.

Specific Eligibility for Regulated Activities

Different types of Regulated Activities under the Virtual Asset Framework demand specific organizational forms:

Entities aiming to effect or carry out Contracts of Insurance must be incorporated as a Body Corporate.
Those engaging in Accepting Deposits may be either a Body Corporate or a Partnership.
Entities acting as the Trustee of an Investment Trust must be a Body Corporate.

Virtual Assets Definition and Regulatory Treatment

In line with the Financial Action Task Force's guidelines, FSRA defines a "Virtual Asset" within the Financial Services and Markets Regulations (FSMR) as a digital representation of value that can be traded digitally, which functions as a medium of exchange, a unit of account, or a store of value. However, it does not have legal tender status in any jurisdiction. Furthermore, Virtual Assets are neither issued nor guaranteed by any jurisdiction and are recognized solely by agreement within the respective user community, distinguishing them from Fiat Currency and E-money.

Digital Securities are recognized under paragraph 58(2)(b) of FSMR as securities encompassing digital/virtual tokens exhibiting characteristics akin to shares, debentures, and units in a collective investment fund. Entities engaging in services related to Digital Securities, such as managing investments or providing advice, require a Financial Services Permission (FSP) and are subject to market intermediaries and market operators' regulations within ADGM. Conversely, Virtual Assets are classified as commodities, and although they are not deemed Specified Investments under the FSMR, market intermediaries handling these assets, such as brokers and custodians, must obtain FSRA approval and an FSP.

Regulatory Approach

The FSRA's regulatory approach delineates the treatment of different categories of digital assets:

Derivatives and Collective Investment Funds of Virtual Assets and Digital Securities are regulated as Specified Investments under the FSMR.
Utility Tokens, which are for access to a specific product or service using a DLT platform but do not exhibit the features of a regulated investment, are treated as commodities.
Fiat Tokens are digital representations of Fiat Currency. If used as a payment instrument, they are regulated under the FSMR and considered Providing Money Services.

Risks and Mitigations

The FSRA outlines risk areas and mitigation strategies within the Virtual Asset Framework:

AML/CFT/Tax: Compliance with the AML Rulebook is mandatory for all Authorized Persons, alongside reporting obligations under FATCA and Common Reporting Standards.
Consumer Protection: The risks associated with Virtual Assets must be transparently disclosed to consumers, and they must be monitored and updated regularly.
Technology Governance: Authorized Persons must ensure robust governance over virtual asset wallets, private keys, origin and destination of funds, security, and risk management systems.
'Exchange-Type' Activities: MTFs using Virtual Assets are mandated to establish market surveillance, fair and orderly trading, settlement processes, transaction recording, a rulebook(s), transparency, and public disclosure mechanisms.
Custody: Providers holding or controlling Virtual Assets or client money (e.g., fiat currencies) must comply with Safe Custody and COBS (Client Order Book Systems) under the FSMR.

Activities involving Virtual Assets that are subject to regulation include:

Operating a Multilateral Trading Facility (MTF)
Acting as a Virtual Asset Custodian
Dealing in or Arranging transactions in Virtual Assets
Managing and Advising on investments in Virtual Assets

Entities performing these functions must adhere to the corresponding regulations and obtain the necessary FSRA approvals.

Capital and Fee Structure

In adherence to the Abu Dhabi Global Market (ADGM) regulations, entities engaging in Virtual Asset activities are subject to specific capital and fee requirements reflecting the substantial supervisory resources needed for these operations.

Capital Requirements

Pursuant to COBS Rule 17.3 and MIR Rule 3.2.1, an Authorised Person dealing with Virtual Assets must maintain regulatory capital in fiat currency. This must equate to at least 12 months' operational expenses for an entity operating a Multilateral Trading Facility (MTF) for Virtual Assets.

Other Authorised Persons conducting regulated activities related to Virtual Assets must hold capital equivalent to 6 months' operational expenses. Suppose an Authorised Person engages in other regulated activities unrelated to Virtual Assets. In that case, the FSRA enforces the higher capital requirements from those mandated by the Prudential – Investment, Insurance Intermediation, and Banking Rules (PRU).

Fee Requirements

Fees are imposed on entities within the ADGM performing Virtual Asset services, including authorization and annual supervision fees. The structure is as follows:

General Virtual Asset service providers must pay an initial authorization fee of USD 20,000 and an annual supervision fee of USD 15,000.
Entities operating an MTF for Virtual Assets are subject to an authorization fee of USD 125,000 and an annual supervision fee of USD 60,000.
A sliding-scale trading levy applies to MTFs handling Virtual Assets, determined by the transactions' Average Daily Value (ADV).
The fees for entities conducting multiple regulated activities are cumulative and adjust according to the specific combination of services provided.

Mandatory Appointments

The General Rulebook (GEN) mandates that every Authorised Person appoint approved individuals to essential roles, including a Senior Executive Officer, Finance Officer, Compliance Officer, and Money Laundering Reporting Officer, all of whom must reside in the U.A.E. Additionally, any Directors of a Body Corporate with headquarters and registered offices within ADGM must be registered as Licensed Directors.

Accounting and Auditing Requirements

The GEN Rulebook requires that:

Financial statements are prepared annually for each Authorized Person and Recognized Body.
The Regulator must be notified of Auditor appointments, terminations, or resignations in the prescribed form.
Appropriate steps must be taken to ensure the selected Auditor possesses the necessary qualifications to audit the entity's business.

Multilateral Trading Facilities (MTFs)

Defined under the FSMR and related guidance, an MTF is a system that consolidates buying and selling interests for investments in a non-discretionary manner, resulting in a contractual agreement. Entities operating an MTF or an Organised Trading Facility must adhere to stringent regulations, including the maintenance of non-discretionary rules and engagement in activities that result in legally binding contracts for financial instruments, Virtual Assets, or spot commodities.

PRU Categorization

The PRU Rulebook categorizes Authorized Persons to determine applicable provisions. Authorized Persons are permitted to conduct regulated activities of a lower category if authorized under their Financial Services Permission.

Categories of Authorised Persons

In the regulatory framework established by the Financial Services Regulatory Authority (FSRA) within the Abu Dhabi Global Market (ADGM), Authorised Persons are classified into distinct categories based on the regulated activities they are authorized to conduct. The classification is as follows:

Category 1: Activities include Accepting Deposits and Managing a Profit-Sharing Investment Account, which is PLS (Profit and Loss Sharing).
Category 2: Providing Credit and Dealing in Investments as Principal.
Category 3: Split into three subcategories (3A, 3B, and 3C), this includes various activities such as Dealing in Investments as an Agent, Managing Assets, Providing Custody, and Operating a Multilateral Trading Facility.
Category 4: Encompasses Arranging Credit, Advising on Investments or Credit, Insurance Intermediation, and other specific activities not included in the higher categories.
Category 5: This category is reserved for those conducting non-mainstream regulated activities, such as Operating a Private Financing Platform.

Capital Requirements

The FSRA mandates base capital requirements for Authorised Persons operating within the ADGM, applicable across all categories as a fundamental component of their financial adequacy.

Base capital requirements vary according to the category of Authorised Persons as follows:

Category 1: USD 10 million
Category 2: USD 2 million
Category 3A: USD 500,000, unless the Authorised Person is dealing in investments as a principal involving OTC Leveraged Products with Retail Clients, in which case the base capital requirement is USD 2 million.
Category 3B: USD 4 million
Category 3C: USD 250,000, which may increase to USD 150,000 or USD 500,000 based on the type of fund managed or the provision of Financing Platforms and holding Client Assets.

Maintenance and Notification of Capital Resources

Authorized Persons in Category 3B, 3C, or 4 must always maintain capital resources that meet or exceed the capital requirement. If capital resources fall below 120% of the Capital Requirements, the regulator must be notified proactively.

Capital Calculation for Categories 3B, 3C, and 4

The capital requirement for these categories is calculated as the higher of the base capital requirement or the Expenditure Based Capital Minimum. The latter is informed by the actual expenses and provides a real-time reflection of the capital adequacy relative to the entity's operational volume.

Regulated Activity of Providing Money Services

For entities engaged in the regulated activity of Providing Money Services, capital requirements are to be calculated as the greatest of:

The base capital requirement,
The Expenditure Based Capital Minimum, or
A Variable Capital Requirement applicable to specific activities within the Money Services domain.

Variable Capital Requirement Calculation for Money Remitters

Money Remitters must calculate their Variable Capital Requirement based on a percentage of their monthly payment volume, with the following tiered structure:

1.25% of the first USD 10 million
0.5% of the next USD 90 million
0.25% of the subsequent USD 150 million
0.125% of any further payment volume

The monthly payment volume is determined by the annual funds remitted, averaged per month, or by a combination of actual and projected figures for newer entities.

Variable Capital Requirement for Payment Account Providers

Payment Account Providers calculate their Variable Capital Requirement using a similar tiered percentage structure of their monthly payment volume, with rates of:

2.5% of the first USD 10 million
1% of the next USD 90 million
0.5% of the subsequent USD 150 million
0.25% of any additional volume

Guidance for Variable Capital Calculation

The FSRA provides guidance on calculating the Variable Capital Requirement, emphasizing a tranche-based approach. Payment volumes are segmented, and different percentage factors are applied to each tranche to determine the cumulative Variable Capital Requirement.

Substantive Operational Presence in ADGM

The FSRA stipulates that an Authorised Person conducting regulated activities in relation to Virtual Assets must have a substantive operational presence within the Abu Dhabi Global Market (ADGM). Central to this requirement is the establishment of the 'mind and management' of the Authorised Person within ADGM to ensure effective control and oversight.

Specific Requirements for Multilateral Trading Facilities

For Multilateral Trading Facilities (MTFs) engaging with Virtual Assets, the FSRA mandates a physical presence within ADGM. This contains involvement in the MTF's operations, including but not limited to:

Control over the order book
Management of the matching engine
Adherence to established rulebook(s)
Ensuring the facilitation of fair and orderly markets
Implementing settlement procedures
Monitoring and prevention of market abuse in line with the Market Infrastructure Rules (MIR) and the Conduct of Business Sourcebook (COBS) Chapter 8

For start-up MTFs, complete regulatory oversight by the FSRA is required over their entire order book and matching engine functionalities. Existing virtual asset exchanges with components of their order book or matching engine located outside of ADGM must delineate the aspects that will fall under FSRA's jurisdiction as part of their application to become authorized MTFs within ADGM.

Exclusive Operation of Markets within ADGM

The FSRA asserts that within ADGM's jurisdiction, only authorized MTFs may conduct market operations that involve the matching of orders or aid in price discovery for Accepted Virtual Assets. The scope and degree of FSRA's regulatory oversight are designed to be comprehensive and may differ significantly from other global regulatory bodies.

Trading Pairs on MTFs

In the trading environment of MTFs, the FSRA permits trading pairs that consist exclusively of:

Exchanges between Fiat Currency (or its equivalent value) and Accepted Virtual Assets
Exchanges between Accepted Virtual Assets and Fiat Currency (or its equivalent value)
Trades involving one Accepted Virtual Asset for another

Links

Guidance – Regulation of Virtual Asset Activities in ADGM

Regulation of Crypto-Asset Activities in Abu Dhabi Global Market (ADGM)

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