Context

No Money for Terror conference hosted by the Union Ministry of Home Affairs concluded with a commitment from the 93 participating nations to end all financing of terror, including through the use of emerging digital technologies such as VDAs.

Concerns regarding virtual digital assets

VDAs for illicit activities: The concerns around the misuse of VDAs for illicit activities require careful legislative responses and forward-looking regulatory guardrails.
Non reporting and non-transparency: On a fundamental level, these concerns stem from a lack of reporting and transparency norms, and an absence of international consensus on regulatory design.
Lack of reliable data: The Reserve Bank of India’s (RBI) Deputy Director highlighted the difficulty in regulating VDAs, given the lack of reliable data on VDA transactions.
Unregulated transactions: This allows bad actors to engage in unchecked transactions and defraud investors, as evinced by one of the (erstwhile) largest VDA exchanges FTX.

Leveraging G20 Presidency: As one of the highest-ranked countries in terms of VDA adoption, and now with the G20 presidency, India has a critical role to play in shaping the global regulatory environment.
Empowering anti-money laundering authorities: In the short term, a viable approach for India is in taking the industry and the investor into confidence by allowing anti-money laundering (AML) authorities visibility over VDA transactions, and the power to impose controls upon them and prosecute in the event of any misuse.
India should adopt FATF guidelines: There are several international templates to this effect. The Financial Action Task Force Guidelines on Virtual Asset Transactions (FATF Guidelines) are a case in point, which have been adopted by various jurisdictions, including the EU, Japan and Singapore.

Minimum anti-money laundering standards: The FATF prescribes minimum Anti-money laundering standards that countries should employ to prevent the likelihood of misuse, and the FATF Guidelines prescribe the same for VDA transactions.
Licensing and reporting of VDAs: The Guidelines are applicable to VDA service providers of member states like India. Key features of the FATF Guidelines include licence/registration requirements and extensive reporting and record-keeping obligations for VDA service providers.
Travel rule obligations: One such obligation is the Travel Rule, which requires service providers to record the originator and beneficiary’s account details, transaction amount, and purpose of transaction for all wire transfers.
Verifying identity above certain threshold: Customer due diligence obligations, which include verifying the customer and beneficiary’s identities should be conducted for all transactions exceeding $1,000.
Obligation on service provider: The FATF Guidelines also require VDA service providers to perform enhanced due diligence obligations (such as corroborating the customer’s identity with a national database or potentially tracing the customer’s IP address to ensure there are no links to illicit activities) when a transaction is with a higher-risk country.

PMLA includes reporting obligation: India’s existing Anti-money laundering framework under the Prevention of Money Laundering Act, 2002 (PMLA) already applies these regulatory tools over traditional financial institutions. Notably, the PMLA also includes reporting obligations for overseas transactions that fall under the ambit of “suspicious transactions” under the framework.
PMLA doesn’t apply to VDAs: Currently, the PMLA does not apply to the VDA industry.
government can bring VDA under PMLA: The government has the power to notify any “designated business or profession” as a reporting entity under the PMLA and can issue a notification that classifies VDA service providers as a designated business.

With the Digital Data Protection Bill and the Digital India Act already in the pipeline, Indians and digital businesses will soon have a coherent rights and responsibility framework to operate within. The time is ripe to extend regulatory oversight over the VDA industry so as to ensure that tech-innovation flourishes in a responsible, accountable manner.

Mains Question

Q. How virtual digital assets and terror financing are interlinked? What is the role of PMLA act in regulation of VDA in India?