Virtual assets - a new challenge for the Mexican financial system

Miguel Gallardo Guerra

BGBG Abogados, Mexico City; Vice Chair, Derivatives Subcommittee of the IBA Banking Law Committee

mgallardo@bgbg.mx

Samuel Uziel Rivero Prado

BGBG Abogados, Mexico City

surivero@bgbg.mx

Introduction

Over the past few years, we have seen the evolution of the world’s financial systems, particularly in terms of how transactions and their functions have changed or targeted certain sectors.

As a result, financial systems have adopted increasingly automated or digital transactions, securities and systems, with the aim of facilitating financial relationships between their subjects – whether users, clients, financial intermediaries or governmental regulators.

Mexico has issued laws to regulate the so-called ‘fintech’[1] entities. On 9 March 2018, the Law to Regulate Financial Technology Institutions (the Fintech Act) was published in the Official Federal Gazette. These institutions are legal entities authorised by the National Banking and Securities Commission (the Commission) to carry out fintech activities. The Fintech Act describes two types of financial technology institutions:

• collective financing institutions (crowdfunding), which carry out activities aimed at connecting the general public in order to provide financing through debt, capital, co-ownership or royalty financing transactions, carried out through computer applications, interfaces, webpages, or through any other means of electronic or digital communication; and
• electronic payment fund institutions, which provide services on a regular and professional basis, consisting of the issuance, administration, redemption and transmission of electronic payment funds.

On 10 September 2018, Circular 12/2018, which was aimed at electronic payment institutions, was published at the Official Federal Gazette and concerned the general provisions applicable to the transactions of electronic payment fund institutions. This Circular lays down the characteristics of the transactions carried out by the Electronic Payment Fund Institutions.

On the same day, the general provisions referred to in Article 58 of the Fintech Act were published, which are aimed at preventing money laundering and terrorism financing. The general provisions applicable to financial technology institutions were also published, establishing the regulatory framework applicable to these institutions.

Six months after the publication of the above provisions, on 8 March 2019, Circular 4/2019 regarding Virtual Assets was published at the Official Federal Gazette, as was Circular 5/2019 regarding the new models and Circular 6/2019 for the collective financing institutions.

Finally, on 20 May 2019, Circular 8/2019 was published at the Official Federal Gazette, which amended Circular 14/2017 regarding the Rules of the Interbank Electronic System Payments.

Virtual assets

Arising from the global evolution in technology, payment methods have also evolved. We have seen this before with the creation of debit cards and credit cards; not too long ago, it was almost impossible to think that a piece of plastic could be used to pay for goods or services. Today we have a new challenge, the so-called ‘virtual assets’ as defined by Chapter Three of the Fintech Act:

‘The representation of value registered electronically and used among the public as a means of payment for all types of legal acts is deemed as a virtual asset and the transfer of which can only be carried out through electronic means. In no case shall the legal tender in national territory, currencies, or any other asset denominated in legal tender or currency be understood as a virtual asset.’[2]

We have the following characteristics:

• it is a security;
• it is electronic;
• it is a payment means used by people;
• it can only be carried out by electronic means; and
• national currency, currencies or other assets in legal tender may never be taken as a virtual asset.

These virtual assets are the most important revolution that the financial world has experienced in years; they have generated great interest from financial institutions ­– especially amongst the existing users and customers of these entities. This has resulted in significant market demand for these assets, coupled with an increase in their value and volatility. They have emerged as a new way to make payments, one that avoids the participation of third parties.

Blockchain

Bitcoin is one of the best-known crypto-currencies; however, there are other virtual assets, such as utility tokens, equity tokens and security tokens. That is why we must understand how these assets work.

Blockchain is a single, sequential, distributed record on a network – that is, the place where transactions are logged. These blocks of information store the number of valid records or transactions, the information regarding each block and its link to the previous block: this generates the availability of the information at any time. Blockchain is the technological infrastructure that supports the operations and transactions of virtual assets.

The Bank of Mexico and its stand

The Bank of Mexico is an autonomous constitutional entity, responsible for issuing currency, generating economic policies to protect the purchasing power of our currency, working to ensure that Mexicans have a healthy financial system and, consequently, ensuring that payment systems function properly.

Therefore, the Bank of Mexico has issued its opinion regarding virtual assets, in addition to issuing regulations and limiting them in various ways. The Bank of Mexico established that virtual assets have a number of problems as a substitute for the Mexican currency, derived from the fact that they do not possess the characteristics of money as we know them, namely deposit in value, means of exchange or unit of account.

Thus, in Circular 4/2019, the Bank of Mexico in its Considerations established that, for the offering of virtual assets and their use by the general public, it finds a problem of information asymmetry. This is a result of:

• the complexity of the mathematical and cryptographic processes that support virtual assets and the difficulty for users in knowing such processes;
• the complexity of the factors that determine the price of virtual assets, the lack of knowledge of the elements that determine supply and demand, and the lack of any reference with which an estimate of their price can be obtained.[3]

Another position of the Central Bank of Mexico is that virtual assets represent a significant risk in terms of preventing operations with illicit resources and terrorism financing, due to the ease of transferring virtual assets to different destinations, as well as the absence of controls and protection measures at a global level.

Accordingly, the Bank of Mexico established that a distance must be given between virtual assets and the financial system; however, it is also true that the Bank of Mexico says it also seeks to promote and take advantage of the use of technologies that could have a benefit, as long as they are used in the context of the internal operation of financial technology institutions and credit institutions. This in turn does not imply an increase in the operational and financial risks, so we must understand that it is intended to protect the final consumer. That is why, in the second paragraph of Provision Three of Circular 4/2019, it is clearly stated that the institutions authorised to operate virtual assets must prevent the transfer, directly or indirectly, of the risk of such transactions to the institution’s customers.

The Tax Administration Service and virtual assets

In addition, the Tax Administration Service ('SAT') has established, in accordance with Article 17, fraction XVI of the Federal Law on the Prevention and Identification of Transactions with Illegally-Obtained Funds ('LFPIORPI'), as a vulnerable activity

‘the usual and professional offering of exchange of virtual assets by subjects other than financial institutions that are carried out through electronic platforms, who manage and operate by facilitating or conducting operations to buy or sell such assets owned by their customers, or providing means to keep, store, or transfer virtual assets other than those recognised by the Bank of Mexico in terms of the Fintech Act.’

From 3 February 2020, it is mandatory to register as a vulnerable activity for the purposes of the LFPIORPI with the SAT, through the Anti-Money Laundering Website. In addition, from 9 September 2019, the identification records of customers or users – the persons involved in the operations carried out with virtual assets – must be integrated.

As a result of the above, and from the operations carried out on 2 April 2020, notices must be submitted by the 17th day of the following month in which the act or transaction was made to the Financial Intelligence Unit through the SAT, where the amount of the transaction performed by each customer is equal to or greater than 645 units of measurement and update (UMA), if that threshold is reached by virtue of the aggregation of operations referred to in the penultimate paragraph of Article 17 of the LFPIORPI. However, if no transaction has been carried out during the corresponding month, a report shall be submitted stating that no acts or transactions were carried out in the corresponding month that are the subject of notice.

Furthermore, the SAT states that information and documentation that supports the vulnerable activity must be kept, protected, and prevented from the destruction or concealment, as well as from that which would identify its customers or users, for a period of five years from the date of the performance of the activity.

Therefore, those who carry out the vulnerable activity must have a document with their guidelines for identifying customers or users, as well as the internal criteria, measures, and procedures to comply with the provisions of the LFPIORPI, its regulations, general rules, and other provisions derived from this law.

In view of the abovementioned, these are the regulations regarding the prevention of money laundering and terrorism financing, which is one of the concerns of our Central Bank.

Circular 4/2019 on General Provisions applicable to Credit Institutions and Financial Technology Institutions in Transactions with Virtual Assets

In accordance with the first provision of Circular 4/2019, the purpose of Circular 4/2019 is to:

• determine virtual assets;
• establish the limitations of the transactions that institutions may carry out with virtual assets;
• establish the time limits, terms, and conditions to be met by the institutions in cases where the virtual assets with which they perform transactions become other types of virtual assets or change their characteristics;
• determine the information related to virtual asset transactions that the institutions must submit to the Bank of Mexico in order to obtain authorisation to perform transactions with virtual assets; and
• establish the characteristics of the authorisations.

The Bank of Mexico states that only financial technology institutions and credit institutions will be able to perform transactions with virtual assets internally, but what should we understand by ‘internal transactions’? Internal transactions are those activities that are carried out internally, to carry out passive, active and service transactions that they execute with their customers, or that they carry out on their proprietary account, including activities carried out by the institutions to support the international transfers of funds.[4]

While the Fintech Act gives us a definition regarding virtual assets, the Circular is more concise and sets forth the characteristics of the virtual assets that can be used to perform transactions:

• to be identifiable units of information, electronically registered, that do not represent the ownership or rights of an underlying asset or that represent said ownership or rights for a value less than these;[5]
• to have emission controls defined by protocol; and
• to have protocols that prevent replications of information units or their fractions.

However, the last paragraph of the fourth provision of this Circular provides that the institutions may carry out internal transactions using virtual assets with characteristics other than those set out above, for which they must be subject to the provisions applicable to them regarding the use of automated data processing technologies and systems.

The Circular is very clear on how to perform transactions with virtual assets: it is only through authorisation granted by the Bank of Mexico for the term that it determines. Therefore, the institution must submit a request to the Central Bank, sent via email to the Management of Authorizations and Queries of Central Banking of Mexico.

Conclusions

We can conclude that virtual assets are an electronic value, used as a means of payment which can only be transacted by electronic means and that, in turn, they are an electronically registered identifiable information unit (blockchain); therefore, they are not a currency under Mexican law.

The authorities of our country have gradually been regulating the issue and have already established their limitations and the obligations represented by the transaction of virtual assets; however, we still see some fear around transactions with virtual assets. This is understandable since, as we note in previous paragraphs, one of the risks observed by the Bank of Mexico is that homologous regulation regarding virtual assets is limited at a global level.

It is true that virtual assets represent a challenge for the financial system in Mexico as we know it, but it is also true that the financial system has to be dynamic and adapt to the generational changes of its users and clients, as well as to the trends and platforms that are created. We have no doubt that virtual assets will spark much discussion, especially considering the Covid-19 pandemic that has shown the importance of information technologies and technological systems.