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Market Surveillance

The Role of Market Surveillance: Building Trust in Crypto Markets

Despite the market turbulence of 2022, crypto adoption is continuing to grow, and regulators are developing more comprehensive frameworks for this nascent asset class.

Like other financial markets, crypto is vulnerable to market manipulation and abuse from nefarious actors, highlighting the growing need for robust surveillance programmes to build greater trust, widen adoption, and protect investors from nefarious activities.

As the crypto markets evolve, how are regulatory approaches in Asia developing, and what role is market surveillance playing in building resilience and trust in the crypto world? These were the topics under discussion at a recent webinar jointly hosted by Regulation Asia and Nasdaq.

Same challenges, different market

Certainly, trust in the crypto markets fluctuates from both institutional and retail investors, and not just because plunging prices and collapsing confidence in 2022 have appeared to dash expectations that the market is moving beyond the wild volatility that characterised its early years. 

According to data from the US Federal Trade Commission (FTC), losses to crypto scams in 2021 were 60 times higher than they were in 2018. Between the start of 2021 and mid-2022, investors and traders were scammed out of more than US$1 billion. Even though crypto’s structure means there is no recovering stolen assets once they’re gone, a lot can be done to block those thefts at the source.

Despite crypto gaining a certain mystique (frequently born of misunderstanding), the essential nature of crypto fraud is nothing new. The FTC reports that almost half of scammed crypto investors said thefts “started with an ad, post, or message on a social media platform.”

“The bad behaviours we have observed in these types of markets are no different from the behaviours we see in the more traditional markets,” said David Kwan, Head of Sales and Business Development for Asia-Pacific at Nasdaq Market Surveillance. “As a surveillance technology provider with the purpose of protecting investors and upholding market integrity, we have seen cases of spoofing, wash trading, money laundering…so why can’t (the industry) apply the same monitoring and the same protection systems in crypto [as traditional markets]? Ultimately, the willingness to apply certain surveillance or integrity protocols to protect investors comes down to the marketplace itself and whether they take on the responsibility of protecting their investors. That is the only way the industry will grow.”

Similarly, businesses wanting to get into the Virtual Asset Service Provider (VASP) arena don’t initially need to look beyond existing policies and procedures for traditional financial institutions. Internal control procedures established back in 2014 in both Hong Kong and Singapore are a “good guide” for establishing the infrastructure, security, and procedural rules needed to set up a crypto exchange. 

“I would really say, strongly, to go back to basics,” said Angelina Kwan, Chief Executive Officer at Stratford Finance Ltd. “There will be some anomalies with virtual assets…but largely, it’s the same business.”

Leaders in regulation

At the regulatory level in Asia, Hong Kong and Singapore are, unsurprisingly, taking a leading role in building the frameworks necessary to build that resilience and trust in crypto markets. 

The Hong Kong Government has gazetted amendments to its Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) that include a new licensing regime for VASPs.

Any business wanting to operate a VASP (currently limited to exchanges and exchange-like services and potentially extending to over-the-counter operations and others in the future) will need a licence from the Securities & Futures Commission (SFC).

For Hong Kong, the term “virtual assets” currently applies to Bitcoin and other altcoins, as well as stablecoins and certain governance tokens, but could be expanded to include non-fungible tokens (NFTs) in the future.

“All the existing guidelines for other financial institutions (FIs) – internal control guidelines, fund-management code of conduct, regulation of automated trading services – all of these will apply to virtual asset licence holders,” said Stratford’s Kwan. 

“The SFC is working on putting a licensing regime in place, and they hope to have that out by the third or fourth quarter of 2022, with full transitioning by March 2023.”

The legislation promises to be more than just a cut-and-paste process, Stratford’s Kwan pointed out. There are provisions covering the use of fraudulent or deceptive devices in virtual asset transactions and also market manipulation.

“It’s actually a really big piece of legislation, and you can imagine all the forms and training that will have to be put in place over the next six months,” Stratford’s Kwan said.

Increasing crypto regulation

Singapore, meanwhile, is also preparing its own legislation to buttress an emerging crypto environment that’s already covered to some extent by the Payment Services Act, which has been in force since January 2020.

The new Financial Services & Markets Bill, approved by Parliament in April 2022, will stiffen regulations and close a gap left open by the Payment Services Act. 

“There’s a gap in the sense that the Payment Services Act does not regulate providers who set up shop in Singapore but do not offer services in Singapore,” said Janice Goh, a partner at Cavenagh Law LLP, an alliance with Clifford Chance in Singapore. “The new Act will require all VASPs who have a place of business in Singapore to be licensed. This is aligned with the proposed framework in Hong Kong.”

This is a response to what the Monetary Authority of Singapore (MAS) considers the “reputational risk” to Singapore of potential bad actors who might be stationed in the city and targeting less well-regulated jurisdictions. 

The Bill also focuses on digitalisation, which is transforming the city’s financial sector and has the potential to disrupt existing regulatory frameworks that were drawn up for more traditional transactions and services. 

Under the Bill, financial institutions will face penalties of more than SGD 1 million for serious cyberattacks or disruptions to essential financial services.

There are, however, key differences between the two structures, Koh noted. 

Hong Kong’s legislation promises to be more comprehensive, at least initially, because it compels VASPs to have policies in place to prevent market manipulation. Singapore’s proposals don’t cover this.

“So, if legal regulators in Singapore want to go after VASPs for market manipulation, they will first have to treat and prove that that crypto asset is actually a security under our securities law,” Koh said. “The provisions in Hong Kong will be much wider…and it will be very interesting to see what type of enforcement actions Hong Kong regulators can bring under these wider market-manipulation provisions.”

Some important steps have already been taken. In Singapore, for example, an investor successfully applied to the courts to freeze the transfer of a rare NFT.

“This decision is very good news,” Koh said. “It’s a first in Singapore and Asia and the first globally in the context of a commercial dispute where it recognises an NFT as an asset.”

Growing institutional interest

The ultimate impact of these regulatory measures should be, of course, to gain the confidence of institutional investors, draw more of them into the market, and release substantial pent-up demand among large FIs.

“Numerous large institutional banks and investment firms have been preparing for this development for a very long time,” said Nasdaq’s Kwan. “When these kinds of regulations come in, we will see an increasing number of market participants, and we will see crypto markets mature.”

“There are a lot of lessons to be learned from practices and experiences in the more traditional established capital markets…and we can gain from adopting those same tried-and-tested risk models and controls for new crypto exchanges and operators to protect investors. Maybe there are changes that we need to apply specifically for crypto assets, but ultimately, when it comes to investors, they want the same protections no matter which asset class they’re trading. They want to ensure that when they invest in something, market integrity is there, and this will only help to get more institutional adoption.”

As of June 2022, about 6.5% of all Bitcoin was held by institutions, up from effectively zero a few years ago – a trend accelerated by high-profile purchases from companies such as Tesla, Square, and MicroStrategy.

Boosting surveillance

But mainstream adoption of crypto markets among retail and institutional investors will not be straightforward, not least because of the difficulty of conducting surveillance and enforcement in markets founded on the concept of immutability and borderless anonymity.  

“Part of the challenge for regulators and exchanges is that they don’t know who is on the other side of transactions,” said Nasdaq’s Kwan. “That’s where Nasdaq will have to really help regulators as well as market participants in terms of the cross-market discussions.”

“We have spent a lot of time educating start-ups who may not have worked in the traditional market space and do not know the full requirements in terms of monitoring what is bad and what is good.” 

In that particular area of operations, many VASPs are inexperienced and unprepared for the rigours of regulated finance.

“I don’t think virtual asset firms have really thought about the cost of enforcement yet,” said Stratford’s Kwan. “It’s much better to put in surveillance and work on knowing your markets and having those procedures before you get slammed by a regulator.”

At the moment, investigation and enforcement actions in Asia are relatively thin on the ground, but that is almost certain to change. In the US, the Securities & Exchange Commission has almost doubled the size of its Crypto Assets & Cyber enforcement unit and has imposed billions in penalties. History suggests regulators in Asia-Pacific will follow suit, which is why stakeholders will be keenly watching the activities of authorities in Hong Kong and Singapore in the coming months and years.

“My guess is that we may see a limited number of enforcement cases in the immediate future,” Koh said. “However, as the regulatory regime establishes itself and matures, and there are more retail investors, we expect regulators in APAC will be very closely watching everyone’s conduct to protect investors.”

For that to happen, market participants will need to work closely with regulators to boost surveillance. Nasdaq, for example, is integrating multiple exchanges in APAC and around the world to bring data together “so that we get a cross-section across a number of different marketplaces so that we can see what is happening,” Nasdaq’s Kwan said. 

“From a surveillance perspective, the technology is there.”

However, there are still significant gaps in that surveillance net, most notably when it comes to monitoring the apps and social media that might signal the first stirrings of trouble.

“Everything that’s going on in the market is probably presaged by 10 minutes on Reddit, Twitter, and other social media,” said Stratford’s Kwan. “So if you’re not on social media, you will be behind in the crypto native world. [Maybe] somebody can think of an app that actually can distill this information as part of an integrated surveillance tool. And maybe this is something that regulators should be thinking about, too.”

However turbulent the market becomes, interest and demand among FIs seem unlikely to wane.

“Ultimately, it’s an investable asset, the appetite to trade and invest is there, and it’s only growing, despite the controversies around Terra, Luna, and other potential cryptocurrencies,” Nasdaq’s Kwan said. “Therefore, we continue to see growth.”



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