As early as March 2014 the Cyprus Securities and Exchange Commission (CySEC) alerted potential investors to the risks associated with investment in virtual currencies or contracts for difference (CFD) linked to them. Its recently-issued circular C244 dated October 13 2017 sets out the conditions Cyprus investment firms must satisfy in the event they provide investment services in respect of such products to safeguard investors' interests.
The circular points out that there is no specific EU regulatory framework governing trading in these products. It also states that there has been no official decision by European regulatory authorities regarding whether trading in CFDs relating to virtual currencies falls under paragraph 9, section C, annex 1 of Directive 2004/39/EU on markets in financial instruments (Mifid). Pending a decision and guidance from the relevant European body, investment firms which have previously obtained approval from CySEC and are permitted under section 6(9)(b) of the Investment Services and Activities and Regulated Markets Law to provide services in virtual currencies or in CFDs relating to them, must adhere to the requirements below.
- They must comply with the provisions of the Investment Services Law and guidance issued by CySEC regarding organisational requirements (including safeguarding of clients' assets, compliance function and internal audit function), conduct of business rules (including marketing communication, appropriateness and best execution), record keeping and capital adequacy.
- Before providing any services to clients in virtual currencies or derivatives linked to them, they must clearly warn their clients of all the risks, and advise them that trading in such products does not entitle them to any protection under the Investors Compensation Fund or the Cyprus Financial Ombudsman scheme.
- They must ensure that all risks associated with the activity are identified, assessed, recorded, monitored and adequately managed.
- They must carry out appropriate due diligence on feed providers such as virtual currency exchanges and liquidity providers and counterparties before establishing a relationship, followed by regular periodic due diligence. Wherever possible, they should use more than one feed provider and should cross-check with other feed providers in order to ensure that best execution principles are followed. Where only a single feed provider is used, they must be able to determine and record how their best execution obligations are met. Any feed providers must be properly licensed and regulated in their home jurisdiction.
- They must clearly disclose the methodology used to calculate the bid and ask prices.
- They must not exceed a leverage limit of 5:1 for trading by retail investors on CFDs relating to virtual currencies.
CySEC has also posted a warning to investors on its website drawing attention to the high risks associated with investment in virtual currencies and financial products based on them. It identifies several additional warning signs as a reason for exercising even greater caution, such as claims of guaranteed high investment returns with little or no risk, unsolicited offers without a full analysis of the risks involved and high-pressure sales techniques. The warning also draws attention to the risky nature of investment in initial coin offerings (ICO), which should only be undertaken by investors who have the necessary experience and knowledge, are confident of the quality of the ICO project itself and are prepared to lose their entire investment.