I INTRODUCTION TO THE LEGAL AND REGULATORY FRAMEWORK
Virtual currencies and services related to virtual currencies in New Zealand are regulated by existing, technology neutral legislation. Given that the rights and functions created in respect of virtual currencies are flexible, each virtual currency or service associated with virtual currencies will be regulated according to its specific properties.
For the purposes of this chapter, the term virtual currencies includes all digital tokens that are recorded on a blockchain ledger.
II Securities and investment laws
The Financial Markets Authority (FMA) has responsibility for the regulation of financial products in New Zealand, and the Financial Markets Conduct Act 2013 (FMCA) is the principal piece of legislation that regulates financial products in New Zealand. The primary purposes of the FMCA are to promote the confident and informed participation of businesses, investors and consumers in New Zealand's financial markets, and to promote and facilitate the development of fair, efficient and transparent financial markets.
Offers of financial products in New Zealand are regulated by the FMCA and regulations made under the FMCA (Regulations). The FMCA and the Regulations:
- impose fair dealing obligations on conduct in both the retail and wholesale financial markets;
- set out the disclosure requirements for offers of financial products;
- set out a regime of exclusions and wholesale investor categories in connection with the disclosure requirements;
- set out the governance rules that apply to financial products; and
- impose licensing regimes.
In general under the FMCA, issuers of financial products must comply with various fair dealing obligations and certain disclosure, governance and operational obligations (subject to certain exceptions). The fair dealing provisions are concerned with misleading or deceptive conduct, and false, misleading or unsubstantiated representations. Failure to comply with the appropriate obligations may result in criminal or civil liability, or both, under the FMCA, and may result in material financial penalties, imprisonment, or both.
At a high level (and subject to the detail below), the disclosure and governance provisions of the FMCA will only apply to the offer of a virtual currency if:
- it is offered in New Zealand;
- it is made under a regulated offer; and
- the relevant virtual currency falls within one of the categories of financial product in the FMCA, or is otherwise designated as a financial product by the FMA.
i Offers in New Zealand
The obligations imposed under the FMCA apply to offers of financial products in New Zealand, regardless of where the issue occurs or where the issuer is based. An offer is deemed to have been offered in New Zealand if it is received by a person in New Zealand (including electronically), unless the issuer can demonstrate that it has taken all reasonable steps to ensure that persons in New Zealand to whom disclosure would otherwise be required under the FMCA may not accept the offer.
ii Regulated offers
An offer of financial products that requires disclosure under the FMCA is a regulated offer. An offer of financial products for issue requires disclosure to investors unless an exclusion applies to all persons to whom the offer is made. Certain specified offers of financial products for sale will also require disclosure to investors. The form and content of the disclosure required in relation to each financial product is set out in the Regulations and is tailored according to the characteristics of the particular financial product being offered.
The FMCA provides that a person must not make a regulated offer unless the issuer has prepared a product disclosure statement (PDS) for the offer, has lodged that PDS with the Registrar of Financial Service Providers (Registrar) and has prepared an online register with the prescribed information.
An offer that is not a regulated offer will still be subject to the fair dealing provisions in the FMCA. As noted above, these provisions prevent people from making false or misleading statements or unsubstantiated representations. Similar obligations are imposed under the Fair Trading Act 1986.
iii Types of financial product
There are four categories of financial products under the FMCA: debt securities, equity securities, managed investment products and derivatives.
Virtual currencies are regulated by the FMCA only to the extent that a particular virtual currency meets the definition of one these categories of financial product. The FMCA sets out a hierarchy of financial products, such that a virtual currency that would prima facie satisfy the definition of more than one category of financial product will default into only one category.
A debt security is defined as a right to be repaid money, or paid interest on money, where that money is deposited, lent to or otherwise owing by any person. Importantly, for the purposes of the definition of debt security, money does not include money's worth. Several prominent virtual currencies, such as Bitcoin and Ether, do not constitute debt securities because there is not a right to be repaid money or to be paid interest by the issuer, or anyone else.
An equity security is narrowly defined in the FMCA as a share in a company, an industrial and provident society, or a building society, but does not include a debt security.
While a blockchain could mimic a traditional share register (with each unit of the virtual currency representing a single share, and shareholders being able to represent trades in those shares by trading in those units), the virtual currency itself would not constitute a share in a company, an industrial and provident society, or a building society. As such, a virtual currency could not be an equity security as defined in the FMCA. This is the case even where a virtual currency gives holders rights traditionally associated with equity (such as certain profit and governance rights).
Managed investment products
A managed investment product refers to an interest in a managed investment scheme, which is broadly defined to include any scheme:
- the purpose or effect of which is to enable participating investors to contribute money to the scheme to acquire an interest in the scheme;
- where the interests are rights to participate in or receive financial benefits produced principally by the efforts of others; and
- where participating investors do not have day-to-day control over the operation of the scheme.
If a product is classified as a debt security or an equity security it would not be a managed investment product.
If a virtual currency is classified as a managed investment product, the FMCA imposes significant disclosure and governance requirements on the underlying managed investment scheme. These requirements include registering the scheme with the Registrar; complying with reporting and governance requirements; and requiring the appointment of a licensed manager and licensed independent supervisor, each of which owe statutory duties of care to investors.
In practice, the nature of a virtual currency may make it impractical or impossible to fully comply with these additional requirements. For example, one of the functions of the manager of a managed investment scheme is to manage the scheme property and investments. This requirement is not compatible with a decentralised blockchain where the scheme property is held in (for example) an Ethereum account associated with a smart contract. If there were a manager who had overall control over this account, the decentralised nature of the blockchain and the autonomous nature of the smart contract would be undermined.
By way of example, the DAO and DAO tokens, which were the subject of a report in 2017 by the United States' Securities and Exchange Commission, could have been characterised as a managed investment scheme and managed investment products (respectively) under the FMCA.2
A derivative is defined as an agreement under which consideration is, or may be, payable to another person at some future time and the amount of the consideration is ultimately determined, is derived from or varies by reference to (in whole or in part) the value or amount of something else (including an asset, interest rate, exchange rate, index or commodity). A derivative does not include, inter alia, a debt security, equity security or managed investment product. Certain virtual currencies that are tied to the value of fiat currencies, or that are tied to commodities such as gold (so-called stable coins), could constitute a derivative under the FMCA.
iv FMA designation and exemption powers
The FMA has certain designation powers under the FMCA, including the power to designate:
- that a security that would not otherwise be a financial product is a financial product of a particular kind. A security is an arrangement or facility that has, or is intended to have, the effect of a person making an investment or managing a financial risk. The FMA has expressed the view that all digital tokens issued in an initial coin offering (ICO) will constitute a security for the purposes of the FMCA; or
- that a financial product is, or is to become, a financial product of a particular kind. For example, if a virtual currency fell within the definition of managed investment product, the FMA could designate such interests as equity securities. In that case, the issuer would still be required to provide disclosure to investors, but would not be subject to the prescriptive governance obligations described above.
Alternatively, the FMA has the power to exempt any person or class of persons, or any transaction or class of transactions, from compliance with certain obligations imposed under the FMCA. For example, the FMA could exempt an issuer of a virtual currency classified as a managed investment product from some of the provisions that would otherwise apply to the issuer.
III Banking and Money Transmission
The Reserve Bank of New Zealand (RBNZ) has responsibility for the prudential regulation of registered banks, non-bank deposit takers and insurers in New Zealand. The RBNZ does not directly regulate virtual currencies. However, as New Zealand's central bank, the RBNZ is responsible for promoting the maintenance of a sound and efficient financial system.
Money transmission services in New Zealand are regulated separately by the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (FSP Act) and the Anti-Money Laundering and Countering Financing of Terrorism 2009 (AML/CFT Act). As the anti-money laundering regime is discussed in Section IV, this section is limited to the FSP Act.
Subject to certain limited exceptions, the FSP Act applies to any person who carries on the business of providing a financial service (a financial service provider) and:
- is ordinarily resident in New Zealand or has a place of business in New Zealand;
- is required to be a licensed provider under a licensing enactment (which includes registered banks, authorised financial advisers, licensed insurers and certain licensed supervisors); or
- is required to be registered under the FSP Act by any other enactment.
The core requirement of the FSP Act is that financial service providers must be registered for the relevant financial service on the Financial Service Providers Register. Financial service providers that provide financial services to retail clients must also join an approved dispute resolution scheme, subject to certain limited exceptions.
The term financial service includes, inter alia, operating a money or value transfer service, and issuing and managing means of payment.
The FMA issued guidance in late 2017 (Guidance) stating that in the context of virtual currency services, exchanges, wallets and ICOs may be considered financial services under the FSP Act.3 By way of example, exchanges allowing virtual currency trading will, according to the Guidance, be operating a value transfer service under the FSP Act. Similarly, the Guidance states, a wallet provider that stores virtual currency or money on behalf of others, and facilitates exchanges between virtual currencies or between money and virtual currencies, will also be operating a value transfer service. The Guidance also points out that trading of virtual currencies that are financial products may also trigger the need for a licence to operate a financial product market under the FMCA.
Enforcing the provisions of the FSP Act in relation to public blockchains is somewhat difficult in practice. The primary issue is that a public blockchain may not be managed by one particular entity, but instead may be managed by the relevant blockchain community. As the core requirement of the FSP Act is that financial service providers are registered, this may prove to be difficult as there may not be one person or organisation who is able to register.
IV Anti-Money Laundering
New Zealand's anti-money laundering regime is set out in the AML/CFT Act, which applies to reporting entities. A reporting entity includes, inter alia:
- financial institutions, which are defined as any person who, in the ordinary course of business, carries on one or more of the financial activities listed in the AML/CFT Act. Those financial activities include transferring money or value for, or on behalf of, a customer, issuing or managing the means of payment, and money or currency changing; and
- any other person or class of persons deemed to be a reporting entity under the regulations or any other enactment.
The AML/CFT Act imposes customer due diligence, reporting and record-keeping requirements on reporting entities. It also requires reporting entities to develop and maintain a risk assessment and a risk-based AML/CFT programme. The AML/CFT Act provides for external supervision of reporting entities by the FMA, the RBNZ or the Department of Internal Affairs. The functions of an AML/CFT supervisor are to, inter alia, monitor the level of risk of money laundering and the financing of terrorism involved across all the reporting entities it supervises; and monitor the reporting entities it supervises for compliance with the AML/CFT Act.
Obligations under the AML/CFT Act generally apply to a reporting entity only to the extent that it provides one of these financial activities to a customer. The term customer is very broadly defined. By way of example, an exchange that allows virtual currency trading could be a reporting entity under the AML/CFT Act, and entities that trade on the exchange could be its customers.
The AML/CFT Act does not specify the territorial scope of the Act. The AML/CFT supervisors have issued guidance on the territorial scope, which states that the relevant financial activities caught by the AML/CFT Act 'must be carried on in New Zealand in the ordinary course of business', and that this implies a place of business in New Zealand. The guidance is difficult to apply to blockchain-based technologies where the technology is online and therefore is not necessarily carried on in New Zealand even though it is accessible to persons in New Zealand.
In the case of virtual currencies, compared to more conventional circumstances contemplated when the AML/CFT Act was enacted, it can be challenging to interpret the legislation to determine who constitutes a reporting entity and a customer. More practically, the inherent anonymity that comes with using many virtual currencies may impose significant challenges for reporting entities to realistically be able to conduct customer due diligence on customers.
In addition, the issues discussed above in relation to the FSP Act also apply to the AML/CFT Act. The lack of a clear owner or manager of a particular virtual currency may make it difficult for regulators to identify the entity that should be complying with the obligations under the AML/CFT Act, and to bring a claim for a breach of obligations.
V Regulation of Exchanges
Exchanges are regulated by the FMCA if the exchange constitutes a financial product market. The FMCA defines a financial product market as a facility by means of which:
- offers to acquire or dispose of financial products are made or accepted; or
- offers or invitations are made to acquire or dispose of financial products that are intended to result, or may reasonably be expected to result, directly or indirectly, in:
- the making of offers to acquire or dispose of financial products; or
- the acceptance of offers of that kind.
Virtual currency exchanges could therefore be regulated if the relevant virtual currency being exchanged constitutes a financial product under the FMCA (discussed above).
A person must not operate, or represent to others that the person operates, a financial product market in New Zealand unless such person has a licence to operate the market under the FMCA or the market is exempt from licensing. A financial product market is taken to be operated in New Zealand if:
- it is operated by an entity that is incorporated or registered in New Zealand or by an individual who is ordinarily resident in New Zealand;
- all, or a significant part of, the facility for the financial product market is located in New Zealand; or
- the financial product market is promoted to investors in New Zealand by or on behalf of the operator of that market, or by or on behalf of an associated person of that operator. However, a financial product market is not promoted to investors in New Zealand merely because it is accessible by those investors.
As noted above, the Guidance indicates that the FMA considers that the licensing regime under the FMCA could apply to virtual currency exchanges.
Licensed market operators must have FMA-approved market rules, and comply with certain disclosure and reporting obligations to ensure that every licensed market is a fair, orderly and transparent market.
VI Regulation of Miners
Miners are not expressly regulated in New Zealand. However, there are certain criminal offences, discussed below, which relate to accessing computer systems for dishonest purposes. In that case, miners who choose to improperly access the processing power of another person's computer system to mine a virtual currency would be committing an offence under New Zealand law.
VII Regulation of Issuers and Sponsors
New Zealand has a disclosure-based approach to the offer of financial products to the public. An offer of financial products for issue will require full disclosure to investors under the FMCA, unless an exclusion applies (as discussed above).
In addition, certain offers of financial products for sale (secondary sales) also require disclosure. For example, if financial products are issued (but not, inter alia, under a regulated offer) with a view to the original holder selling the products and the offer for sale is made within 12 months of the original issue date, that secondary offer will require disclosure.
As discussed above, for a regulated offer of financial products a PDS must be prepared, and certain information relating to the offer must be contained in a publicly available register entry for the offer. The PDS must be lodged with the Registrar, and the register entry must contain all material information not contained in the PDS. Material information means information that a reasonable person would expect to, or to be likely to, influence persons who commonly invest in financial products in deciding whether to acquire the financial products on offer, and is specific to the particular issuer or the particular financial product. Investors to whom disclosure is required must (subject to certain exceptions) be given the PDS before an application to acquire the relevant financial products under a regulated offer is accepted or the financial product is issued.
The Regulations set out detailed requirements for the timing, form and content of initial and ongoing disclosure for financial products, including limited disclosure for products offered under certain FMCA exclusions. The content requirements for a PDS are prescriptive, and include prescribed statements and page or word limits. The Regulations impose different disclosure requirements for different types of financial products.
The FMCA includes an exclusion for offers to wholesale investors, which include:
- investment businesses;
- people who meet specified investment activity criteria;
- large entities (those with net assets of at least NZ$5 million or consolidated turnover over NZ$5 million in each of the two most recently completed financial years);
- government agencies;
- eligible investors;
- persons paying a minimum of NZ$750,000 for the financial products on offer;
- persons acquiring derivatives with a minimum notional value of NZ$5 million; and
- bona fide underwriters or sub-underwriters.
Even where an exclusion (including the wholesale investor exclusion) applies, certain disclosure requirements may still apply.
As discussed above, the application of these provisions to offers of virtual currencies turns on whether they are a financial product or are designated a financial product by the FMA.
VIII Criminal and Civil Fraud and Enforcement
The New Zealand courts have held that intangible property is capable of being property for the purposes of criminal law. Accordingly, under the Crimes Act 1961 (Crimes Act) (the primary piece of legislation that prescribes criminal offences in New Zealand), there are a number of criminal offences that could apply to the use of virtual currencies. These include theft, obtaining property or causing loss by deception, as well as crimes involving computers.
It is an offence to obtain property or valuable consideration by deception, or cause loss to another person by deception. This could cover circumstances in which a person is scammed by a malicious issuer of an ICO (where the issuer purports to raise money for a project by issuing virtual currency in an ICO with no intention of honouring its obligation to deliver certain products or services to the investor who purchased the virtual currency). In this particular situation, the FMCA also provides for offences for misleading or deceptive conduct in relation to disclosure of information made by the issuer under the FMCA.
It is possible that the general offence of theft could also apply to virtual currencies. However, if that theft was procured by a person hacking another's computer or accounts, prosecution as a crime involving computers may also apply. These include accessing a computer system for dishonest purposes and accessing a computer system without authorisation. This could cover the recent trend of viruses that hijack a target computer's processing power for the purposes of mining virtual currencies. As with other parts of New Zealand law, this crime is not concerned specifically with virtual currencies, but is drafted broadly enough that the kind of activity above would be covered.
The New Zealand police have authority to investigate alleged crimes and to prosecute individuals charged with an offence under the Crimes Act in a court (with Crown solicitors as required). The New Zealand courts may impose fines, prison sentences and other penalties prescribed in the Crimes Act where an offender is found guilty (maximum penalties are prescribed by the Crimes Act).
As far as civil law is concerned, the same legal analysis is likely to apply whether cash or virtual currencies are obtained by fraudulent means. The difference is more likely to be practical, and in particular the practical difficulties of identifying, or enforcing a judgment against, the defendant.
In these circumstances, an innocent party may wish to consider remedies against third parties (who may be more readily identifiable). For example, if a third party comes into possession of fraudulently obtained virtual currency, and was not a purchaser for value, then a claim of knowing receipt, a proprietary restitutionary claim or a claim for unjust enrichment may be available. However, if the third party was a bona fide purchaser for value, then these remedies will likely not be available.
New Zealand has no specific tax regime for virtual currencies. Instead, the taxation of virtual currencies is governed by the existing legal framework. It is necessary to consider both the Income Tax Act 2007 and the Goods and Services Tax Act 1985 (GST Act).
i Income tax
Broadly, a person may become subject to income tax on amounts derived from virtual currencies in circumstances where the amount is derived from:
- a business of the person and is not a capital receipt;
- carrying on or carrying out an undertaking or scheme entered into or devised for the purpose of making a profit; or
- disposing of personal property of the person if the property was acquired with the purpose of disposing of it.
The Inland Revenue Department (IRD) has issued preliminary guidance on the tax treatment of virtual currencies, in which it states that virtual currencies should be treated as personal property (not currency) for income tax purposes.
In relation to provisions that refer to a person's purpose, it is the person's subjective dominant purpose at the time of acquiring the property that is relevant. Therefore, if at the time of acquiring virtual currency a person does so with the purpose of later disposing of it, any amounts derived from the disposal (e.g., for a sale or exchange) will be treated as income (and therefore be subject to income tax). The IRD's guidance suggests virtual currencies will generally be acquired with the purpose to sell or exchange because (in general) virtual currencies do not produce an income stream or any benefits, except when sold or exchanged. However, each amount derived from virtual currencies should be considered separately in order to determine whether the virtual currency was acquired for the purpose of disposal and whether the amounts derived from the disposal are income to which income tax will apply.
ii Goods and services tax
Goods and services tax (GST) is imposed under the GST Act, and is charged on supplies in New Zealand of goods and services by a registered person in the course or furtherance of a taxable activity.
A person makes supplies in the course or furtherance of a taxable activity if the supplies are in the course of an activity (whether or not for pecuniary profit) carried on continuously or regularly by the person involving the supply of goods and services for consideration. The term taxable activity includes any activities of business or trade, and therefore it may be relevant to determine whether the supplier is a person carrying on business for income tax purposes.
For the purposes of GST, virtual currencies are best classified as choses in action, which are included in the definition of services. The sale of virtual currencies would therefore be a supply of services and subject to GST if the supply is made in New Zealand by a registered person, and in the course or furtherance of a taxable activity carried on by that person.
As virtual currencies are arguably services, not money, for the purposes of the GST Act, any transaction involving the exchange of virtual currency for goods or services will be treated as a barter transaction. Under the GST Act, this involves two separate supplies: the supply of virtual currency from person A to person B; and the supply of goods or services from person B to person A.
Therefore, GST could be chargeable in respect of the supply of goods and services (for which the payment in virtual currency is consideration) as well as the supply of the virtual currency. Given that the virtual currency is functionally a means of payment, this would seem to be the wrong outcome in policy terms. Australia has recently amended its GST legislation to address this issue, and New Zealand is expected to consider whether a similar amendment to the GST Act is necessary.
Supplies made in New Zealand
In general, goods and services are deemed to be supplied in New Zealand if the supplier is resident in New Zealand, and are deemed to be supplied outside New Zealand if the supplier is a non-resident.
However the supply of a virtual currency may in many circumstances meet the definition of a remote service for the purposes of the GST Act. A remote service is defined as a service that, at the time of the performance of the service, has no necessary connection between the place where the service is physically performed and the location of the recipient of the services.
Where the services (the virtual currency) being supplied are remote services, the recipient of the services is a person resident in New Zealand, and the recipient of the service is not registered for GST, or is registered for GST but does not acquire the virtual currency for the purposes of carrying on his or her taxable activity, then a supply made by a non-resident is treated as being made in New Zealand unless the services are physically performed in New Zealand by a person who is in New Zealand at the time that the services are performed. In the context of virtual currencies, it is difficult to determine how the service could be physically performed, and therefore this exclusion is unlikely to apply. If the non-resident is, or is required to be, GST-registered (see below), non-residents will be required to account for GST on such supplies.
A non-resident person making supplies of remote services must treat the recipient of the supply as a person resident in New Zealand if any two items of a specified list of indicia are non-contradictory and support the conclusion that the person is resident in New Zealand. However, in cases where the non-resident also has certain evidence that the person is resident in a country other than New Zealand, the supplier must use the more reliable evidence to determine the person's residence.
Supplies made by a registered person
GST is only chargeable in respect of supplies made by a registered person. Broadly, a person is liable to be registered for GST if the total value of supplies made in New Zealand exceeds, or is expected to exceed, NZ$60,000 in a 12-month period. The registered person definition includes a person who is required to register for GST. Therefore, failure to register for GST does not exempt a person from compliance with obligations imposed under the GST Act. Persons selling virtual currencies exceeding NZ$60,000 in a 12-month period may therefore be liable to be registered.
If a non-resident who makes supplies of remote services determines that the recipient of the supply is a New Zealand resident (as described above), the supplier must treat the recipient as not being a registered person unless the recipient notifies the supplier that he or she is a registered person, or provides his or her registration number or New Zealand business number.
X Looking ahead
Public and regulator interest in virtual currencies continues to grow in New Zealand and globally. The FMA is the key regulator in New Zealand in respect of virtual currencies, and its position in respect of developments in this area has been clearly stated in the Guidance.
One of the purposes of the FMCA is to promote innovation and flexibility in the financial markets, and the FMA has stressed that its job is not to stop innovative businesses from succeeding. However, promoting innovation does not mean that the FMA will allow risks of new technology and products to be passed on to retail investors in a manner that investors do not understand. Accordingly, the FMA's position is that open and early communication is vital for persons seeking to launch blockchain-related products and technology in New Zealand.
While we are yet to see significant activity in blockchain-based products and technologies from New Zealand, at least one ICO has been conducted by an entity based in New Zealand. In early 2018, New Zealand blockchain company Centrality announced that it had raised the equivalent of approximately US$80 million by issuing CENNZ tokens to investors. To the extent that the CENNZ tokens were offered for sale in New Zealand, the offer was limited to wholesale investors, such that the offer was not a regulated offer requiring compliance with the disclosure obligations described above.
In addition, while New Zealand does not have a national digital currency, the RBNZ has given consideration to the issue, and in June 2018 announced that it would not issue an official digital currency in the foreseeable future. However, the RBNZ went on to state that it would continue to monitor the situation, but considered that at present it is too early to determine whether a national digital currency should be issued.
1 Deemple Budhia and Tom Hunt are partners at Russell McVeagh. The authors would like to acknowledge the contributions of Lucy Becke, Hamish Journeaux, Michael van de Water and Young-chan Jung.