Japan’s regulatory reckoning: FSA targeting exchanges in AML efforts

In 2017, Japan became the first country to regulate cryptocurrency on a national level, following the largest recorded theft in blockchain history, when Japanese cryptocurrency exchange lost over USD 516 million. And yet, the country’s regulatory framework, which seeks to balance innovation with consumer protection, couldn’t prevent the theft of over USD 60 million from Japanese cryptocurrency exchange Zaif in 2018.

Whilst authorities continue to tackle the ever-present threat of theft and hacking, Japan’s Financial Services Agency has turned its attention to applying its anti-money laundering efforts (AML) to exchanges. Recently, the FSA inspected Huobi Japan and Fisco Cryptocurrency Exchange, examining the entities’ internal oversight, including AML processes. Both companies had recently overhauled their management structures with Fisco acquiring Zaif and Huobi taking over BitTrade.

Sources have been reserved about the details of the investigations, limiting comments to statements about ensuring consumer protection and legal compliance. But what adds an extra element of intrigue to the inquiries is the fact that FSA had granted Japan’s Virtual Currency Exchange Association self-regulatory status in October 2018.

With the greenlight to regulate itself, the Association could police and sanction exchanges for violations. Additionally, the FSA’s decision gave the Association the authority to establish rules to, among other things, bolster AML procedures and oversight. The decision to allow self-regulation was calculated to allow a balance between fast-growing innovation and consumer safeguards so that Japan could continue exploring cryptocurrency’s potential.

However, the FSA’s recent crackdown on Huobi and Fisco demonstrate that authorities are ready to utilize regulatory oversight to ensure full compliance with AML protocols. The FSA’s actions seem to indicate that it is not willing to wait for self-regulation to address on-going concerns. Instead, it will step in to review an exchange’s internal operating procedures to satisfy any doubts connected to operational parameters.

Whether investigations will be limited to exchanges that have undergone some type of large scale or dramatic change remains to be seen. For now, Japanese exchanges and the Virtual Currency Exchange Association may continue to work toward robust self-regulation whilst remaining mindful of the FSA’s unexpectedly extensive regulatory reach.