While the FSCA announcement on crypto is a welcome development, it is not enough to protect retirement funds tempted to invest in crypto assets before stricter regulations are in place.

By Andile Makholwa

South African authorities have taken the first major step towards regulating the fast-growing but high-risk crypto industry, after years of sitting on the fence. But it may be a few more years before enough safeguards are in place for pensions funds to feel entirely safe buying into crypto assets.

In a move welcomed by investment professionals, the Financial Sector Conduct Authority (FSCA) in October 2022 declared crypto assets to be “financial products” when it came to financial advice. This means that, after an exemption until December 2023, only licensed financial advisors will be allowed to advise people about investing in crypto assets.

For several years, South Africa has been under pressure to provide legal certainty around investing in digital financial assets, and to provide a mechanism to weed out fraudsters.

This has become all the more urgent after the collapse of FTX Trading crypto exchange, which was widely regarded as the gold standard of the industry.

FTX sent shockwaves through markets when it filed for bankruptcy in November. It turns out that even though it had $9bn in liabilities, it had barely $900m in assets — implying that the 100,000 people owed money by FTX are likely to lose quite a lot.

This put added pressure on countries to regulate crypto investments. South Africa may be lagging global peers, but it is at least moving in the right direction.

“We have seen both the prudential authority (the SA Reserve Bank) and the market conduct authority (the FSCA) declare crypto currencies as financial assets or financial products,” says Craig Pheiffer, the chief investment strategist at Sasfin Wealth.

Pheiffer says the Reserve Bank’s attitude to crypto has been shaped by its efforts to eliminate money laundering and the financing of crime, as well as its attempts to enforce the country’s exchange control rules. “The FSCA is motivated by its approach to investor protection and maintaining the integrity of the financial markets,” he says.

Kara Meiring, an associate in dispute resolution at Cliffe Dekker Hofmeyr, says the aim of the declaration is to ensure that where many people are already trading in crypto assets, these activities are better regulated. The goal is to ensure investors are “offered sufficient protection against potential illicit activities” in the crypto sector, Meiring says.

So where does this leave pension funds?

While this is a welcome development, it is not enough to protect retirement funds that may be tempted to invest in crypto assets before stricter regulations are in place.

As it is, almost all retirement funds in SA are subject to regulation in terms of the Pension Funds Act. To promote prudent, long-term investments, Regulation 28 of the Act imposes limits on the extent to which a retirement fund may invest in any particular asset class.

Seemingly in anticipation of the declaration, Regulation 28(3) was amended in July 2022 with effect from 3 January 2023. This inserted a definition of the term “crypto asset” and introduced a new sub-regulation, which explicitly says that “a fund may not invest in crypto-assets.”

The National Treasury confirmed as much, saying that: “retirement funds will continue to be prohibited from investing in crypto assets. The excessive volatility and unregulated nature of crypto assets require a prudent approach, as recent market volatility in such assets demonstrates.”  

In a nutshell, this means that while financial advisors may market crypto currencies to individual investors, retirement funds are prohibited from investing in them — for now.

According to a raft of papers published by the FSCA for consultation, further steps need to be taken to ensure crypto assets are properly governed, so that investors are protected.

More work to be done

In its consultation paper, the FSCA says there is “mounting risk in the crypto asset environment due to an exponential increase in the provision of crypto assets in South Africa and, coinciding with that, the rapid growth in interest in the use of crypto assets for investment.”

These risks, says the authority, have been heightened by a significant increase in scams which have been touted as providing crypto investment opportunities.

“Declaring crypto assets as a financial product under the FAIS Act was therefore viewed as a critical interim step towards protecting customers in the crypto asset environment, pending the conclusion of broader developments surrounding crypto assets through, for example, the Conduct of Financial Institutions (COFI) Bill,” it says.

Critically, the absence of consensus on even the basic definition of crypto assets has been one of the major challenges.

For many years, the SARB argued against defining crypto currencies like bitcoin as money. In a position paper, an Intergovernmental Fintech Working Group (IFWG) for crypto assets says that it’s a “digital representation of value that is not issued by a central bank, but is capable of being traded, transferred or stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility”. These assets apply cryptographic techniques, and are constructed using distributed ledger technology. 

Clarity on the precise definition is needed since, in some circles, cryptos have even been compared to customer loyalty or rewards programmes, which could be converted into cash.

Still, it seems large companies are becoming more comfortable with the idea.

After the FSCA’s declaration, for example, grocery chain Pick n Pay said it would accept cryptos as payment. The retailer said it tested a payment service technology that allowed customers to buy groceries with cryptocurrency at till points with any Bitcoin Lightning-enabled app such as BlueWallet or Muun. “The transaction is as easy and secure as swiping a debit or credit card,” Pick n Pay said. 

“From a purely economic perspective, crypto assets may well be regarded as a currency,” says Meiring. “However, from a legal perspective we have not yet received clear guidance from the legislature on whether crypto assets could be defined as a currency for purposes of, for example, the Income Tax Act.”

Nonetheless, she says, the FSCA declaration is a welcome step to bring crypto assets under the country’s regulatory roof. Greater clarity will only spur acceptance of the asset class.

Beware of “get-rich-quick” schemes

For regulators, the priority is to protect investors.

This is especially since cryptos have experienced a few boom-and-bust cycles, says Pheiffer.

“If one looks at bitcoin trading over the past two years, it has traded from $16,000 up to $63,000, down to $30,000, up to a record high of $67,000 in November 2021, and down to its current level of $16,000 again. It’s clear that the crypto currencies have been extremely volatile, and while financial assets can and do exhibit volatility, [this] is seen as excessive for investment by retirement funds,” he says.

Still, many expect the industry to keep growing, which is why legal certainty is needed. But at this stage, investors are urged to tread carefully.

Says Pheiffer: “There are thousands of crypto currencies and each day many new currencies are created and many fall away. The decentralised ledger technology of blockchain that drives crypto currencies is here to stay and some of the big crypto names will likely go on to thrive. The industry is essentially still in its infancy.”

The flip side of that is that in any emerging industry, get-rich-quick schemes proliferate, fuelling speculation in these new assets.

“The get-poor-quick stories are not heard as often, but they must be just as prevalent given the market volatility. The industry just has more to do to convince regulators that crypto assets are the preserver of retirement fund investors too,” he says.      

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