Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 23 - Evidence - February 19, 2015
OTTAWA, Thursday, February 19, 2015
The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:30 a.m. to study the use of digital currency.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Good morning, and welcome to the Standing Senate Committee on Banking, Trade and Commerce.
Today is the fourteenth meeting in our special study on the uses of digital currency, including potential risks, threats and advantages of these electronic forms of exchange. To date the committee has received presentations from a wide range of witnesses, including government agencies, digital finance experts, academics and bitcoin companies.
In our last meeting we heard from the RCMP and CSIS on the potential risks of digital currencies. Today we will continue on this subject with the Financial Transactions and Reports Analysis Centre of Canada, better known as FINTRAC. Created in 2000, FINTRAC is Canada's financial intelligence unit. It is an independent agency reporting to the Minister of Finance. It was established and operates within the domain of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, which members will recall we had the task of revisiting and reviewing two years ago.
FINTRAC's mandate is to facilitate the detection, prevention and deterrence of money laundering and the financing of terrorist activities while ensuring the protection of personal information.
This is especially relevant with regard to digital currency as we have learned that there is a potential to use digital currencies to launder money and to use it for other illicit purposes.
Today I'm pleased to welcome from FINTRAC, Bernard Gagné, Deputy Chief Compliance Officer, Compliance Relations and Support; and Martin Tabi, Manager, Research and Strategic Intelligence and International Relationships. From the Department of Finance we have Lisa Pezzack, Director, Financial Sector, Financial Sector Policy Branch; and Ian Wright, Chief, Financial Crimes - Domestic, Financial Sector Policy Branch.
Ms. Pezzack is going to speak first, to be followed by Mr. Tabi.
Ms. Pezzack, the floor is yours.
[Translation]
Lisa Pezzack, Director, Financial Sector Policy Branch, Department of Finance Canada: Thank you for the opportunity to appear before the committee and provide an update on our work related to virtual currencies. I would like to introduce my colleague Ian Wright, Chief of the Financial Crimes Domestic Section.
First I want to congratulate the committee members for their work on studying the use of digital currency. Your proceedings have been very informative for our policy development work.
In March 2014 my predecessor appeared at the inaugural meeting of this committee's study on digital currency and delivered a presentation on virtual currencies in Canada that provided background on the subject. I am sure that you have benefited greatly over the course of the last year from the numerous expert witnesses that have appeared before the committee.
[English]
At the March 2014 session, the Finance presentation highlighted some of the benefits of virtual currency, for instance as a means of financial innovation and to support low-cost and low-value transactions. These benefits have to be evaluated against any concerns when making decisions on how and whether to regulate the sector. There are some important risks associated with the use of digital currencies.
For example, the increased levels of anonymity and the ease of transferring small or large amounts of value make it vulnerable to being exploited for money laundering and terrorist financing activities. Other important risks exist in the areas of consumer protection, taxation and payment system oversight.
We must also give consideration to the challenges that the industry itself is facing, including some very well-known cyberfraud events and difficulties that virtual currency-related businesses are facing in accessing banking services.
At the same time, we do not want to be too intrusive and must find a balance that does not hinder the ability of Canada to reap the economic benefits of innovation in virtual currency-related businesses, and not drive these businesses and adopters to grey markets or even into the dark markets of the Internet, further reducing regulatory oversight and financial transparency.
Since March last year, we've undertaken consultations to continue to better understand the underlying technologies, the businesses involved and the risks and implications of the changing landscape of virtual currencies. This includes meetings with provincial and federal government departments and agencies, as well as discussions with a range of virtual currency businesses and foreign jurisdictions.
The consultations were useful in providing us insight into the virtual currency industry composition and the business structures, the risks and risk-mitigation strategies of businesses, as well as the regulatory strategies in other jurisdictions.
We are also drawing on work being led by the department to better understand domestic money laundering and terrorist financing risks. This work is being supported by a dozen federal departments and agencies under our federal anti-money laundering/anti-terrorist financing framework and will help to better inform the development and implementation of effective policies and operational approaches to mitigate the broad range of risks, including those posed by virtual currency.
We are working closely with our partners through the Financial Action Task Force, the international standard-setting body on anti-money laundering and anti-terrorist financing. Virtual currency is an inherently global issue that requires international coordination to mitigate the risk of regulatory arbitrage.
For international transactions, the potential ability to pay in a currency that requires no currency exchange is clearly a benefit.
[Translation]
Last June, the Financial Action Task Force published a paper entitled Virtual currencies: Key Definitions and Potential AML/CFT Risks, which builds on their earlier work on new payment products and services. This very useful paper was an effort to suggest a conceptual framework for understanding virtual currencies, their uses and possible abuses. This better allows representatives of the market place, the regulators and law enforcement, to understand each other by creating a shared vocabulary.
We have brought a copy of this document for you. Building on this earlier work, the Financial Action Task Force is developing draft guidance on how to take a risk-based approach to treating virtual currencies within the Task Force's anti-money laundering and anti-terrorist financing framework. We would be happy to forward a copy of the document to the committee when it is released.
[English]
The role of regulating does not fall to the federal government alone. Provincial governments have the primary role in regulating the activities of businesses similar to money services businesses, like those operating in the virtual currency sector, and more broadly for consumer protection issues.
The Financial Consumer Agency of Canada, or FCAC, has issued a warning of the risks of virtual currency, including those of cybertheft and the volatility of price, which is particularly salient with the bitcoin price drop from about $1,200 Canadian in November 2013 to $295 Canadian today.
The FCAC also provided some tips under its financial literacy mandate on the use and storage of virtual currency to mitigate some of those risks. However, FCAC's compliance mandate is limited to federally regulated financial institutions, such as banks.
At the federal level, our responsibilities and authorities flow from our anti-money laundering and anti-terrorist financing legislation, the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, which I will refer to as PCMLTFA, just to be short.
The federal government has taken steps to address certain risks associated with virtual currencies. Economic Action Plan 2014 announced that the government would bring forward legislative and regulatory amendments to strengthen the PCMLTFA. Legislative amendments were introduced in the budget bill, which received Royal Assent on June 19, 2014. These include an amendment to capture dealers in virtual currencies as money services businesses under the act.
The department is currently developing the regulations that are needed to enact these legislative provisions. The regulations related to virtual currencies will define what types of virtual currency businesses will be covered and which specific obligations should be applied.
This can be challenging in the context of virtual currencies, which is a business environment that is constantly evolving and utilizes technologies outside our normal frameworks. Furthermore, there are challenges in regulating in an environment where there may not be any central authority that a legislation or regulatory framework can target. In the case of bitcoin, for example, there is no home country whose legislation and regulations should govern the currency's behaviour.
We expect the obligations will be largely similar to the existing obligations for money services businesses, which include registration, customer identification and due diligence, recordkeeping and an internal compliance regime, as well as reporting suspicious and certain prescribed transactions.
The volume and velocity of virtual currency transactions remains relatively small compared to the traditional financial system. However, the vulnerability of virtual currency businesses to illicit activities remains, as shown by the numerous examples that were provided to the committee in earlier testimony. As with many emerging technologies, the full utility and level of adoption of virtual currencies is not yet clear.
I would also note that recent media reports reflect on some of the challenges that bitcoin is facing, including reputational risk as the number of scandals grows, as it becomes more linked with illegal activities and the dark web and that price volatility drives speculative position in bitcoin as a commodity rather than as a means of exchange for commercial transactions.
We will seek to mitigate money laundering and terrorist financing risks of virtual currencies while preserving the benefits of financial innovation. This will be achieved by a targeted regulatory intervention in the most vulnerable areas, such as virtual currency exchanges that facilitate the transfer of virtual currency into the traditional financial system. It is at these points where virtual currencies are exchanged for fiat currency, or what some of us would call real or national currencies. In traditional terms, this would make these exchanges for fiat currency a money services business.
[Translation]
Consistent with other international approaches to anti-money laundering obligations to virtual currency businesses, many of these businesses are the on-ramps and off-ramps of the virtual currency environment. This approach will also avoid constraining further innovation by ensuring that the government is not unduly regulating the underlying technology and infrastructure of virtual currency, such as the source code or "miners," as well as the individual users of virtual currency.
As the policy development continues, we plan to consult with a target group of stakeholders with some specific proposals. And as part of the regulatory process, stakeholders can provide written comments when the regulations are pre-published in the Canada Gazette.
We look forward to the committee's final report on its study on digital currency. Your recommendations will inform the development of our final regulatory proposals.
[English]
Mr. Chair, I would now like to turn to my FINTRAC colleague Martin Tabi to make his opening comments.
[Translation]
Martin Tabi, Manager, Research and Strategic Intelligence and International Relationships, Financial Transactions and Reports Analysis Centre of Canada (FINTRAC): Good morning. Thank you for inviting us to speak with you today regarding your broader study on digital currencies.
Before I get started, I would like to introduce my colleague, Bernard Gagné, FINTRAC's Deputy Chief Compliance Officer responsible for our Compliance Relations and Support Unit. Mr. Gagné is here to address your compliance-related questions.
As this committee knows very well, the Department of Finance, FINTRAC, police, intelligence and national security agencies, prosecutors and approximately 31,000 businesses across the country all have a role to play as part of Canada's anti-money laundering and anti-terrorist financing regime in creating a hostile environment for those who seek to abuse our financial system and threaten the safety of Canadians.
The Proceeds of Crime (Money Laundering) and Terrorist Financing Act establishes obligations for financial services entities, money services businesses, casinos and other businesses subject to the act to establish a compliance program, identify clients, monitor business relationships, keep certain records and report specific types of financial transactions to FINTRAC.
Through our compliance program we help to ensure that businesses meet their legal obligations. While enhancing deterrence throughout the system, compliance with the law also ensures that businesses provide us with the reports we need to develop actionable financial intelligence for our law enforcement and national security regime and international partners.
Last year, we provided 1,143 disclosures of actionable financial intelligence to our partners to assist them in their investigations of money laundering, terrorism financing, and threats to the security of Canada.
As Canada's financial intelligence unit, FINTRAC works very closely with the RCMP, CSIS and other lead agencies to ensure that we have a comprehensive understanding of the threat environment so that we are well positioned to contribute to the priority investigations of our law enforcement and national security partners.
[English]
With our Research and Strategic Intelligence and International Relationships groups, we also work with experts, stakeholders and international partners on a broad range of issues that may have an impact on our compliance or intelligence operations, on Canada's anti-money laundering and anti-terrorist financing regime more broadly, or on the regimes of our international partners.
This type of collaborative research has been particularly valuable in relation to virtual currencies, where our database of transaction reports is of limited use as transactions undertaken with these currencies have not been subject to prescribed reporting under the PCMLTFA or regulations.
Since the beginning of the committee's study, a number of expert witnesses have discussed the benefits and risks posed by virtual currencies. We have followed this testimony very closely. From our own research, we recognize that virtual currencies are being used by a large number of people around the world for a range of legitimate purposes.
We also understand that there are certain characteristics of virtual currencies that may be appealing to criminals. Most notably, like cash, some of these currencies can provide at least a certain degree of anonymity for those carrying out transactions. As such, they can be used to acquire illegal products and services while remaining difficult to trace. They can also be used to hide or move significant amounts of money gained from illicit activities.
We shared the views expressed by CSIS and the RCMP a few weeks ago at this committee that virtual currencies hold the potential to become a tool for threat actors in the future, particularly as it relates to money laundering and terrorist financing.
As this committee is aware, and as our colleagues have mentioned, as part of the Economic Action Plan 2014 Act, Parliament changed the definition of money services business prescribed in the PCMLTFA to include persons or entities engaged in the business of dealing in virtual currencies as defined by regulation.
We have informed reporting entities that the statutory amendment will come into force after regulations have been published in the Canada Gazette. Until regulations are published and in force it is status quo for reporting entities and for our compliance operations. MSBs that need to register with FINTRAC are those that are engaged in the business of foreign exchange dealing; remitting or transmitting funds by any means or through any person, entity or electronic funds transfer network; or issuing or redeeming money orders, traveller's cheques or other similar negotiable instruments.
Thank you, Mr. Chair and honourable senators. We'll be pleased now to answer your questions.
The Chair: Thank you, Mr. Tabi, for your presentation.
You know, with regard to bitcoin transactions, the committee members have been trying to wrap their heads around the ideas of privacy, anonymity and traceability.
Quite frankly, over the period of our hearings, we have had quite conflicting opinions on whether bitcoin transactions are traceable or if they can be done completely anonymously. As a matter of fact, we even had two witnesses from the same organization express different points of view on this.
Now I note, Mr. Tabi, in your remarks you sort of hedge a little here and you say "as such they can be used to acquire illegal products and services while remaining difficult to trace." Well, you know, something might be difficult, but you can do it.
What is your view? Are bitcoin transactions traceable?
Mr. Tabi: Thank you, Mr. Chair. Our view is that it is difficult to trace. And it's not only for FINTRAC. This issue is not only about the financial transaction. As you know, FINTRAC focuses on financial transactions. Virtual currencies and the way they operate in the system, are not only traceable via the transaction itself, but are also a cybercrime issue, so it would involve many other partners within the regime for which we could count on for the traceability aspect of this. But there are elements of it that provide, potentially, criminals some ease in order to be able to hide their funds and move their funds, so that's why it is a concern for us.
Senator Massicotte: Was that a yes or a no, chairman?
The Chair: I thought the needle was pointed a little closer to maybe it's not traceable, even with all the efforts that you might put into it?
Mr. Tabi: For us at FINTRAC alone, it will not be traceable. That will be a challenge for sure.
The Chair: Do you think other entities can trace where funds might originate?
Mr. Tabi: I think you've heard a lot of witnesses helping you on this. I'm not going to be able to comment further on their abilities.
The Chair: That's the challenge. There have been a lot of views on it.
Mr. Tabi: Yes, there have.
Senator Massicotte: The answer is very clear to me.
The Chair: Okay. I'd like to start our list of questions with the deputy chair of the committee, Senator Hervieux-Payette, to be followed by Senator Bellemare.
Senator Hervieux-Payette: Thank you and welcome. Perhaps you will allow me a little question related to the actuality. You talk about traceability. Why were you not tracing the HSBC people who were not paying their taxes in Canada?
Sometimes we cannot trace the money, the real money, so how are you going to trace the one that is totally different in terms of they are not parked in one specific building somewhere in the country but it is in the cloud.
If your organization is not able, who has the technical capability to do that? Is it our agency that is doing the spying that has all the big computers like they have at the NSA?
Where and who will develop the system whereby we will eventually, with the collaboration of other countries, be able to find who is doing the transactions and between whom. Actually, this is the biggest issue. You can regulate everything, but if you don't know who is doing what, it is not helpful.
Asking them to register, if they know that you cannot find them, they won't register. So I'm asking you, who has the capability and where is it coming from and do you have exchange with foreign entities, whether international organizations or specific countries like the U.S., to find a way of making sure that we're doing better than even real money in a real bank outside of the country?
Mr. Tabi: Thank you. To answer this question, there are a couple of elements here. For FINTRAC, our role is to work with reporting entities. So in terms of traceability, we receive transactions from reporting entities, and we work with these reports. So of course we need to work closely with reporting entities, which are submitting to us various kinds of reports, including the suspicious transaction reports, large cash transaction reports with the threshold of $10,000 and the wire transfers that are international. On that front, it covers some part of the question about the international nature of the problem.
Quickly, to answer your question specifically related to partnering with other FIUs in the world, we do have a memorandum of understanding in place to exchange information with 90 different FIUs, like FINTRAC, in the world. So yes, we can exchange. You specifically pointed to the U.S. We do have an MOU with FinCEN, the equivalent of FINTRAC in the U.S., and, yes, we do exchange with FinCEN. I would actually confirm that FinCEN is our most important partner, for obvious reasons.
In terms of domestically, talking about the traceability of the specific example that you're mentioning, there are, of course, other partners involved in this. You've pointed to intelligence services, and yes, they have the ability to trace other elements. CRA, because you mentioned the tax aspect, would also be involved in that kind of work as well, so it's a collaborative effort between several departments or agencies in Canada to tackle this kind of issue.
Senator Hervieux-Payette: Did we have any reports as of today? You talked about 1,143 reports last year. Was there one on bitcoin?
Mr. Tabi: One disclosure on bitcoin? I'm sorry that I'm not going to be able to share specific details of disclosures as per our legislation. The disclosures that we disseminate are strictly guided by our legislation, which is the PCMLTFA, and we're providing such information to a specific list of recipients, such as the RCMP and CSIS. And with regard to results on investigations, I would leave it to law enforcement authorities or intelligence services to provide you more information on investigations.
Our role at FINTRAC is to provide the financial intelligence component, which is one important and unique part of a bigger puzzle, so that's probably a question for investigation authorities in terms of results on this.
Senator Hervieux-Payette: But you have 1,143 reports. Is it strictly the regular money? I'm not asking you who did it. I'm asking you if you have, let's say, 1,100 of regular money and then 43 for bitcoin. I'm asking if you had any reports.
Mr. Tabi: In terms of specifically related to virtual currencies, as I indicated in my opening remarks, at this time, because virtual currencies transactions are not yet covered under the act, our database of transactions, as of now, is of limited use in terms of having clear indication and findings with regard to virtual currencies because right now specific transaction related to virtual currencies are not covered.
As of now, the only way we would be able to capture that into a specific report, into a suspicious transaction report, for example, would be only if an entity that is currently covered, such as a bank. So in the non-virtual world, as of now, a bank would be able to detect and identify something related to virtual currencies.
We do have some instances of that, but it's very limited in order to help us do our work for now.
Senator Hervieux-Payette: Thank you.
[Translation]
Senator Bellemare: I have two questions. The first concerns the important element of traceability. Concerning exchange points, for instance automatic tellers, or those who oversee exchange points where Canadian money is used to purchase bitcoins, do you think it is possible to devise a mechanism allowing us to identify individuals who purchase bitcoins?
Perhaps it would not be easy to identify those who receive bitcoins at the other end of the transaction, especially if this takes place in Africa and is used to finance terrorism, but perhaps this could give us some clues. While trying to avoid interfering with the innovation process, could regulating exchanges on our territory give us a good indication?
[English]
Ian Wright, Chief, Financial Crimes - Domestic, Financial Sector Policy Branch, Department of Finance Canada: Yes, it would do that very much. As Lisa noted, it would put upon these entities, which would be regulated, similar sorts of requirements that are on MSBs currently: customer due diligence, identification, record keeping and reporting requirements. What I will call the virtual currency money services businesses, VCMSB, would then be looking at collecting that sort of information; it would be very useful. You are correct in that it's more of a challenge as we're looking at this. It's the other end of the chain, absolutely, just because of that anonymity issue.
[Translation]
Senator Bellemare: Could technology allow us to regulate that? And if you develop regulations, will it be possible to implement them?
[English]
Mr. Wright: Absolutely.
[Translation]
Senator Bellemare: Do you have something to add, Mr. Tabi and Mr. Gagné?
Bernard Gagné, Deputy Chief Compliance Officer, Compliance Relations and Support, Financial Transactions and Reports Analysis Centre of Canada (FINTRAC): No, aside from confirming what our colleagues from the Department of Finance have said; if we ask participants to identify the clients who come to them to purchase or sell bitcoins, this is no longer a matter of technology, but of obligation.
Senator Bellemare: My second question is for Ms. Pezzack. We read in the papers that Quebec is developing regulation. Does the federal Department of Finance discuss these matters with Quebec? Are you on the same wavelength?
Ms. Pezzack: We have begun discussions with the provinces and other federal departments, and we are also holding consultations with businesses in this area.
[English]
Mr. Wright: The Quebec framework is a complement to our legislation and regulations. Our regulations still apply to entities in Quebec, but Quebec has chosen to take an extra step and move forward with some of the things we're thinking of applying directly to the virtual currency, VC, side. As Lisa mentioned, the federal-provincial jurisdiction issue is here, so we have to work closely with authorities in Quebec to make sure the appropriate authorities are working. We view it very much as complementary.
[Translation]
Senator Bellemare: Because the matter of constitutional powers is important.
In the course of these discussions, do you also have contacts with the State of New York, which is in the process of regulating cryptocurrencies?
[English]
Mr. Wright: We don't have a direct relationship. We have seen some of the material and we have spoken with them over time. I think we will have more discussions with them because they have a much broader regime. They have almost that mix of what we have as federal-provincial in terms of their abilities to look at consumer issues and some of those are a bit more outside our purview. We certainly look at the U.S. as being at the forefront and one of the leaders.
[Translation]
Mr. Tabi: Through the relationship we have with the representatives of FinCEN, which like FINTRAC has a responsibility for regulation, we can consult a network of established stakeholders in the United States. We have had discussions about various practices.
We have also had this type of discussion at the international level. Ms. Pezzack referred in her statement to the work of the Financial Action Task Force, the international body that studies money laundering and anti-terrorist financing. This also allows us to exchange information with a larger group and not just the Americans.
Senator Massicotte: Thank you to our witnesses. Ms. Pezzack, in your text you talk about international standards and approaches. Two paragraphs define the direction you are taking. You are now drafting regulations. I think you are indeed aiming to monitor points where money, the Canadian dollar, is exchanged for virtual currency. In other words, there is an entry point and an exit point.
If I understand correctly, the regulation would focus on monitoring these two points in order to identify the client, as banks do. Have I understood that correctly?
Ms. Pezzack: I would say yes, but Mr. Wright has more experience in this area than I do.
[English]
Mr. Wright: As I think you've heard, the challenges are very much in the decentralized entities such as bitcoin, which is the Kleenex of virtual currency. The notion of decentralized is very difficult as no single entity acts as a single exchange that you can go in and regulate like we have in the rest of our payment systems. That is not to say, however, that we may not necessarily target bitcoin as well.
There may be occasions when we could look at these exchanges and say, for example, "It's not just the virtual currency but also any transactions going on that you are managing between different entities using bitcoin that we have a value of $10,000 or more." The fiat/virtual currency interchange is a key one for us to try to tackle. We are also trying to look at what we could do within the restrictions of a decentralized and the problems with a decentralized on possibly getting some reports about the flow of bitcoin as well as fiat currency.
Senator Massicotte: In your presentation, which I suspect you prepared, you talk specifically about an international approach and about an exchange of virtual currency to hard currency. You have expanded that to say that no, you're actually going to look at obtaining additional information or controlling to agree to exchange virtual currency for virtual currency or for goods. I'm trying to get that because it's beyond what you said in your speech.
Mr. Wright: It wouldn't be for goods. Just as within our normal AML/ATF framework, we don't make retailers responsible for reporting when you use cash. I was just trying to say that we've spoken already about the great challenge of trying to identify within the block chain systems. It was built for a purpose and it does that purpose well.
Senator Massicotte: We should concentrate more on what is written versus your expansion.
Mr. Wright: We think the key point for AML/ATF will be that interchange to the real payment system — the real money system as it matures. Right now, the depth of the bitcoin market isn't great. Terrorists and money launderers can't buy everything they want to buy. Dell and Expedia are advertising acceptance of bitcoin. What they've really done is enter into a third-party relationship to manage that. It is not Dell or bitcoin. There still needs to be that fiat currency aspect. For us, it appears that the most practical way to tackle it for now is to look at the exchange side.
Senator Massicotte: If you did that, would you apply the same limit of $10,000? Is it the same standard?
Mr. Wright: That's what we're looking at. We said that we intend to go out and do more consultations and discussions. We would be consistent with the current limit.
Senator Massicotte: So $10,000 plus any suspicious activity, in summary.
Mr. Wright: $10,000 is for a large cash transaction right now, so we would look for a bitcoin equivalent for that. With EFTs, electronic fund transfers, the foreign ones, it is hard to understand how we might actually be able to enforce and supervise that sort of issue. I would turn to my FINTRAC colleagues to address that. We're looking at the same monetary thresholds.
Senator Massicotte: International standards have shown New York in particular, which is leading somewhat, as is California. They're doing $2,000 for the virtual currency. Does that influence you at all?
Mr. Wright: We will certainly look at that. I wasn't aware of that, but we will certainly look into that.
Senator Massicotte: You also talked about consumer protection because you have a role there, and you mentioned that there have been some announcements recently warning Canadians that there has been an immense variation in currency, highly speculative, be careful. In that same light — and you have a responsibility there — I'm not sure it has done enough to warn Canadians, but having said that, if you look at international standards, they are also spending time on that issue. Some people will take cash and not only convert, but can actually hold your cash and make you own virtual currency. Therefore, the world is looking at saying maybe for those people — because we have had scandals in the last couple of months, the money has disappeared; maybe it was never there, who knows — it may be also required that they hold that collateral and not only deal with the identification of people but should also be forced to say: "If you want to invest in virtual currency and want to put $10,000 in conversion, maybe you should put that $10,000 or some equal collateral to make sure the money is there if you ever need to get access to it."
Your speech did not deal with that. Is that something you're looking at?
Ms. Pezzack: It's complicated. On the consumer protection issue, the FCAC is only responsible for dealing with consumer protection issues as they arise out of federally regulated financial institutions. If we look at those operators of virtual currency as being a money service business, rather than a federally regulated financial institution, this is where we run into the need to have these ongoing discussions that we're having with the provinces and territories because they are responsible for supervision and management of money services businesses. That's part of the complication.
Nonetheless, I think that FCAC took the sort of proactive approach of raising this awareness through the financial literacy work they're doing because there's a lot of talk about it. There's a lot of media about the issues related to it as well.
What did the second part of your question relate to?
Senator Massicotte: Holding collateral as we force banks to hold collateral.
Ms. Pezzack: Again, it comes down to the solvency issue and how your business is set up. The Canadian firm CAVIRTEX said in their material that they hold 100 per cent collateral for the coins they were exchanging. In a virtual currency world that's opaque and international, it's very hard for anyone in government to say: "You have to hold this kind of reserve for the currency that you are trading." You're not necessarily going to know who has the big pile of currency at any particular moment.
Senator Unger: Thank you, members of the panel. I'm subbing in this committee, so Ms. Pezzack, I was glad to hear you say it's complicated, because it is.
First of all, do illegitimate or terrorist groups who operate in this currency world know who the other players are? They're obviously dealing with somebody and maybe in real currency or hard assets, if that's possible, but do they know each other? Or can they know each other?
Ms. Pezzack: I would have to speculate on that, but I can tell you if you want to send money to somebody else through this network, you have to have their address. Presumably, you would get their address from somebody that you knew, so in some sense there may be a connection. I'm not sure that it is always the case if it's some sort of an exchange.
Mr. Tabi: You're correct. In order to be able to exchange, you would need to know the address or information of the other partners or stakeholders involved in the transaction inside the bitcoin world. Again, that's, as I confirmed at the beginning, for FINTRAC. We cannot receive these kinds of reports from the covered reporting entities at this time.
Senator Unger: If you set up a legitimate organization and started trading, would that enable you to know who some of the other players are to get into what I think is an underworld of currency?
Ms. Pezzack: I think that's consistent with what the RCMP and CSIS were saying when they were before the committee a couple of weeks ago. There are layers in the Internet. There is sort of what we see and then the grey zone and there's the black zone.
I think you'll find some of these businesses run in the sort of upper layer and some of them run in the bottom layer. I think it's probably mostly a question of intent, whether or not you want to be in a legitimate business or you want to get on this Silk Road, as it existed before, which was full of illicit trading, bartering and that sort of thing.
Senator Unger: Could a legitimate organization get into that dark market of the Internet for information?
Mr. Wright: Let me clarify that bitcoin itself isn't the dark market. The dark market is a part of the web that utilized bitcoin as a means of exchange. In itself it's not the dark market. Yes, two people have to contact each other in order to initiate an exchange between them, and that anonymity is in the wallets.
If I may, I can use this maybe to come back to an earlier question which dealt with the ability for us to break the anonymity. I think what you're pointing at is what we have heard in discussions. Top-down, so off the chain block you have a transaction. Your ability to burrow down through that to identify an individual is very difficult. These people will be exchanging other than just through the bitcoin, and once you identify an individual, I think law enforcement finds it's not as difficult then to use other investigative means and use the bitcoin information tied in with other information, such as email exchanges and these sorts of things, to build a bit of a link. It's still difficult; certainly, no one is saying it's easy. But I think, and you may have heard this yourselves: top-down, very difficult; bottom-up, a challenge, but not quite as difficult.
Senator Unger: Are there any crimes that you are aware of that are associated with this industry?
Ms. Pezzack: There have been a couple of major investigations, for example, the Silk Road case which the FBI broke, and the Silk Road version 2.0 and 3.0, so, yes, there are places you can go, if you have those types of connections and the knowledge to get involved in a market that's essentially a black market of illicit goods and money laundering.
Mr. Wright: One other example raised by the RCMP where they're seeing this is ransomware. Viruses are sent to your computer, they scramble all your information, and then they ask you to send bitcoins and they'll give you a code so you can unscramble your information. If you don't do it, they wipe your drive and you lose the information. I think that's one where they have actually seen bitcoin being used.
Senator Unger: Thank you.
The Chair: Senator Unger, you're quickly understanding how complicated this is.
Senator Tannas: As usual, I find with this great group that if you go last, you've got maybe a shred of a question left because it's been asked and answered, which is terrific.
Just so that we're clear, because I think Senator Massicotte talked about this, you mentioned on-ramps and off-ramps. Clearly that's in your purview; you're going to take care of that. You've been given the legislative tools to do so; we're waiting on regulations.
Ms. Pezzack: Yes.
Senator Tannas: To use the automotive analogy, there's the parking lot, so the people who provide wallet services. I'm reading in here somewhere about transmitting and remitting. Do you think that gives you enough to get at the wallet service providers? We're going to quickly get into consumer protection, and you say "that's not our game; that is the province's game." Are we clear that that is the province's game so that we are not making a bunch of recommendations for the provinces? It's the federal government, but it's really because we've determined through legislation that this is a money service business and that, by inference, means that anything to do with consumer protection is the province's business.
Ms. Pezzack: Yes.
Senator Tannas: Is that right?
Ms. Pezzack: Yes.
Senator Tannas: Is there anything to be done with wallet service providers in your view that we ought to be talking about? Or do you have enough with the wording as it is now to make sure that wallet providers give you or get you what you need, if you need them?
Mr. Wright: It's interesting. We have looked at it. We have not spent a lot of time. It's something we'll certainly look into in more detail now. A wallet is really just holding this chain block, holding this information.
Senator Tannas: Yes, but we heard a lot of information that the next step — nothing is new again. We're back to Wells Fargo, where you need to put your cash in a box that is protected from bad guys. So wallet service providers are going to be the next level that, as bitcoin becomes more used, you don't get your bitcoin stolen and you have to have it in a "bank."
Mr. Wright: I'm looking at it from the ML/TF lens, but as Lisa indicated from a consumer protection issue —
Ms. Pezzack: On the payment side, we've been talking to wallet providers unrelated to the money laundering terrorist financing, and different wallet providers offer different services.
For example, if you buy something and you use PayPal to pay for it, PayPal becomes the merchant of record, so they will have information on you. If you use Apple Pay, which is not yet in the Canadian market but it is in the U.S., they're an IT platform. So yes, you're going to have an Apple wallet, but they're not involved in the transaction in any way. They are not the merchant of record.
Part of it will depend on how the wallet is set up as to whether or not you'll be able to see into it and whether or not they would have the information on the customer that you would expect. I think it's something that we're still thinking about in terms of how far we can go. There are different ways of organizing a wallet. That's part of it.
Senator Tannas: If something comes to you that you think we ought to be providing a recommendation on, let us know, specifically around that service of custody, once it has been exchanged.
Second, have you got any advice for us? You may quickly say this isn't your area, but you're in finance. We heard a lot about bank account access, that people in this industry are not able to access banks. We also heard in the United States that even after New York presents, people will still not be able to get access to bank accounts.
Do you think that once we complete all of this work — because I think the banks in Canada are clearly worried about AML/ATF. So once your stamp of approval is on that, would you expect that the banks would move forward? Or is there a piece of legislation we need to put in place that would encourage the banks to start giving people accounts and give them cover if it doesn't turn out the right way?
Ms. Pezzack: That's a good question. It's complicated. Can I say that again?
Part of the work that we do with Financial Action Task Force, also in terms of our domestic work, is looking at the question of risk. Some Canadian banks — and this is the case internationally — are saying "I don't want to deal with that business because it's too risky, and I can't see into that business enough to risk manage in a way that I'm comfortable, that I'm not going to get myself into trouble on the money laundering or terrorist financing side."
Part of what we're doing in the Financial Action Task Force is trying to move to a more risk-based approach that would allow us to determine — if you take the RCMP's and CSIS's view that there isn't a lot of bitcoin in the market now, we don't have huge concerns about the level of crime, that would suggest that it's a relatively low-risk process and that may give the banks greater comfort.
At the end of the day, though, they have to make business decisions about what they will or will not accept as risk, and we can't make them give bank accounts to people they feel are high-risk clients.
Senator Black: Thank you all for being here. This is extremely helpful. You're very informed on this topic and this is helpful to us. I have a very simple question, and it really is directed to my friends at FINTRAC.
Do you believe that you have the tools today to do what's required to fulfill your mandate vis-à-vis any inappropriate activity involving cybercurrencies?
Mr. Tabi: Thank you. As I indicated at the beginning in my opening remarks, as of now, our database with regard to virtual currencies is of limited use because we are not covering exchangers on the virtual currency side. The only way we would currently be able to get some information prior to having the regulation in place is when current reporting entities, such as banks and the other 31,000 entities in Canada, would be in a position to identify that kind of thing.
At this time, we do not receive sufficient information with regard to transactions related to virtual currencies, but work is being done on regulations, and we're working closely with the Department of Finance on this.
Senator Black: You've indicated today that if there is activity that would normally be brought to the attention of FINTRAC, if that activity is being prosecuted with bitcoin, you do not have the tools or the mandate to investigate. Is that what you've said?
Mr. Tabi: One important clarification, FINTRAC does not investigate. We don't have investigative powers. We're an administrative agency, so we receive reports from reporting entities that are covered under the legislation, so our limit right now is to receive from the ones that are covered.
All these reports that I've named before we can receive right now, but the entities that are operating in the virtual world exclusively right now that are not covered do not, at this time, submit any kind of reports to FINTRAC.
Senator Black: I see. And if this world, if these exchanges were characterized as money service businesses, would that then solve that issue for you?
Ms. Pezzack: The legislative framework is in place, and we're working on the regulatory framework which will enact, basically, the legislative provisions which would then require the money services businesses to report to them.
Senator Black: So that should solve that problem? I want to ensure you have the tools you require to do what you need to do, and I think once we get these regulations in place, you should have the tools?
Mr. Tabi: Well, the regulations are being developed right now, so I guess once we see the regulations and can operationalize new tools, we'll be in a better position to confirm that.
Senator Black: Would you have any suggestions for us? We're coming near the final stages. Would you have any suggestions that might be helpful to assist your organization?
Mr. Tabi: Well, there is work being done right now — again we're waiting to see how we will be able to operationalize. I think we need to continue the work with the Department of Finance to see what we will end up with, and then after that it's going to be our colleagues on the compliance side to be able to operationalize all this and start receiving, and it's only once we see what will be developed and put in the Gazette that we'll be in a better position to comment.
Mr. Wright: I will assure you that we will work very closely and we do work very closely with FINTRAC to ensure they have the appropriate tools within what we are able to provide, given the privacy and Charter concerns, which are paramount.
Senator Black: I want to ensure that you do have the tools required.
Mr. Wright: We always work very closely with FINTRAC. We have a very good relationship with them.
Senator Black: Wonderful. Well, that wasn't complicated, was it?
Senator Tannas: I had a supplemental question on this subject. You mentioned something, and I want to make sure that we're crystal clear. You've reported 1,143 actionable issues, items, whatever. So essentially, if you have no investigative powers whatsoever, it was really the 31,000 folks that gave you exactly 1,143 suspicious transaction reports; is that right?
Mr. Tabi: Let me maybe elaborate a little bit on this. When we're talking about a disclosure of actionable intelligence to partners and we're talking about 1,143, we're not talking about only one report submitted by one reporting entity.
The technical analysts at FINTRAC are developing cases, when we're talking about a case it could represent several reports on, for example, one big network. The work of a technical analyst at FINTRAC would be to gather the information of several reports to then disclose one case to a partner that is listed under the legislation. So one of the 1,143 cases could involve several reports and, as I mentioned, these reports could include suspicious transaction reports, which come with no threshold at all. As long as a reporting entity would meet its threshold of reasonable ground to suspect, it can submit information to FINTRAC with regard to a financial transaction, and we do have all the other objective reports related to the threshold of $10,000 and other kinds such as casino disbursement reports. So it's a package.
[Translation]
Senator Maltais: I have two questions. The first is about a source of concern for me, because I get the impression that everyone is floundering when it comes to bitcoins. I remember reading an article in an American newspaper that referred to bitcoins as monkey money; the American Treasury said that. Today, it is running after the monkey. We had not heard much about bitcoin before the chair of the committee suggested this topic, which we have been studying for a few months. Now we see that government bodies are taking an interest in this.
Have you been caught unaware, or are you ahead of things in this file?
Ms. Pezzack: That is a good question.
Mr. Tabi: I can attempt to answer in a general way on the situation at the international level.
Senator Maltais: No, I am asking about the situation in Canada; I will come back to the international level later.
Mr. Tabi: Very well. In Canada, as in all the other countries, when I look at the work being done at the international level, I do not think we are lagging behind. The various countries and the great leaders of the world are all in the process of preparing legislation, in order to adapt. You are correct, however; this is a technology that is evolving very rapidly, to which we have to adapt, and we have to develop measures quickly to deal with it.
Ms. Pezzack mentioned some cases, such as that of the Liberty Reserve, and another international one, dealt with by the Americans, but also in collaboration with 17 other countries, including Canada, as the RCMP confirmed a few weeks ago. The RCMP also confirmed, as did CSIS, that there are very few cases in Canada up until now, and that they are being dealt with in any case.
Senator Maltais: What concerns me is that the Canada Revenue Agency does not seem to be very present. There is an old saying in Canada according to which income tax will chase you from birth until the grave; and yet we have not heard much from the Canada Revenue Agency on this matter. Their representatives appeared before the committee and I asked them if I could pay my income tax in bitcoins; they answered no. Fine. That was the only definitive answer I got. I get the feeling that they do not know where they are going with this, or they are at sea in an ocean where they cannot see any possible landfall.
Ms. Pezzack: I do not want to comment on the actions of another department; it is not my place to judge. I would say that with all of the changes that are happening in this area, the pace of the changes represents a challenge, not only for us, at the Department of Finance, but also for other departments, as we attempt to meet them.
Senator Maltais: I would also like to talk about traceability. We do not seem to have evolved much in that respect. If you are in Kitimat in British Columbia and you eat an egg in the morning and it is bad, we can find out in an hour whether it came from Saint John, New Brunswick, or Newfoundland and Labrador, but we cannot trace bitcoin transactions.
Traceability is the implementation of a system whose objective is to ensure compliance with regulations. We do not have regulations; what is the point of traceability if there is no regulation?
Ms. Pezzack: We are working on bringing in those regulations right now.
Senator Maltais: Are you working on both sides at the same time, that is to say in order to create an effective traceability system? There is one for the food sector in Canada; could you not call the Department of Agriculture to ask them how it is done?
Ms. Pezzack: I don't think so.
[English]
Mr. Wright: I think what you're pointing to, and what the challenge is, is the web. We can look, as we talk about the on-ramp and the off-ramp. Once it gets into the ether, it's not a commodity. It's not an entity that you can put a tracking number on and you can say that this went from this person to this person to this person.
We don't have that ability. It's not a real solid thing, right, and the web is international, as Lisa said.
You point to a huge challenge.
[Translation]
Senator Maltais: That is what I wanted to hear you say. In short, there is no security in connection with the bitcoin system. You cannot trace information. Anyone can do shady transactions.
Ms. Pezzack: That is true.
[English]
Mr. Wright: That is why we're looking at the on-ramp and the off-ramp. Those are the two points that we've identified, and I think those have been identified by this committee with other witnesses, where we can impose the ability to apply CDD, other requirements on identification and the normal sorts.
[Translation]
Senator Maltais: Are there any dubious transactions taking place currently on Canadian soil?
Ms. Pezzack: That may be so.
Mr. Tabi: You are correct. Traceability is a problem. At this time there are bitcoin transactions that are difficult to track in the system because there is a certain degree of anonymity involved. However, we can draw a parallel with the non-virtual economy and cash. If I withdraw $500 from my bank account and exchange it on the street corner with my colleague Bernard Gagné, that will also complicate traceability. Cash presents the same problem. However, the problem becomes much more complex in the virtual world. Your committee's research has also shown that the speed at which transactions can be done is also a factor. It is also a matter of volume. Large sums can be exchanged quite quickly in the virtual world. As our colleagues from the RCMP and CSIS confirmed, there is a potential for this system to be used for illicit purposes.
Senator Massicotte: You are referring to global financial transactions. You know the practices involved well. Why are we seeing this move to virtual currency? What are the monitoring systems? What are we learning from our international partners? What point have they reached?
Ms. Pezzack: As I mentioned, a report was published last June which created a common terminology. In other countries, the original terms can be used in a different way. They are also establishing guidelines for digital mining. I expect they will be ready shortly. We will send you a copy of those guidelines as soon as they have been approved by the members.
It is complicated. All of the countries have more or less the same problems and are all asking themselves the same questions.
Mr. Tabi: Indeed, FATF, which is an international organization, has published two documents. There is also the Egmont group which like FINTRAC develops indicators to pool knowledge and better understand the reasons behind this rapidly evolving phenomenon. These two international organizations have both done some work in this area. The FATF, under the direction of our colleagues from the Department of Finance, is involved in this work, as are several other partners. So Canada is getting involved. So is the Egmont group. We are working with partners in order to gain a better understanding of this phenomenon which is evolving rapidly. Guidelines are being established to help in this work. You have no doubt heard about the 40 FATF recommendations in the context of a fourth evaluation round which is taking place at this time. Provisions were already in place to deal with new technologies. Among these 40 recommendations there is one that is entitled "new technologies," according to which the global partners, all of those who belong to the FATF, i.e. close to 200 countries, are to keep track of these new technologies and put in place provisions as they emerge. We have an obligation, according to the recommendations of the FATF, to react to these emerging technologies as quickly as possible.
Senator Massicotte: We need to focus on on-ramps and off-ramps. Is that the current trend?
Ms. Pezzack: I believe it is. It would be one way of helping to develop the guidelines. When a transaction crosses several borders, it is a sign that we have to regulate the way in which we do business.
Senator Massicotte: The Americans may be ahead, because this technology is rooted there, even if it is international. Are the Americans leading in terms of regulation?
[English]
Mr. Wright: I think they released it in the last week or two what their plans will be. I don't think we'll be too far behind them, but it's along the same lines.
Senator Massicotte: "They" being who?
Mr. Wright: New York State and FinCEN.
Senator Massicotte: Obviously New York State has decided to say that this process is too slow. They've issued their announcement, their directive, in June 2014. They've issued an amendment in December 2014, and they expect to issue their final position shortly. So they haven't waited for this international committee to say "here's where you should go." They sort of said this problem is urgent, there have been immense difficulties, immense surprises, maybe consumers losing money. Maybe we should learn a bit from that also and not wait too long.
Ms. Pezzack: And this is always the problem with trying to make a regulatory framework, particularly in an area that's new. You don't want to put in place regulations too soon that stifle innovation, and you don't want to let it get out of hand. So part of what we are looking at as we look at developing our regulatory framework is the scope of what we're talking about.
We're not seeing a huge amount of bitcoin or virtual currencies being used here in Canada, and when you take the risk-based approach to regulation, which we try to do, if there's not a lot of business then the risk is, by definition, not that high.
Do we feel comfortable that we're moving in the right direction in a timely enough fashion? I would say yes.
[Translation]
Senator Bellemare: My comments will be in the same vein as Senator Massicotte's. Do you know when your regulation will be ready?
[English]
Mr. Wright: We don't at this point, no.
[Translation]
Senator Bellemare: Can you at this time give us a clear idea of the definition you will use in your regulations on digital currency? Are you going to define it as a payment method, or a commodity? Since there are implications regarding financial legislation according to how it is defined, do you already have some idea or has that not yet been decided in the course of your study?
[English]
Mr. Wright: We're going to use the broad term "virtual currency," I would think, when it comes to the end. How CRA may choose to interpret for the purposes of their own rulings — and they have come out with a couple of rulings already, without treating it as barter and capital gains and those sorts of things. But that is certainly one of the key issues that we are looking at how do we define.
What we're really looking at is the entity, so we need to be able to define what entities are trading in these virtual currencies. You have raised a good point, and it is part of our current thinking and what we're trying to ensure that we do.
As we've spoken, technology changes so quickly. If you're too prescriptive, then you'll be back a year from now trying to revisit. So we're trying to make sure that we have something that provides an appropriate boundary but at the same time isn't too prescriptive and also, as Lisa says, doesn't stifle innovation.
Bitcoin isn't necessarily the issue; it's how it's used and how the rails of bitcoin are used.
[Translation]
Senator Bellemare: If it is considered to be a commodity that allows for capital gains, there can also be losses, and this will complicate financial management.
Ms. Pezzack: When the regulation is drafted it will be published in the Canada Gazette, and there will be a period of consultation to give people a chance to express their viewpoints on this, which will allow us to see whether we have gotten to the heart of the issue.
[English]
The Chair: In the 1950s, there was a new technology that was called television. Many thought there was no future for it. Why would anybody sit in front of something and watch it when they could listen to something on the radio and do other things at the same time?
In the 1970s, there was another new development, a new technology. The Internet came on the stage, and many, if not the majority, thought it would be available to download porn or to see porn and to distribute drugs. It's come a long way.
Are we in the same situation with virtual and digital currencies today, in that we are basically just at the beginning?
Ms. Pezzack: Well, I think we probably are. Much like the other examples you've given, it takes time to figure out where exactly it's going to go and how it will develop.
I certainly don't want to leave the impression that we think that bitcoin is only used for bad. There are advantages to having a currency where you can do your export-import business without having to go through foreign exchange in and out of every country. There are certainly advantages to virtual currencies.
And like any nascent industry, there are a number of players in the business, and they approach the business in different ways. That's part of the homework that we're in the process of doing, understanding how different virtual currency organizations work and what their approach to their business will be.
We do have concerns about making sure that we maintain the safety and stability of the financial system, that consumers understand what they're getting or not getting as part of that process, and that we make sure we're meeting international obligations in relation to anti-money laundering and anti-terrorist financing. So that is the world that we are grappling with and trying to reach conclusions on in terms of defining what our regulatory regime will look like.
The Chair: As you approach it, do you differentiate between what might be termed the centralized virtual currencies, such as M-PESA and Kenya is accounting for 50 per cent of the transactions that are taking place within the country tied to the fiat currency of Kenya, versus the decentralized currencies such as bitcoin? Is there a difference in approach, or are they lumped together as one category of being virtual currencies?
Ms. Pezzack: Well, I think there is a difference between the centralized and non-centralized.
The Chair: Right.
Ms. Pezzack: The M-PESA example that you talk about, you've got a very close link to the fiat currency. Where you have a close link to the fiat currency, you have a clear nexus where you can regulate because you can see it; it's tangible.
When you start looking at decentralized currency — and this is partly what we were setting out in the legislative framework — you may have a money services business based in the U.K. providing money services through virtual currency to someone here in Canada who's then selling something to somebody in a third country. Where do you regulate that? That's very hard because they don't necessarily have a home country; certainly bitcoin doesn't.
There's no point in making regulation if you can't actually regulate, so that's the challenge. I know you understand what I'm talking about because I've read the testimony that you've had before you, and it's complicated.
The Chair: Well, that's perhaps a good way to conclude. I must say, in all of the meetings that I've attended in the Senate on any subject, it's very rare that you get unanimity among all the members of the committee and all the witnesses that we have before us, but clearly we do today in a sense that we all agree it's complicated.
On behalf of all of the members of the Senate Banking Committee, we'd like to express our great appreciation for your appearance today. You've been very helpful in our deliberations. Thank you again. This meeting is concluded.
(The committee adjourned.)