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CIMA’s Guidance on Virtual Asset Custodians and Trading Platforms

In December 2024, the Cayman Islands Monetary Authority (CIMA) published its “Statement of Guidance Virtual Asset Custodians and Virtual Asset Trading Platforms” (the “Guidance”). This document outlines the Authority’s minimum expectations for managing risks and operations by virtual asset custodians and trading platforms, as regulated under the Virtual Asset (Service Providers) Act (the “Act”). It focuses on key recommendations in areas such as governance, client protection, and trading platform integrity.

Governance

The Guidance is not intended to be prescriptive, exhaustive, or a comprehensive approach to managing VASP-related risks and operations but provides a foundational framework for compliance and good practices.

The Guidance emphasizes that the governing body, be it a Board of Directors, General Partner, or equivalent, must possess an appropriate mix of skills, experience, and independence. These qualities enable members to discharge their duties effectively while navigating the unique complexities of the virtual asset industry. Directors are encouraged to evaluate their personal commitments to ensure they have the time and resources needed to fulfill their responsibilities fully.

The Guidance also mandates an annual formal review of the custodian’s or trading platform’s policies and procedures by an independent third party. This review ensures alignment with the obligations set out in the Act and accompanying rules. Such independent assessments help maintain regulatory compliance while fostering a culture of accountability and continuous improvement within the organization.

Conduct of Business

The Guidance emphasizes that virtual asset custodians and trading platforms must implement policies to ensure fair treatment of clients, clear communication, and effective management of conflicts of interest. Entities are required to disclose potential conflicts, such as financial incentives that could favor certain clients, and to establish safeguards, including separating conflicting duties, to protect client interests.

Clear communication is also vital, with the Guidance highlighting the need to inform clients of withdrawal timeframes, potential delays due to safeguarding measures like offline wallets, and any material changes to services. These measures help ensure clients are well-informed, protected, and able to trust the integrity of the platform or custodian.

Risk Management

The Guidance emphasizes the necessity of a comprehensive risk management framework for virtual asset custodians and trading platforms. Such a framework should outline clear processes for identifying, evaluating, and managing risks to client assets, operations, and reputational integrity. To ensure its effectiveness, the framework must be approved by the governing body and undergo regular reviews, at least annually or when significant changes occur in the business environment.

A detailed risk register forms a critical component of this approach, documenting all identified risks, mitigation measures, and assigned responsibilities. By maintaining and updating this register, entities can make informed, timely decisions and demonstrate a proactive commitment to safeguarding their clients and operations.

Cybersecurity

The Guidance places significant emphasis on the need for robust IT policies and regular testing to safeguard virtual assets effectively. Virtual asset custodians and trading platforms are required to conduct annual penetration testing through independent third parties. This rigorous testing helps identify vulnerabilities and strengthens defenses against cyber threats, ensuring the security and resilience of IT systems.

In addition to testing, entities must implement comprehensive IT policies tailored to address the specific risks associated with virtual assets, such as smart contract vulnerabilities and storage security. By combining robust cybersecurity measures with regular assessments, custodians and platforms demonstrate their commitment to protecting client assets and maintaining operational integrity.

Client Protection

The Guidance underscores the critical responsibility of virtual asset custodians and trading platforms to safeguard client assets through stringent custody and reconciliation measures. To ensure assets are protected from misappropriation or third-party claims, entities must implement robust procedures for segregation of client assets, frequent reconciliation of balances, and accurate record-keeping.

Reconciliation processes, as outlined in the Guidance, include daily comparisons of internal account balances with distributed ledger records and prompt resolution of discrepancies. Additionally, custodians must maintain secure storage methods, such as multi-factor authentication and meticulous management of private keys, to minimize risks associated with theft or loss. These measures collectively uphold client confidence and reinforce the security of their investments./p>

Trading Platform Integrity

The Guidance outlines key requirements for virtual asset trading platforms to maintain market integrity and protect clients. Platforms must implement surveillance systems to detect and report suspicious activities, with systems tailored to their size, transaction volume, and risk profile. This ensures transparency and deters market abuse.

Fair pricing mechanisms are also essential, requiring platforms to establish robust price discovery processes and disclose pricing components clearly. Additionally, for leveraged trading, platforms must adopt prudent practices, such as limiting leverage based on client experience, maintaining margin requirements, and offering negative balance protection to prevent clients from incurring excessive losses. These measures foster trust and ensure platforms operate with accountability and fairness.

Conclusion: A Valuable Framework with a Watchful Eye

The Guidance serves as a comprehensive manual for virtual asset custodians and trading platforms striving to align their operations with CIMA’s expectations. By addressing governance, risk management, cybersecurity, and client protection, it provides clear pathways to compliance and operational excellence.

However, the detailed nature of the Guidance also suggests a cautious oversight approach, perhaps reflecting CIMA’s concern about the inherent risks of the virtual asset industry. While this might seem stringent or paternalistic, it underscores the importance of building trust and credibility in this evolving sector. For custodians and platforms, embracing these standards is not only about meeting regulatory requirements but also about establishing a foundation for long-term success in their relationships with clients and regulators alike.

If you’re a promoter, director, manager, or general partner of a Cayman Virtual Asset Custodian or Trading Platform wondering how this Guidance might impact your business, don’t hesitate to reach out to your legal counsel at Vale Law. We’re here to provide guidance, clarify regulatory requirements, and help you craft policies and procedures that meet your goals while ensuring compliance with Cayman Islands regulations and recommendations.

Shelley Do Vale: shelley.vale@valelaw.ky

Santiago Mtnez-Carvajal: sc@valelaw.ky