New York Tightens Rules on Sub-Custodians and Asset Segregation

New York regulator revises virtual currency custody regulations, emphasizing the use of sub-custodian licenses and rigorous separation of customers.

The Department of Financial Services (DFS) in New York has issued revised regulations on the custody of virtual currency that seek to enhance the security of customer assets. 

This update focuses on stricter regulations of the way in which license entities handle custody, especially with reference to sub-custodians and segregation of customer assets.

DFS Demands Clear Segregation to Guard Customer Assets

The new regulation now requires that virtual currency entities (VCE Custodians) should separate customer virtual currency on internal ledgers as well as on-chain wallets. 

Either there should be separate wallets per customer or omnibus wallets, which are exclusively used by the individual customers as a trustee or agent, with clear and auditable records.

The DFS needs policies so that the beneficial interests of the customers are always clear and up to date. 

This separation has ensured that there is no mix-up of the corporate and customer funds, thus enhancing confidence in the custody services that are executed within the regulations of New York.

Strict Rules for Sub-Custodian Approval to Boost Transparency

One of the updates is that any sub-custody arrangements must be a material business change that must be pre-DFS approved. 

VCE Custodians should provide the regulator with a comprehensive risk assessment, service contracts, and revised policies prior to the implementation of sub-custody. 

Sub-custodians must adhere to all of the requirements of the DFS, such as full compliance with the titling of accounts with the name of the customer signifying the benefit of and a firm separation between proprietary assets and the sub-custodian. 

This is to seal some loopholes that may expose the assets of customers to the risks of third-party custodians.

The DFS emphasizes that custodians should not believe they are already the owners of the customer’s virtual currency or that they can use it to enter into business agreements, e.g., to take loans or to grant credit. 

Contracts with clients must be explicitly written on a custodial, not a debtor-creditor relationship, with clear disclosures on custody arrangement and third parties. 

These terms should be accepted by customers prior to any form of transactions to help provide transparency and protect their interests in the virtual currency market, which is constantly changing.

These amended guidelines of the DFS of New York represent an effective move towards increased accountability and protection requirements in the virtual currency custody industry. 

Compliance and transparent disclosure require vigilance by the entities to retain customer confidence and avoid regulatory sanctions.

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