On 24 September 2020, the European Commission published its digital finance strategy, which includes a comprehensive framework for facilitating distributed ledger technology (DLT) and crypto-assets in the financial sector.
The strategy’s proposed legislative measures include those previously considered by the Commission:
- A regulation on markets in crypto-assets (‘MiCA’) that aims to create a comprehensive framework for crypto-assets, such as payment and utility tokens, not already subject to European financial services legislation.
- A regulation on a pilot regime for DLT market infrastructure.
- A directive amending, among other legislative acts, MiFID II to clarify the definition of financial instruments in respect of security tokens.
Below are 15 key observations on this proposed EU crypto-assets framework (13 for MiCA, and two on the other proposals).
1. A delicate balance between supporting innovation and regulating
The Commission aims for MiCA to enhance legal certainty – and ensure consumer and investor protection, market integrity and financial stability – in relation to crypto-assets.
One thing MiCA does not propose to do is to limit the use of stablecoins in the EU. The Commission also proposes to regulate stablecoins without only allowing stablecoins that are pledged at a 1:1 ratio with fiat currency, as was recently suggested by Germany, France, Spain, Italy and the Netherlands in a joint statement.
2. Harmonisation is key
The MiCA draft recognises that different national regimes exist for crypto-assets and services related to them, which hinders scaling-up crypto-related activities at EU level. According to the Commission, this limits access to funding and sometimes even access to necessary financial services.
The aim of fostering harmonisation also explains the purposed use of a (directly applicable) regulation. For the same reason, MiCA includes a passporting regime for crypto-asset service providers and cross-border notifications of the issuance of crypto-assets.
3. A comprehensive – but subsidiary – regulatory framework
The definition of crypto-assets in MiCA is broad and captures all representations of value or rights that may be transferred and stored electronically, using distributed ledger and similar technology.
However, it only applies to crypto-assets that do not already qualify as MiFID II financial instruments, e-money, deposits, structured deposits and securitisations and so, in a sense, is a 'subsidiary' piece of legislation. An exception to that rule would be an 'e-money token' that can, at the same time as being regulated by MiCA, qualify as e-money under the electronic money directive.
4. A 'small' prospectus regime for crypto-assets other than stablecoins
Issuers of crypto-assets must publish a crypto-asset white paper to offer crypto-assets to the public or request admission to a trading platform for crypto-assets.
Exemptions from these requirements apply. To some extent, they mirror exemptions under the Prospectus Regulation (eg if crypto-assets are offered only to qualified investors or less than 150 investors per member state). However, also crypto-assets which are automatically created through mining as a reward for the maintenance of the DLT or the validation of transactions are exempted.
MiCA sets out minimum disclosure requirements for the white paper, including a description of the crypto-assets and risk factors. A risk warning that crypto-assets may not always be transferable and liquid must also be included.
The white paper needs to be notified to one member state authority and include an assessment of why the crypto-asset does not qualify as a MiFID financial instrument. The issuer can instruct the home state authority to instruct other member states’ authorities where the crypto-asset shall be offered or admitted to trading.
Issuers also need to comply with governance requirements, such as acting honestly, fairly and professionally, and in the best interest of the holders of crypto-assets. In case of time-limited crypto-asset offerings, the issuer must ensure that the funds and crypto-assets collected during the offering are kept in custody by a credit institution or a crypto-custodian. Funds need to be returned if an offering is cancelled. This may help to prevent fraudulent initial coin offerings (ICOs), often called 'ICO scams'.
While national authorities are not allowed to establish an ex ante approval requirement for white papers, they can suspend or prohibit the offer if the white paper or the issuer does not comply with the relevant requirements.
5. Three regimes for three types of stablecoin
MiCA appears to distinguish between three types of stablecoin, which are in turn regulated differently.
Asset-referenced tokens
This is a type of crypto-asset whose main purpose is to be a means of exchange and that purports to maintain a stable value by referring to the value of several fiat currencies, one or more commodities, or one or more crypto-assets (or a combination of such assets). This applies to, for instance, stablecoins with a 'basket of currencies'.
E-money tokens
MiCA describes e-money tokens as a type of crypto-asset whose main purpose is to be a means of exchange and that purports to maintain a stable value by being denominated in a (read: 'one') fiat currency. Such tokens may already qualify as e-money under the current regime.
Algorithmic stablecoins
These are stablecoins that do not reference one or more fiat currencies or other assets and aim to maintain a stable value, via protocol, that provide for the increase or decrease of supply of such crypto-assets in response to changes in demand.
Such Algorithmic stablecoins should not be considered as asset-referenced tokens, according to recitals of MiCA provided that they do not aim at stabilising their value by referencing one or several other assets. They may be subject to the provisions for crypto-assets in general.
6. More scrutiny for stablecoin issuances
Issuers of asset-referenced tokens have to publish a white paper, comply with extensive governance requirements and be authorised with a national competent authority under a bespoke MiCA regime.
The governance requirements comprise:
- own funds requirements (€350,000 or 2 per cent of reserve assets – or 3 per cent in the case of significant asset-referenced tokens);
- governance arrangements (with a particular focus on IT security);
- complaints-handling and qualifying holding procedures; and
- ensuring safe custody of the funds received in exchange for tokens with credit institutions or crypto-asset service providers.
Granting interest to holders of asset-referenced tokens is prohibited.
7. E-money tokens to be treated (almost) like e-money
The Commission aims to avoid regulatory arbitrage between e-money and e-money based on DLT, and therefore plans to treat e-money tokens generally like e-money.
Issuers must therefore be authorised as an e-money or credit institution and observe the relevant governance and e-money redemption rules.
In particular, redemption of e-money tokens must be carried out by way of cash or credit transfer – which suggests that redemption must be in fiat currency (instead of other crypto-assets). If redemption is not carried out within an agreed time period, those who safeguard the funds or distribute the tokens must redeem them.
8. Issuers of asset-referenced and e-money tokens could fall under EBA supervision
To fall under its supervision, the European Banking Authority (EBA) must determine that an entity is ‘significant’, which means crossing certain thresholds in terms of customer base, value or market capitalisation, number of transactions, size of reserve assets, significance of cross-border activities and interconnectedness with the financial system.
These thresholds will be determined by delegated legislation but must not be lower than 2 million customers, €1bn value or market capitalisation, 500,000 transactions/€100m transactions per day, €1bn in reserve assets, and use in seven or more member states.
‘Significant’ issuers of asset-referenced tokens will, if the Commission’s proposal is accepted, be supervised solely by EBA. However, for ‘significant’ issuers of e-money tokens, EBA will only partially supervise certain requirements directly, namely capital requirements, remuneration policy, liquidity monitoring, the safe custody and investment rules, interoperability rules and the rules on orderly wind-down of the issuers. The remaining requirements are supervised by national authorities. According to the recitals of MiCA, this ‘dual supervision’ is justified by the risks for financial stability that are caused by significant asset-referenced tokens.
9. Crypto-asset service providers – a 'mini-MiFID'
Under MiCA, crypto-asset service providers will become subject to a licensing and supervisory regime that mirrors MiFID II to some extent.
For specific crypto-asset services, specific additional requirements apply. The crypto-asset services largely mirror MiFID II investment services (with crypto-assets instead of MiFID II financial instruments as reference points), with MiCA aiming to regulate them in a proportionate manner.
The recitals to MiCA further state that crypto-assets service providers should be authorised to make payment transactions in connection with the crypto-asset service they offer only where they are authorised as payment institutions in accordance with PSD2.
An EU passport will be established – one of the most important tools to remove the barriers currently raised by regulatory fragmentation.
10. Market abuse rules
The market abuse regulation’s main requirements (disclosure of insider information, and prohibition of insider dealing and market manipulation) will also apply to crypto-assets.
However, there is no equivalent to the CRIM-MAD, ie member states have the right but not the obligation to impose criminal sanctions on these wrongful activities in relation to crypto-assets.
11. Limited application to regulated institutions
Credit institutions that fall under the Capital Requirements Regulation (CRR) and issue asset-referenced tokens or provide crypto-asset-related services do not have to apply for an additional authorisation under MiCA.
MiFID investment firms can provide crypto-asset services where they are authorised to provide MiFID investment services that are similar to the crypto-asset services they intend to provide (such as the execution of orders for crypto-assets instead of other financial instruments). However, they remain subject to the MiCA operational requirements.
12. A jump-start for regulated crypto-companies?
Crypto-assets (other than asset-referenced tokens and e-money tokens) issued before MiCA enters into force are not subject to the offering rules (eg the white paper requirement).
For crypto-asset service providers that already provide services, a transitional period of up to 18 months applies, within which they must obtain a licence.
However, for entities already authorised under national law to provide crypto-asset services,member states can establish a 'simplified authorisation procedure'. This may help, for instance, German or French companies that are already licensed under the national regimes.
13. Less flexibility for third-country providers
MiCA’s third-country regime is currently not comparable to those under other regulations. While issuers of crypto-assets (except asset-referenced crypto-assets) do not have to be incorporated in the EU, crypto-asset service providers have to. There is, in particular, no equivalent regime similar the third-country passport under MiFID/MiFIR.
14. No harmonised interpretation of 'security tokens' without further guidance
The proposed directive amends the definition of financial instruments under MiFID II by including such 'instruments issued by means of distributed ledger technology'. While this clarifies that 'security tokens' may be financial instruments, it does not clarify the circumstances under which they actually do.
The Commission notes in its digital finance strategy that 'additional interpretative guidance on the application of existing rules will improve regulatory clarity' and this will clearly be needed to harmonise any differences between member states.
15. A blueprint for future financial market infrastructure?
The idea of piloting a DLT market infrastructure regime shows that amendments to market infrastructure are considered carefully by the Commission.
The operation of a MTF that only admits to trading tradable securities that are issued recorded, transferred and stored using DLT (DLT MTF) requires a separate permission that can only be obtained by investment firms or operators of regulated markets. For these operators, the proposal introduces different exemptions from existing rules (subject to additional supervisory approval), such as permitting DLT MTFs to provide direct trading access to retail clients and to admit to trading DLT transferable securities that are not recorded in a central securities depository (CSD) but on the MTF’s distributed ledger.
Only authorised CSDs can operate a DLT securities settlement system (SSS) after having received an additional permission for this purpose. A DLT SSS operator can further be exempted (subject to supervisory approval) from certain requirements, such as that he does not need to ensure that ‘dematerialised securities’ require a book entry record. It is also possible to deviate, for instance, from the rules that aim to ensure the integrity of the issue (the 'reconciliation measures') and the asset segregation rules.
However, all of these exemptions require that further measures be put in place. For instance, waiving the requirements on cash settlements requires the DLT SSS operator to ensure delivery vs. payment by other means, including by way of commercial bank money (in a token-based form) or e-money tokens.
The Commission has put forward a comprehensive framework that will certainly spark a debate among the industry and law-makers on the regulation of crypto-assets.
