Tuesday, October 20, 2020
Article co-written by Andrew Tzialli, Corporate M&A Group and Head of Cryptocurrency and Blockchain at Philip Lee, and Daniel Lawlor, Managing Director, Aquest.
As it stands, numerous activities regarding the supply, purchase, and exchange of cryptocurrencies and crypto-assets often fall within the regulatory “cracks” across the EU. Whilst there is an acceptance that certain crypto-asset related activities are captured by exiting e-money regulations, (specially EMR (European Communities (Electronic Money) Regulations 2011)) or by the broader regulation of EU financial markets on the issue of securities and/or other financial instruments, (for example, MiFID (Markets in Financial Instruments Directive)), a detailed and tailored regulatory regimen for crypto-assets is broadly absent.
The EU’s proposed Regulation of Markets in Crypto-Assets (MiCA) seeks to address these issues with a new comprehensive framework. If MiCA is passed into law, the EU would likely become the world’s most significant regulated area for crypto-assets.
Here are five things you need to know about the new proposals.
1. EU-wide standardisation, application, and clarification
Whilst a number of EU countries have adopted (or plan to shortly adopt) rules governing crypto-asset activities, a harmonised EU approach is currently absent. The implementation of an EU-wide framework will help to provide legitimacy and transparency to a sector regularly accused of lacking both. It will also allow certain passporting rights for compliant businesses across the EU.
With this increased transparency, prospective investors will be better placed to assess risks that have thus far been inherent in an often volatile sector.
It is also clear that MiCA does not seek to overlap with existing regulation (being that referred to above), and is aimed at regulating three specific classes of crypto-asset: asset-backed/referenced tokens (i.e. those backed by commodities, fiat or other crypto stable coins); utility tokens; and e-money tokens (now newly defined to clearly distinguish them from traditional e-money as we know it).
2. Who will this apply to?
MiCA will provide for regulatory obligations and requirements in respect of a broad range of services, including: trading platforms for crypto-assets; the exchange of crypto-assets for fiat currency or for other crypto-assets; custody of crypto-assets; receiving and transmitting orders for crypto-assets; the execution of orders for crypto-assets on behalf of third parties; and advice on crypto-assets.
The regulations will apply to anyone providing any of the above activities within the EU.
3. What sort of obligations will MiCA impose?
Many of the requirements will mirror those already in place for other financial services providers (in accordance with MiFID) including: having an EU presence; minimum capital requirements; rules regarding holding client funds; risk management; and having a range of policies and procedures in place governing the service offering, complaints, etc., to name but a few.
For issuers of crypto-assets, a form of prospectus will also need to be published. Whilst this prospectus is referred to as a “whitepaper”, the contents will be far more substantive than many of the whitepapers published by crypto-asset issuers in the past. Details of the assets in question, clarity around the risks, communicating in a clear, honest, professional, fair, and non-misleading manner, will all be essential.
Requirements for issuers of asset-referenced tokens and e-money tokens will go further. A notable requirement in the MiCA proposal, for example, is that e-money tokens must be issued with a 1:1 redemption guarantee (i.e. if you paid €1 for your token, you must have a guarantee that you can get your €1 back at any time).
4. Will this have an impact on innovation?
Regulating to facilitate innovation is an oxymoron. As soon as you introduce rules and require firms to seek authorisation, you immediately stifle innovation. The tricky thing about regulating in an innovative space is to set the bar at the right level. Set it too low, and you don’t achieve what you set out to – investor protection and legal certainty. Set it too high and you cut the initiative off at the knees by making the cost of entry so high that no one can afford to enter this space and create and innovate.
When it comes to MiCA then, the devil will be in the detail. The current draft text includes references to de minimus thresholds and proportionality but much of the technical detail remains to be written by EBA and ESMA in Level 2 measures. Once regulators get down to drafting the minutae of technical rules, they tend to look for more rather than less; to push for the greatest levels of investor protection and transparency rather than balance against the need for greater innovation and lower barriers to entry.
It will be interesting to see if regulators can resist their natural tendencies to set the bar so high that it kills the initiative before it ever gets anywhere. It will be the job of the legislators to make sure that that doesn’t happen. However, looking at the levels of detail and prescriptiveness across all European financial services legislation (e.g. MiFID, PRIPS and CRD) would not fill you with too much hope.
Unregulated firms come from a world where they are used to being innovative, agile and dynamic. Upon moving into the regulated space, these firms will immediately find that their flexibility and time to market are constrained. They now have a regulator looking over their shoulder who will want to pre-approve anything that they do. Getting used to that culture shift can be an enormous challenge for firms who are used to doing their own thing.
5. What else do crypto issuers or crypto service providers, need to watch out for as the implementation of MiCA progresses?
The biggest single difference between a regulated financial services firm and an ordinary operating company is that while operating companies act in their own best interests (in the interests of their shareholders), regulated firms must act in their clients’ best interests. This means favouring their clients’ interests even if that is against their own best interests and even if it hits them in the pocket. Again, this is a huge cultural and mindset shift for firms that are not used to being in the regulated space – but firms that fail to grasp this will hit compliance issues sooner or later.