A few weeks ago, a draft of the Proposal for a Regulation of the European Parliament and the Council on Markets in Crypto-assets was leaked. As I heard from one of its authors that the actual final draft would differ from the leaked document, I held off publishing my thoughts.
A few hours ago, the final legislative package was published. So, here we go with the analysis!
My subjective opinion on key takeaways is as follows:
- The proposed legislation is part of a larger Digital finance package, and consists of three main pieces: (1) a pilot regime for blockchain-based financial market infrastructures; (2) comprehensive regulation of crypto-assets, including stablecoins, and crypto-asset service providers and (3) amendment to MiFID2, which makes it clear that financial instruments include such those instruments which are “issued by means of DLT”.
- This is important. While the scope of the proposed Package may seem limited, it is going to have a big impact for any blockchain applications on financial markets and beyond, and even for the wider fintech sector.
- Most of the rules will likely not come into force until many months from now. However: (1) that does not relate to all proposed regulations and (2) while the new rules will not come very quickly, they will stay with us for a long time.
- In general, the crypto-asset framework seems to be primarily a late reaction to old developments in the crypto markets, such as emergence and growth of centralized exchanges (at least since 2013) or ICOs (2017-2018), but also newer ones such as stablecoins (in practice since 2019). One of the key tasks of the industry now is to make sure that the rules clearly developed as a response to the past will not stifle future innovation.
- At a glance, the proposed rules are not controversial. For example, crypto-asset regulation almost exclusively applies to some centralized services around crypto-assets which clearly deserve regulatory coverage (issuance, custody, exchanging, etc.). At the same time, extremely broad definitions may fire back at all innovators in the space, primarily in DeFi.
- Some of the topics covered by the new legislation, such as stablecoins, are heavily politicized. There will be a big role to play by the industry to make sure that the rules remain reasonable, neutral and innovation-friendly.
- There seems to be some ambition by the Commission to create local rules which will set global standards (similar to e.g. GDPR). Note that this applies to crypto – an industry which is even more global and border-less than other internet and technology areas. These territorial aspects will create many tensions, similar to what the blockchain and crypto space has experienced with respect to US regulations and policy.
- Industry coordination and feedback is now needed more than never. The next few months will decide the regulatory approach for the years to come. Fortunately, there are various self-organization efforts happening right now.
What is this about?
The EU Commission has proposed a legislative package (“Package”) which consists of the following:
- Proposal for a Regulation of the European Parliament and the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (“MiCA Regulation”);
- Proposal for a Regulation of the European Parliament and the Council on a pilot regime for market infrastructures based on distributed ledger technology (“DLT Pilot Regulation”);
- Proposal for a Directive of the European Parliament and of the Council amending Directives 2006/43/EC, 2009/65/EC, 2009/138/EU, 2011/61/EU, EU/2013/36, 2014/65/EU, (EU) 2015/2366 and EU/2016/2341 (“MiFID2 Amendment”), which, among other changes, makes it clear that MiFID2-regulated financial instruments include such those instruments which are issued by means of DLT.
Below I am analyzing all the above proposals.
The purpose of this summary
Now, what’s the goal of this analysis?
- Note that I am publishing my notes a few hours after the official publication. More in-depth analysis will certainly be due, but I think that a preliminary analysis of more than 200 pages produced by the Commission will help the community and industry organize and coordinate. Think of it as an attempt to begin much needed discussion, not an ultimate voice or opinion.
- This is even more important as we need more public debate. I do hope that others will follow and publicly express their thoughts on important aspects of the Package.
- Anything presented here is my personal opinion. It’s not related to any of my professional engagements, and all merit and shame is mine.
Table of contents
In this summary, I don’t cover all possible aspects of the Package. Instead, I focus on those points which seem of most relevance to me. These include brief commentaries on the below:
- The EU Commission’s assumptions, principles and goals
- The Package’s relationship to other legislation
- MiFID2 Amendment
- DLT Pilot Regulation
- MiCA Regulation
- What comes next
The EU Commission’s assumptions, principles and goals
The Package comes as one of the very first elements of the Digital Finance Package. The declared goal of the Package is to ensure that the EU financial regulatory framework can benefit from technology and innovation.
The Package is a serious piece of financial regulation. DLT Pilot Regulation and MiFI2 Amendment will directly amend the current EU financial regulatory regime in a significant way. MiCA Regulation will arrive as a serious piece of completely new financial regulation. It follows the logic of traditional regulations of financial markets, and to some extent can be thought of as a “copy-paste” of MiFID2, regulating similar activities, yet relating to different types of instruments (crypto-assets as opposed to financial instruments).
As such, MiCA in a way “validates” crypto markets, where lack of specific regulations was often indicated as an obstacle to larger adoption, especially among regulated financial institutions. Bringing them directly under the umbrella of a broader financial regulatory regime is a certain recognition of the new “regulated asset class”.
The Commission’s self-declared goals of the Package are the following:
- To deliver legal certainty
- To support innovation
- Consumer and investor protection and market integrity
- To ensure financial stability
Other values which are underlined by the Commission are technological neutrality; limiting the risks of fraud, money laundering and other illicit practices; better access for EU customers to fast, cheap and efficient payments; and better access for investors to new investment opportunities.
The Package’s relationship to other legislation
The legislative action largely creates a brand-new piece of regulation. It remains to be seen how it will interact with the existing financial regulation. What will be extremely important in practice is determining when a given asset is a crypto-asset (including asset-referencing token or e-money token) and when it qualifies as e.g. a financial instrument or “old” e-money. The proposed rules do not solve this interpretative problem, and regulatory guidance at the EU level—due to national discrepancies—will be more needed than ever.
The proposed amendment to MiFID2 makes it clear that financial instruments include those instruments which are “issued by means of distributed ledger technology”. There was consensus around the current definition among blockchain legal practitioners, but the proposed amendment will provide final clarity on the issue.
DLT Pilot Regulation
In my opinion, the DLT Pilot Regulation is one of the most interesting pieces of the Package. It effectively aims at creating a sandbox regime which, thanks to some regulatory derogations, will allow the existing financial market infrastructures to experiment with blockchain and DLT.
If designed and implemented properly, such a pilot regime will be a perfect opportunity to deploy some interesting blockchain-based solutions for digital securities trading without all the current legal uncertainty, and allow both market participants and regulators to educate themselves and see what more fundamental changes to the legislation could be made.
In practice, DLT market infrastructures (DLT MTFs and DLT securities settlement systems, which can be created by an investment firm or a market operator) would be able to be temporarily exempted from some current legal requirements. That would mean that, e.g.:
- Recording of securities with a Central Securities Depository is not necessary for DLT MTFs (recording them on its DLT would be used instead)
- DLT MTFs would be able to provide direct access to retail clients
- DLT MTFs would be allowed to use so called settlement coins, etc.
The usage of DLT market infrastructures would be limited to a certain category of transferable securities, that is – shares of market capitalization of less than EUR 200 million and bonds of an issuance size of less than EUR 500 million.
DLT Pilot Regulation is a great step in the right direction. Still, it could be improved, e.g. in terms of allowing a larger group of market players to benefit from the experimentation space it aims to create.
According to the proposal, the regulation would apply 12 months after its entry into force.
In short, MiCA Regulation creates a completely new, fully harmonized regime of crypto-asset regulation in the EU.
MiCA will be an EU legal act. It is very vague, however, in terms of defining its territorial scope. Except a few specific provisions in the proposal which specify this, its scope is defined in a very general way:
“This Regulation applies to persons that are engaged in the issuance of crypto-assets or provide services related to crypto-assets in the Union.”
In practice we will see many practical problems related to some global blockchain and crypto products which are not specifically linked or addressed to the EU, yet are available from the EU. It remains to be seen if MiCA would become the second EU legal act of a truly global impact (after GDPR).
Definitions of key terms used by the MiCA Proposal are one of the most important elements of this document.
Its authors declare that key terms such as “crypto-asset” and “distributed ledger technology” should be broad to ensure that they are future-proof. Indeed, the proposed definitions are very general:
- ‘distributed ledger technology’ or ‘DLT’ means a type of technology that support the distributed recording of encrypted data;
- ‘crypto-asset’ means a digital representation of value or right, which may be transferred and stored electronically, using distributed ledger technology or similar technology;
- ‘asset-referenced tokens’ means a type of crypto-asset that purports to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one or several crypto-assets, or a combination of such assets;
- ‘electronic money token’ or ‘e-money token’ means a type of crypto-assets the main purpose of which is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender;
- ‘utility token’ means a type of crypto-asset which is intended to provide digital access to a good or service, available on DLT, and is only accepted by the issuer of that token;
Even if regulation of certain services related to crypto-assets introduced by MiCA are precise, the fact that the above definitions are so broad will have profound implications.
First and foremost, MiCA will regulate crypto-assets. Importantly, this is only those crypto-assets which currently fall outside of the scope of EU legislation. As a result, crypto-assets which constitute financial instruments, e-money, etc. will remain to be regulated by existing regulatory regimes (MiFID2, EMD, etc.). Notably, MiCA will not apply to some other instruments such as any CBDCs (Central Bank Digital Currencies) issued by the ECB or national central banks.
Asset-referenced tokens are subject to some stringent rules. Interestingly, according to one of the proposed recitals, “so-called algorithmic ‘stablecoins’ that aim at maintaining a stable value, via protocols, that provide for the increase or decrease of the supply of such crypto-assets in response to changes in demand should not be considered as asset-referenced tokens, provided that they do not aim at stabilising their value by referencing one or several other assets”.
Regulation of crypto-asset service providers
Providers of the following services will be regulated by MiCA Regulation:
- the custody and administration of crypto-assets on behalf of third parties;
- the operation of a trading platform for crypto-assets;
- the exchange of crypto-assets for fiat currency that is legal tender;
- the exchange of crypto-assets for other crypto-assets;
- the execution of orders for crypto-assets on behalf of third parties;
- placing of crypto-assets;
- the reception and transmission of orders for crypto-assets on behalf of third parties;
- providing advice on crypto-assets;
The above list to some extent mirrors the list of regulated investment services in MiFID2. All of the above are further defined in the MiCA Proposal.
Crypto-asset service providers will need to be legal persons with a registered office in a member state, authorized and supervised by a local competent authority. One of the perks of MiCA, and perhaps indeed its most valuable advantage, will be that crypto-asset service providers will be able to benefit from a passporting regime.
Crypto-asset service providers will be subject to multiple requirements (related to protection of their clients, prudential requirements, organizational requirements, etc.).
Offering and marketing of crypto-assets
This part of the MiCA Regulation proposal is a late response to ICOs. It sets forth requirements for offering and marketing of crypto-assets, such as an obligation to draft and publish a white paper of a specific form and content, performing marketing activities within certain boundaries, notification of a relevant authority, etc.
The definition of the “issuer” (“”issuer of crypto-assets” means a legal person who offers to the public any type of crypto-assets or seeks the admission of such crypto-assets to a trading platform for crypto-assets”) suggests that only centralized entities are considered to be subject to the new regime, which is important e.g. from the perspective of the wave of new governance tokens triggered by the yield farming within DeFi space. Moreover, airdrops, mining and NFTs are explicitly excluded.
Also, offering of asset-referenced tokens and their admission to trading are subject to much more stringent, and complex, rules. Even more strict rules will apply to significant asset-referenced tokens, as measured among others by the size of the customer base, market cap, number and value of transactions, size of the reserve assets, cross-border activities, or the interconnectedness with the financial system.
Proposed rules on e-money tokens are probably the most peculiar part of the entire MiCA Regulation proposal. On one hand, a new regulatory category of “e-money token” will be created, and defined as
“ a type of crypto-assets the main purpose of which is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender”.
It will be separate from the existing category of “electronic money”, as currently regulated by the EMD, yet the applicable rules will rather make the “new” e-money token very close to “old” e-money:
- Only credit institutions and e-money institution will be able to act as issuers;
- E-money tokens which do not provide all holders with a claim on the issuer will be prohibited, etc.
E-money token, and especially significant e-money token, issuance will be subject to some strict requirements.
The proposed MiCA Regulation gives real teeth to both national competent authorities and EU level supervisors, EBA and ESMA. An example may be the power “to suspend, or to require a crypto-asset service provider to suspend, the provision of crypto-asset service for a maximum of 10 consecutive working days on any single occasion where there are reasonable grounds for believing that this Regulation has been infringed”.
MiCA Regulation will introduce much needed rules related to market abuse risks on crypto-asset trading platforms. That includes rules on disclosure of inside information and prohibition of insider trading, unlawful disclosure, and market manipulation.
What comes next?
When adopted, the package will shape the EU’s crypto-asset markets, and more generally frameworks for blockchain-based financial innovations, for the years to come. Any change in the package will take years, which is especially significant for an industry which often experiences dramatic developments within months.
Change will not come overnight, as the MiCA Regulation will apply 18 months since its entry into force (important note: except the rules on asset-references and e-money tokens). However, industry coordination and feedback is now needed more than never. Please make your voice heard, and I encourage everyone, and especially those who are developing truly innovative and decentralized financial products, to take part in the public debate which starts now.
Source: LinkedIn article