After years of anticipation on December 19, 2019 the European Commission (the Commission) issued a public consultation on crypto assets, which concluded on March 19, 2020. The consultation paper follows detailed due diligence including a report on virtual currencies by the European Parliament, the setting up of the Blockchain observatory to monitor the use cases of blockchain, an audit of existing legislation from the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA), and an attempt to bring it within the remit of the European Crowdfunding Service Providers Regulation.
The all-encompassing consultation covers three main areas:
- The classification of crypto-assets
- The treatment of crypto-assets which are covered by EU legislation, and
- The treatment of crypto-assets which fall outside of the scope of EU legislation.
Following extensive feedback from the industry and regulatory authorities from around the world, the Commission issued a “non-paper” in May 2020, which includes options of possible approaches that may be taken in the proposal.
For crypto-assets which could qualify as MiFID II financial instruments there are three options to consider:
1. Non-legislative measures which would provide guidance on how existing legislation applies to crypto assets
2. Targeted legislative changes removing provisions acting as a barrier to issuance, trading and post-trading of security tokens, or
3. A pilot regime, for example for a three-year period, creating a new DLT market infrastructure.
For crypto-assets that fall outside the regulatory perimeter there are two options to consider:
1. An E.U. opt-in regime that would benefit from an E.U. passport to expand their activities cross border, or
2. A fully harmonised regime for crypto-asset issuers and service providers.
For Stablecoins there are three options to consider:
1. Bespoke legislative measures on Stablecoins issuers (including disclosure requirements on ’stable coin’ issuers as well as requirements imposed on the reserve)
2. Regulating Stablecoins by extending the scope of e-money Directive 2 (EMD2), or
3. Measures aimed at limiting issuances of and services related to Stablecoins in the E.U.
Lavan Thasarathakumar, a former advisor at the European Parliament and now a Consultant at Hogan Lovells and Head of Regulatory Affairs at Global Digital Finance explains, “The non-paper is a form of soft diplomacy tool that is used to stress test ideas with E.U. treasuries and gain some political buy in before the full proposal is released. What is interesting here is the proposal of the opt-in regime. This is a regime that has been used to great effect in France and has clearly been something that has been a popular suggestion in the consultation. However, this is a difficult regime to adopt across E.U. wide.
“We saw the issues that this created during the European Crowdfunding Service Providers Regulation (ECSP). With an opt-in regime, we would be asking all national competent authorities (NCAs) to run their own regulatory regime but then another potentially vastly different one for those that opt-in to the Europe wide regime, this would not create the regulatory clarity that we intended to create. In ECSP it was the Council comprised of the member states, who had removed the opt in regime and in its place created a harmonised regime. I am therefore not surprised that this has been removed in the latest non-paper and it would not surprise me if this is something that is met with resistance by the member states and subsequently removed.”
Earlier this months, following comments from the Director General – Financial Stability Financial Services and Capital Markets (DG FISMA), the department in charge of this proposal, the Commission released an updated version of the non-paper adding further detail to the approach that they propose to take.
The core themes that this paper discussed were:
· The clarification of the notion of financial instruments
· A pilot regime, and
· A bespoke regime under the name Markets in Cryptoassets Regulation.
This theme has been consistent with communication coming out of the Commission for some time. The Commission stance has always been to take a technology neutral approach and whilst there has been pressure for the Commission to regulate cryptoassets or ban them, doing so would end up being product regulation, which the Commission rarely do in any case, and in doing so would be regulating technology.
This would not be in line with objectives set up by President von der Leyen for a Europe that fully grasps the potential of the digital age and strengthens its industry and innovation capacity.
Instead, the approach that has been taken is one of focusing on a regulatory framework for cryptoasset service provider looking to create legal certainty but also enhance market integrity by having standards for people such as issuers, brokers, exchange, and wallet providers.
It is important to ensure that the regulation of a cryptoasset should follow its economic function. In order to clarify this and ensure full harmonization on this approach, it is suggested that there is a modification of the notion of financial instruments to make sure that such financial instruments can be issued on a digital ledger. This legislative amendment would be supplemented with an interpretative guidance to increase convergence.
On the Pilot Regime, the Commission notes that a sandbox like approach could be created to assess DLT market infrastructures. This would enable both market participants and regulators to gain experience on the use DLT, the benefits of that technology and the novel form of risks it creates.
At the initial stage there is an easy entry where the DLT market infrastructure would be either a DLT Multilateral Trading Facility (MTF) or a DLT Central Securities Depository (CSD). Prospective market participants would be required to obtain a specific permission granted by their NCAs under the conditions set out in the new legislation, and on the top of their existing authorization as investment firm or CSD. While this may seem to favour the incumbents, it is understandable given the pilot stage of this regulation.
In addition, in order to avoid creating any financial stability risks, the DLT market infrastructure would only be allowed to admit to trading or to record on the digital ledger simple financial instruments like shares and bonds.
ESMA will issue a non-binding opinion on the permission to be granted and the exemptions requested by the applicant, taking into account the objectives of investor protection, market integrity or financial stability and with the view to ensuring the consistency and proportionality in terms of exemptions granted by competent authorities to DLT MTFs. ESMA would also fulfil a coordination role between competent authorities.
The applicant will also be subject to additional requirements which are all aimed at enhancing the knowledge and diligence of the national competent authorities.
This pilot regime is envisaged as a temporary regime to enable market participants, regulators and the European Supervisory Authorities (ESAs) to gain experience on the use of DLT in the E.U. financial service legislation. After a three-year period, it is intended that the Commission would produce a detailed report on this pilot regime to the Council and Parliament.
The largest part of the non-paper is the detail on the proposed bespoke regime, Markets in Cryptoassets (MiCA). The regime is being considered in the form of a Regulation to establish harmonized requirements at E.U. level for issuers that seek to offer their cryptoassets across the Union and cryptoasset service providers wishing to apply for an authorization to provide their services in the single market.
This initiative would replace existing national frameworks applicable to cryptoassets not covered by existing E.U. financial services legislation and doing so, the regulation will also look to establish E.U. wide definitions for a number of key terms.
Regarding requirements on issuers of cryptoassets, the main requirement of MiCA would be to mandate the publication of a harmonized whitepaper/information document accompanying an issuance of cryptoassets in the E.U. with mandatory disclosures detailed description of the issuer, the project and planned used of funds, conditions of the offer, rights and obligations attached to the cryptoassets and risks.
Certain exemptions to this whitepaper would also be implemented for small offerings of crypto-assets, value under one million Euros within a twelve-month period, and for offerings aimed at qualified investors as defined in the Prospectus Regulation.
The whitepaper, and marketing communications related to the issuance, would not be subject to pre-approval by NCAs, but they should be notified to NCAs before their publication. The issuer must provide adequate details to the NCA in order for them to determine whether the crypto-asset in question in fact does not qualify as a financial instrument under MiFID II or e-money under EMD. If the whitepaper does not comply with the mandatory disclosures, the NCA would have the possibility to suspend or prohibit the offer, or make it public that the offer does not comply with E.U. regulation.
The non-paper then goes into the requirements on asset-backed cryptoassets, often described as stablecoins, which indicated that issuers of asset-backed cryptoassets would:
· have to be established as an E.U. legal entity
· be obliged to disclose the rights attached to the asset-backed cryptoasset, including any potential direct claim on the issuer or the reserve of assets, and
· be required to publish a whitepaper with additional mandatory disclosures, compared to other cryptoasset issuers.
There would also be a provision preventing issuers of asset-backed cryptoassets and cryptoasset service providers from granting any interests related to the length of time during which a holder of asset-backed cryptoassets holds such cryptoassets.
An important aspect of this is that the Commission would be empowered to take a delegated act to specify specific circumstances and thresholds allowing for the differentiation between asset-backed cryptoassets and significant asset-backed cryptoassets.
Issuers of significant asset-backed cryptoassets would be subject to additional capital requirements and to liquidity management and interoperability requirements.
Once the asset-backed cryptoassets has been designated as significant, the supervision of the issuer could be conferred to EBA. The supervision of e-money issuers that would meet the criteria of significance under MiCA could also be transferred to EBA.
On cryptoasset service providers, MiCA would regulate the following services:
· custody and administration of cryptoassets on behalf of third parties;
· operation of a trading platform for cryptoassets;
· exchange of cryptoassets against fiat currency by using proprietary capital;
· exchange of cryptoassets against other cryptoassets by using proprietary capital, reception and transmission of orders for cryptoassets on behalf of third parties, execution of orders on behalf of third parties;
· placing of cryptoassets; advice on cryptoassets and payment transactions in asset-backed cryptoassets.
“We are expecting the Commission proposal to come out in late September and it is clear that it will be a substantial one. It is a great opportunity for Europe to stake its claim as the hub for cryptoasset activity, embracing the opportunities and mitigating the risks.
“The pilot regime will offer the opportunity to upskill national regulators and the ESAs before further steps are taken if necessary. Whilst this proposal is going to be a seminal moment in the discussion of cryptoassets, it is important to note that we are only at the beginning of the process. Once the proposal is released in September, it is over the European Council and the European Parliament and I have no doubt that there will be plenty more debate on this”, says Thasarathakumar.