On 24 September 2020, the European Commission (the Commission) published a much anticipated proposal on the establishment of an EU-level regime for crypto-assets; the Markets in Crypto-Assets Regulation (MiCA)1.
The effect of the MiCA proposal, if ultimately adopted, would be to bring substantially all crypto-assets within the perimeter of EU financial services regulation. This includes decentralised cryptocurrencies such as Bitcoin, utility tokens such as Filecoin, and digital collectibles secured on a blockchain such as Crypto-kitties. Indeed, the very purpose of the proposal is to capture all crypto-assets not currently covered by EU financial services legislation. The proposal would represent a significant expansion of the EU’s regulatory perimeter and likely result in a significant upheaval for firms wanting to operate or promote a crypto-asset project in the EU or to provide services in respect of crypto-assets.
In this Update we set out an overview of some of the Commission’s key proposals and consider their implications.
The Commission’s Proposals
The draft text of MiCA, which is still a long way (and a lot of political negotiation) away from final adoption, sets out a regime to regulate issuers of crypto-assets and providers of crypto-asset services, including exchanges, custodians, and firms providing investment type services in respect of crypto-assets.
MiCA reiterates that crypto-assets that qualify as financial instruments are already subject to the Markets in Financial Instruments Directive (MiFID) and that crypto-assets that constitute e-money under the existing Electronic Money Directive (EMD)2 definition fall within EMD and the second Payment Services Directive (PSD2)3. In each case, such crypto-assets would not be subject to MiCA; however, MiCA does provide some crossover insofar as firms authorised under other EU directives could issue crypto-assets, provided that they comply with the additional disclosure obligations under MiCA4.
MiCA forms part of a broader package of measures coming under the Commission’s Digital Finance Strategy, including a legislative proposal for a pilot regime to test distributed ledger technology (DLT) market infrastructure solutions for the trading and settlement of financial instruments5.
E-money tokens, asset-referenced tokens, and crypto-assets
MiCA distinguishes among the following types of crypto-assets:
- e-money tokens, which are defined as crypto-assets the main purpose of which is to be used as a means of exchange, and that purport to maintain a stable value by referring to the value of a fiat currency that is legal tender6
- asset-referenced tokens, which are defined as those crypto-assets that purport 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 assets7
- crypto-assets, of which e-money tokens and asset-referenced tokens form part, which are defined as a digital representation of value or rights that may be transferred and stored electronically, using DLT or similar technology8; in this Update, when intending to refer to crypto-assets that are not e-money tokens or asset referenced tokens, we use the term “general crypto-assets”
The proposal also includes a definition of “utility token,” being a type of crypto-asset intended to provide digital access to a good or a service available on DLT and accepted only by the issuer of that token9. A utility token falls within the meaning of the broader term crypto-asset and is used principally in relation to disclosure requirements for projects that are not yet in operation and that carry a risk that the proposed good or service may never be provided10.
Requirements on crypto-asset issuers
MiCA imposes investor disclosure requirements on issuers of all crypto-assets covered by the regulation, although more onerous obligations apply to issuers of asset-referenced tokens and e-money tokens.
For a general crypto-asset to be offered to the public in the EU or to be admitted to a crypto-asset trading platform in the EU, the issuer must first prepare a “white paper.” The white paper must be registered with a designated EU regulator in one of the member states where the crypto-asset will be marketed or admitted to trading on a crypto-asset trading platform, and published on the issuer’s website. MiCA sets out requirements for the content and form of the white paper, which include provisions requiring detailed descriptions of the project, the rights and obligations attached to the crypto-asset, information on the underlying technology, and a description of the risks involved. MiCA requires that such disclosures be fair, clear, and not misleading. Significantly, MiCA also imposes liability on the issuer for damages in case of a failure to meet this standard. MiCA requires that issuers establish a legal entity, thereby providing investors with an identifiable party against which they can seek redress.
Issuers of general crypto-assets do not, however, have to be established in the EU; nor do they have to be authorised under any EU directive, meaning that MiCA arguably presents more advantages than disadvantages to an issuer of a general crypto-asset — at least for those with an identifiable financial use case. In particular, MiCA will provide a much greater degree of legal certainty, remove fragmented national regimes, and provide the ability for a general crypto-asset to be marketed on a pan-EU basis from a single point of entry, including by non EU issuers.
In contrast, issuers of e-money tokens and asset-referenced tokens must be established in the EU and, as set out further below, must be authorised under the EMD or MiCA, respectively. This means that issuers of stablecoins from outside the EU will be required to establish a significant local presence before they are able to offer their product to customers in the EU. In the context of Brexit, UK-based issuers of stablecoins will likely face significant additional costs if they want to market their stablecoin product into the EU, compared to an EU issuer.
Stablecoins — e-money tokens and asset-referenced tokens
Although they are both types of stablecoin, e-money tokens and asset-referenced tokens are given distinct treatment under MiCA11. In particular, an issuer of e-money tokens must become authorised as an e-money issuer under the EMD12, whereas an issuer of asset referenced tokens must become authorised under MiCA, resulting in slightly different requirements.
More importantly, because an e-money token will be classified as e-money under the EMD, the Commission’s proposal seeks to ensure that holders of e-money tokens benefit from the same protections afforded to holders of traditional e-money under the existing EMD. This means issuers of e-money tokens must provide token holders with a right to redeem their tokens at par, and this must be protected by funds safeguarded by the issuer. No such obligation applies to the issuer of an asset-referenced token (although that issuer would be free to provide such a right without triggering the definition of an e-money token).
MiCA applies an additional level of compliance in respect of issuers of e-money tokens and asset-referenced tokens deemed to be “significant” according to size tests that will be further developed by the Commission. In principle, this is designed to capture issuers of “global stablecoins.” The higher capital requirements, obligations relating to interoperability of their technology, and liquidity management provisions that will apply to such issuers are designed to counter the greater perceived risks to financial stability posed by global stablecoins.
On the other hand, MiCA provides an exemption from the authorisation requirements for issuers of e-money tokens13 and issuers of asset-referenced tokens14 that are restricted to qualified investors (as defined in the Prospectus Regulation15), thus reflecting a degree of proportionality within the proposal consistent with the generally lower level of investor protection offered under other EU regimes to qualified investors (or professional clients per the MiFID II16 regime) versus retail investors. Qualified investors would nonetheless be provided with a claim against the issuer of an e-money token under MiCA17.
Crypto-asset services
As well as the requirements on issuers, MiCA also sets out a framework for regulated “crypto-asset services,” modeled largely on the range of investment services under MiFID II, and from which MiCA’s title draws its inspiration. In order to provide crypto-asset services, which include the operation of a trading platform for crypto-assets and the exchange of crypto-assets for fiat currency or other crypto-assets, the relevant firm must be authorised as a crypto-asset service provider18, an investment firm19, or a credit institution20. The authorisation process will involve significant scrutiny over a firm’s business, including in relation to its executive management and in particular their suitability and competence, its owners/controllers, and its systems and controls.
Sidley analysis
Influence of Libra
Although the Commission has been actively reviewing the EU crypto-asset landscape for a number of years, it seems clear that a significant driver for this new proposal was the announcement, in 2019, of the Facebook-backed Libra stablecoin proposal.
Indeed, while the concept of a stablecoin has been around for several years in various guises, the entry of a large technology player such as Facebook into the stablecoin market, awoke regulators across the globe to the potential for a stablecoin to achieve global reach21. Until 2019, the comparatively small market size across all crypto-assets allowed regulators to take the view that crypto-assets remained a niche concern22. In that sense, Libra forced crypto-assets into the regulatory mainstream.
Differentiated requirements may still be difficult to meet
The comparative seriousness of the issues posed by global stablecoins is reflected in the structure of the MiCA proposal. While general crypto-assets (including pure cryptocurrencies and utility tokens) are subject to an investor disclosure regime, e-money token issuers and asset-referenced token issuers are subject to authorisation requirements under EMD and MiCA, respectively.
Moreover, significant e-money tokens and significant asset-referenced token issuers are subject to an even more burdensome authorisation regime that includes enhanced capital requirements, going beyond even those that would apply to an e-money issuer under the EMD. It is clear that the Commission has taken on board the conclusions of the G7 Working Group on Stablecoins, which, in October 2019, stated that “No global stablecoin project should begin operation until it adequately addresses relevant legal, regulatory, and oversight requirements.”
Although the MiCA proposals for issuers of general crypto-assets do not seem onerous by comparison, the white paper disclosure regime may still represent a significant hurdle to many businesses, particularly where the underlying use case for the crypto-asset is non financial in nature.
As for crypto-asset service providers, while any requirement to become authorised as a result of MiCA is still a few years away, many firms may find themselves with a steep learning curve to be ready to be regulated by an EU financial services regulator. Significant investments in systems and controls, as well as personnel, may be required for such firms. Notably, a number of the proposed organisational and conduct of business requirements for authorised firms are not currently market standard for crypto-asset businesses.
MiCA in the UK?
The text of MiCA is still far from final form; however, the substantive architecture of the proposal seems unlikely to change significantly. MiCA is purely an EU proposal; according to HM Treasury23, the UK government is still considering whether to expand the scope of the UK financial services regime to capture crypto-assets as one or more types of specified investment. It remains to be seen whether the UK will seek to adopt a similar structure to that under MiCA24.
Conclusion
As with any new regulatory regime, the winners are most likely to be those with the deep pockets and experience that enable them to absorb the new requirements and take advantage of benefits of the new framework — namely, access to a new EU single market for crypto-assets. From the perspective of traditional financial market participants, the framework offered by MiCA is likely to be a welcome development, as it will simultaneously create a regulated framework in which such firms are comfortable to operate as well as erect barriers to entry from would-be challengers.
1 Proposal for a Regulation on Markets in Crypto-assets, and amending Directive (EU) 2019/1937, COM(2020) 593/3 2020/0265 (COD).
2 Directive 2009/110/EC.
3 The second Payment Services Directive (EU) 2015/2366. PSD2 would apply to the extent that a crypto-asset qualifying as e-money, and thereby “funds” for the purposes of PSD2, was used in the performance of a payment service.
4 For example, credit institutions, when issuing asset-referenced tokens, including significant asset reference tokens, are not subject to the provisions of Chapter I of Title III, which describes the procedure for authorisation of asset referenced token issuers (except for Articles 21 and 22 on white papers) or to Article 31 (own funds).
5 Proposal for a regulation on a pilot regime for market infrastructures based on distributed ledger technology, 24 September 2020, (COM(2020) 594 final), 2020/0267 (COD).
6 Article 3(1)(4) MiCA.
7 Article 3(1)(3) MiCA.
8 Article 3(1)(2) MiCA.
9 Article 3(1)(5) MiCA.
10 See Article 5(5)(d) MiCA.
11 Recital (26) provides that algorithmic stablecoins do not qualify as either e-money tokens or asset-referenced tokens because they do not rely on another asset by which to stabilise their value.
12 Article 43(1)(a) MiCA, referring to EMD.
13 Article 43(2) MiCA.
14 Article 15(3) MiCA.
15 Prospectus Regulation (EU) 2017/1129.
16 The recast Markets in Financial Instruments Directive (2014/65/EU), together with the Markets in Financial Instruments Regulation (MiFIR) Regulation (EU) No 600/2014, “MiFID II.”
17 Because Article 43(2) provides an exemption only from the authorisation requirements in Article 43(1) and not to the issuance and redeemability requirements in Article 44.
18 Article 53(1) MiCA.
19 Per article 2(6), investment firms authorised under MiFID are not subject to the authorisation requirements in Title V of MiCA where they provide only one or several crypto-asset services equivalent to the investment services and activities for which they are authorised under MiFID. Article 2(6) provides a mapping indicating which investment services and cryptoasset services are considered to be equivalent.
20 Per article 2(5), credit institutions are not subject to the authorisation requirements in Title V.
21 See, e.g., the G7 Working Group on Stablecoins, “Investigating the impact of global stablecoins,” October 2019, available here.
22 See, e.g., the Financial Stability Board’s “Crypto-asset markets: Potential channels for future financial stability implications,” 10 October 2018, p. 9, available here.
23 HM Treasury, “Cryptoasset promotions” Consultation, July 2020, see paragraph 4.39, available here.
24 HM Treasury is consulting on a proposed expansion to the UK financial promotions regime that would capture a range of crypto-assets (although not non-fungible tokens); however, the proposal would impose a marketing restriction rather than any authorisation requirement.
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