MiCA: A “beta version” of crypto-assets regulation in the EU

Author: Alexander Prognimark, CFA

Alexander Prognimark, CFA from the CFA UK Future of Money Working Group looks at new regulations brought in to manage the crypto-assets market.

Gone are the days when a red bus in London would sell you the dream of a shiny post-Brexit future for the NHS; instead passersby are shown some friendly market timing musings from crypto exchanges i.e. “if you’re seeing bitcoin on a bus, it’s time to buy”^[1].

Digital assets

The list of potential buyers goes well beyond retail names and expanding rapidly - it now includes not just traditional risk-seekers such as hedge funds, HNWs and family offices, but even a few S&P 500 listed corporations that have acquired positions in bitcoin^[2]. In short, the brave new world of the “crypto-assets” market is here.

Ironically the technology behind the craze was born out of certain anti-establishment sentiment, yet through the decade of perseverance and ever-growing number of apologists, it has managed to convert even such bastions of established financial world as central banks to at least consider creating new digital complements to cash, running on some variant of distributed ledger^[3].

Despite all the enthusiasm, the research shows that even for central bank digital currencies (arguably more respectable cousins of crypto currencies) it is either impossible or unclear how to issue them under existing bank laws in 80% of the jurisdictions in the world^[4].

Timely and necessary regulation

That makes a proposal of the first supra-national regulation for crypto assets (the Markets in Crypto-Assets (MiCA) brought forward in late 2020 as a part of the European Digital Finance package^[5] both timely and necessary.

To complement the proposal a Regulation on a Pilot Regime for Market Infrastructures based on Distributed Ledger Technology (DLT Infrastructure Regulation) has been announced – in a way a first pan-European sandbox that aims to create regulatory safe space for incumbents and allow the regulator to learn more about ‘market realities’ of DLT-based products^[6]. The participants will be exempt from certain requirements introduced by MiCA.

Arguably a proposal created to address intentions of certain corporations to run their own payments ledger with token referenced to fiat currencies^[7] it however attempts to cover multiple different types of the “crypto-assets” and classify them in a somewhat precise manner.

Let’s briefly review the major elements of the new proposal (see the below table for the terms).

Title I of MiCA details its scope and definitions including definitions for crypto-assets, asset-referenced tokens and e-money tokens. Title from II to IV provide the core of MiCA, the rules on issuers of crypto-assets. Title III specifically deals with stable-coins (re-branded as ARTs).

Title V provides general authorization and operating requirements for certain service providers to crypto-assets aka CASPs. Title VII stipulates the supervisory competencies of national competent authorities (NCAs) for ART and EMT issuers, the competencies of the European Banking Authority (EBA) for SARTs, and joint competency with NCAs for significant EMTs. The remainder of MiCA deals with a legislative technique^[8].

Any company regardless of the country of the incorporation which advertises or offers the business to European clients would need to follow the proposed regulation. Hence the main benefit of compliance is the EU-wide passport given to CASPs allowing them to conduct and market their business anywhere within the union.

 However, the price of such “passport” is what arguable can be described as “mini-MIFID” requirements, which include among other things:

• Having an entity established in the EU and obtaining a license
• Satisfying ongoing capital requirements
• Complying with organisational requirements (employee qualifications, IT security, record keeping, AML etc)
• Holding client assets separably in a credit institution or central bank
• Having complain procedures
• Prevent conflict of interests
• A number of other requirements listed within the proposal (such as information dissemination, operational risk management etc)

The issuers of tokens have additional requirements such as:

• Publishing a whitepaper following an EU Prospectus regulation which should be submitted to competent authority along with an explanation on why the issuance is going to be outside of MIFID regulation.
• Marketing that follows fair, clear, and not misleading standards
• For ARTs and EMTs the authorisation under E-Money directive is required:
  O Meeting prudential requirements
  O Robust governance arrangements
  O Publicly disseminated information in relation to assets in circulation or any event that can affect value of the tokens

As can be seen, MiCA is an ambitious legislative project within the EU and at this point is open for discussions and negotiations by the council of ministers which eventually will lead to a review by European parliament. The process would normally take at least a few years, however given current priorities within the EU, namely resolving issues stemming from the COVID pandemic, it can take much longer.

What does the future look like?

It would be of great interest if the future discussions will be able to address some of the weaknesses within the proposal already highlighted by researchers, such as better clarity with regards to the scope i.e. how specific instruments will be falling into either MiCA or MIFID framework^[9].

Another issue that future discussions would probably need to articulate and clarify are the responsibilities of the crypto-asset custodians in the event of ownership transfer due to technological issue; for example, if an update to the codebase results in vulnerability which leads to illegal transfer of ownership of the tokens to the third parties who would be legally obliged to compensate the clients.

The DLT Pilot regime that accompanies MiCA can be potentially leading to a welcome pan-European sandbox for new innovative companies, however certain industry groups have already pointed out that proposed requirements “are disproportionate or these exemptions are unenforceable”. One can argue that established players might benefit more from the proposed regime versus future newcomers^[10]   

In the post-Brexit world, it would also be interesting to see how closely (if at all) the UK regulatory approach will be to the proposed framework.  According to July 2020 consultation papers by HM Treasury, the UK government is still considering whether to expand the scope of the UK financial services regime to capture crypto-assets^[11]. Across the pond, despite quite an active participation and discussions by multiple US regulatory bodies, there is still lack of uniform definitions or much of a formal rulemaking at federal level with regards to crypto-assets^[12].

Sometimes, what starts as an ad on a red bus can easily lead to significant legislative efforts and regulator’s headaches in the future.

References

^[1]https://www.reddit.com/r/Bitcoin/comments/la4lcm/london_bus_ads_spotted_multiple_times/

^[2] https://www.bbc.co.uk/news/business-55939972

^[3] https://www.bis.org/publ/work880.htm

^[4]https://www.imf.org/en/Publications/WP/Issues/2020/11/20/Legal-Aspects-of-Central-Bank-Digital-Currency-Central-Bank-and-Monetary-Law-Considerations-49827

^[5] https://ec.europa.eu/info/business-economy-euro/banking-and-finance/digital-finance_en

^[6] https://www.law.ox.ac.uk/business-law-blog/blog/2020/11/dlt-pilot-regime-eu-sandbox-last

^[7] https://www.diem.com/en-us/white-paper/#cover-letter

^[8] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3725395

^[9] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3725395

^[10] https://www.sidley.com/en/insights/newsupdates/2020/11/analysis-of-the-proposed-eu-markets-in-cryptoassets-regulation

^[1]1 https://www.sidley.com/en/insights/newsupdates/2020/11/analysis-of-the-proposed-eu-markets-in-cryptoassets-regulation 

^[12] https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations

 Alexander Prognimak, CFA, Product Management Specialist