The proposed regulation will provide greater consumer and investor protection and lessen the risks of participating in digital finance.
By Stuart Davis
The EU Commission has published a proposal for a wide-ranging EU regulation covering cryptoassets and e-money tokens, both of which are currently largely unaddressed in EU financial services legislation.
The draft Markets in Cryptoassets Regulation (MiCA) has been designed to:
- Increase legal certainty in the area of cryptoassets
- Support innovation and promote the development of cryptoassets and the wider use of distributed ledger technology (DLT)
- Instil appropriate levels of consumer and investor protection and market integrity in an area that presents many of the same risks as traditional financial instruments
- Ensure financial stability
MiCA creates a new EU-wide licensing regime for cryptoasset issuers and service providers along with substantive conduct of business and consumer protection requirements. MiCA also introduces a new EU-wide passport that is available to market participants who become licensed under the MiCA regime in their home member state.
This blog post provides a high-level summary of the types of cryptoasset businesses that will be impacted and some of the key requirements that will apply to them, as well as explains the proposed transitional arrangements and next steps. While the details on how MiCA will be applied have not yet been published and may take one to two years, it is clear that the EU Commission has drafted an ambitious, full-scope regulatory regime for cryptoassets that should create a significant amount of certainty for issuers and service providers of cryptoassets.
The proposal is part of the EU Digital Finance package, a set of measures designed to make the EU fit for the digital age and to further enable and support the potential of digital finance in terms of innovation and competition while mitigating the risks involved. In addition to the proposal for MiCA, the package also includes a proposal for a pilot regime on DLT market infrastructures, a proposal for digital operational resilience, and a proposal to clarify or amend certain related EU financial services rules. These complementary proposals are intended to address clear obstacles to the use of DLT in the financial sector and to allow for experimentation for market infrastructures within a safe environment with the aim of exploring the need for possible further developments in this area.
The EU Commission is concerned that the legal framework applying to issuers of cryptoassets and cryptoasset service providers has become fragmented across the EU, noting that key objectives such as ensuring investor protection, market integrity, and financial stability cannot be sufficiently achieved by EU member states acting alone. The Commission writes in its proposal that these objectives can be better achieved by creating a framework on which a larger cross-border market for cryptoassets and cryptoasset service providers could develop.
Given that a lack of legal certainty has been a significant anchor on the development of the cryptocurrency market in the EU and globally, MiCA should foster growth of the EU markets in cryptoassets, paving the way for newly regulated businesses to achieve legitimacy within the arena of financial services providers, thereby encouraging greater institutional investment and participation in this space.
MiCA has been designed to interplay with existing EU financial services legislation and authorisation requirements meaning that many of the requirements it imposes on cryptoasset issuers and service providers will be familiar to legal and compliance professionals in traditional financial services, although adapted to meet the idiosyncracies of this new technology.
Watch out for our upcoming Client Alert which will cover in detail the MiCA legal framework. To subscribe to our Client Alerts, please click here.
What types of cryptoasset businesses will be impacted?
MiCA applies to persons that are either: (i) engaged in the issuance of cryptoassets; or (ii) provide services related to cryptoassets in the EU. Cryptoassets are defined broadly to mean a digital representation of value or rights that may be transferred and stored electronically, using distributed ledger technology or similar technology.
1. Crypto-asset issuers
Cryptoasset issuers are any legal person who offers to the public any type of cryptoassets or seeks the admission of such cryptoassets to a trading platform for cryptoassets (a Crypto-exchange). There are three key categories of cryptoasset issuers:
- Issuers of asset-referenced tokens: Asset-referenced tokens are cryptoassets 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 of several cryptoassets, or a combination of such assets. Issuers of asset-referenced tokens are required to be authorised by their home state regulator. They must comply with a substantive list of prudential, conduct of business, and governance requirements (including requirements relating to the maintenance and custody of reserve assets), and they must draft a white paper relating to the offer of cryptoassets that must be approved by the issuer’s home state regulator in advance of the offer.
Furthermore, the European Banking Authority (EBA) has the power to classify asset-referenced tokens as “significant asset-referenced tokens” with such tokens being subject to enhanced regulation through a supervisory college. This enhanced regulation is designed to mitigate risks to financial stability that may be inherent in significant “stablecoins”.
- Issuers of e-money tokens: E-money tokens are cryptoassets 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 tender. Issuers of e-money tokens are required to be authorised by their home state regulator as a credit institution or an e-money issuer and, as such, will be subject to the requirements of the second e-money directive (EMD II).
Issuers of e-money tokens must also draft a white paper relating to the offer of cryptoassets and submit it to the issuer’s home state regulator at least 20 working days before the white paper’s publication (although it does not need to be approved by the home state regulator).
Issuers of e-money tokens must ensure that holders of e-money tokens are provided with a claim on the issuer, that such tokens are issued at par value on the receipt of funds, that they are redeemable immediately at the demand of holders at par value, and that the conditions of redemption are clearly stated. Issuers of e-money tokens are prohibited from paying interest on the tokens.
As for “asset-referenced tokens”, the EBA has the power to classify e-money tokens as “significant e-money tokens” with such tokens being subject to enhanced regulation through a supervisory college.
- Issuers of cryptoassets that are not asset-referenced tokens or e-money tokens: Issuers of these types of cryptoassets (e.g. utility tokens) do not need to be licensed in order to offer their cryptoassets to the public or seek admission to a Crypto-exchange and, provided that they comply with the requirements of MiCA, they are permitted to do so throughout the EU. Issuers are required to comply with a broad range of requirements, including, but not limited to:
- Drafting a white paper that complies with prescribed form and content requirements
- Ensuring marketing communications comply with form and content requirements
- Submitting the white paper and marketing communications to the issuer’s home member state regulator at least 20 working days before publication of the white paper to the public, along with an explanation of why the relevant crypto-asset is not a financial instrument or structured deposit under the second markets in financial instruments directive (MiFID II) (Directive 2014/65/EU), electronic money under EMD II (Directive 2009/110/EC) or a deposit under the EU Directive on Deposit Guarantee Schemes (Directive 2014/49/EU)
- Providing the issuer’s home state regulator with the intended start date of the offer along with a list of the member states where the issuer intends to offer their cryptoassets to the public or intend to seek admission to trading on a Crypto-exchange
It should be noted that the issuer’s home state regulator is not required to approve the white paper or marketing communication in advance of the public offer or admission to trading of the cryptoassets. However, member state regulators have a broad range of powers to suspend or prohibit offers of cryptoassets to the public where they consider that the requirements of MiCA are not being met.
MiCA also introduces prohibitions and requirements to prevent market abuse involving cryptoassets, including prohibitions on insider dealing, unlawful disclosure of inside information and market manipulation. Inside information relating to cryptoassets is defined broadly to mean any information of a precise nature that has not been made public, relating, directly or indirectly, to one or more issuers of cryptoassets or to one or more cryptoassets, and that, if made public, would likely have a significant effect on the prices of those cryptoassets.
2. Crypto-asset service providers
Crypto-asset service providers are subject to authorisation requirements and a broad range of general prudential, conduct of business, and governance requirements, as well as additional requirements that apply depending on the types of crypto-asset services being provided.
There are eight types of licensable crypto-asset services and these broadly map to existing investment services and activities under MiFID II (noting that safeguarding and administration of financial instruments under MiFID II is an ancillary activity only, but has been upgraded to a core crypto-asset service under MiCA):
- The custody and administration of cryptoassets on behalf of third parties
- The operation of a trading platform for cryptoassets (i.e. a Crypto-exchange)
- The exchange of cryptoassets for fiat currency that is legal tender
- The exchange of cryptoassets for other cryptoassets
- The execution of orders for cryptoassets on behalf of third parties
- Placing of cryptoassets
- The reception and transmission of orders for cryptoassets on behalf of third parties
- Providing advice on cryptoassets
There are exclusions from the requirements of MiCA for cryptoassets that fall within the following categories which will continue to be regulated by relevant existing EU regulation:
- Financial instruments and structured deposits within the scope of MiFID II (Directive 2014/65/EU)
- Electronic money within the scope of EMD II (Directive 2009/110/EC), except where they qualify as electronic money tokens under this Regulation
- Deposits within the scope of the EU Directive on Deposit Guarantee Schemes (Directive 2014/49/EU)
- Securitisations within the scope of the Securitisation Regulation (Regulation (EU) 2017/2402)
Credit institutions are not subject to the authorisation requirements when providing cryptoasset services, nor are MiFID investment firms, provided that the relevant cryptoasset service maps to the relevant MiFID investment service or activity for which they are authorised.
Insurance undertakings or undertakings carrying out reinsurance and retrocession activities within the scope of Solvency II (Directive 2009/138/EC) fall outside the scope of MiCA when carrying on activities regulated by Solvency II.
Persons who provide cryptoasset services exclusively for companies within their corporate groups will also fall outside the scope of MiCA.
Public offer exemptions
A range of public offer exemptions apply that exempt issuers of cryptoassets from the authorisation and conduct requirements of MiCA provided that the public offer complies with certain conditions.
With respect to the public offer of cryptoassets, other than asset-referenced tokens or e-money tokens, the MiCA requirements will not apply if:
- The cryptoassets are offered for free
- The cryptoassets are automatically created through mining as a reward for the maintenance of or validation of transactions on a or similar technology
- The crypto-asset is unique and not fungible with other cryptoassets
- The offering of cryptoassets is addressed to fewer than 150 natural or legal persons per Member State acting on their own account
- The total consideration of such an offering in the Union does not exceed €1,000,000, or the corresponding equivalent in another currency or in cryptoassets, over a period of 12 months
- The offering of cryptoassets is solely addressed to qualified investors and the cryptoassets can only be held by such qualified investors
With respect to the public offer of asset-referenced tokens or e-money tokens, the MiCA requirements will not apply if :
- The asset-referenced tokens/e-money tokens are marketed and distributed exclusively to qualified investors and can only be held by qualified investors
- The average outstanding amount of asset-referenced tokens/e-money tokens does not exceed €5,000,000, or the corresponding equivalent in another currency, over a period of 12 months, calculated at the end of each calendar day
It should be noted that when issuers of asset-referenced tokens or e-money tokens rely on these exemptions, they must still produce a white paper conforming to the prescribed form and content requirements, and submit that white paper to their home member state regulator at least 20 working days before publication of the white paper to the public.
Will there be any transitional arrangements available?
Cryptoasset service providers will have 18 months from the date that MiCA comes into force in order to become authorised and will only be required to comply with the requirements of MiCA once granted an authorisation within that period. However, until authorised, crypto-asset service providers will need to continue to comply with the existing national laws of member states.
Cryptoassets other than asset-referenced tokens and e-money tokens, which were offered in the EU prior to the date on which MiCA comes into force, will benefit from a grandfathering provision and will not be subject to the requirements of MiCA.
Asset-referenced tokens and e-money tokens, however, will not benefit from any grandfathering provision and will be required to comply with the requirements of MiCA from the date on which it comes into force.
What are the next steps?
While the EU Commission has not yet published the legislative roadmap for MiCA, under the EU legislative process the proposal will be transferred to the European Parliament (EP) and then the European Council (the Council) for review at first reading under the Ordinary Legislative Procedure. There is no time limit at the first reading stage.
If the proposal is not agreed at first reading, it will then go on to a second or possibly third reading stage where time limits do apply (three months, with the option of an additional month for each of the EP and the Council at second reading, and six weeks with the option of an additional two weeks for each of the EP and the Council at third reading). It could therefore take one to two years for MiCA to be formally adopted.