The European Union (EU) has earned the title of becoming the world’s first jurisdiction to introduce a regulatory environment specifically for overseeing a market in crypto-assets. Meantime, the UK government is currently drafting legislation on this sector while the US is said to be examining the EU’s new regulation with a view to developing its own set of standards.
General US financial services governance has proven less than fully capable in providing the resilient regulatory regime necessary in light of the high-profile collapse of giant crypto-asset trader, FTX, and the associated preceding demise of a USD stablecoin and cryptocurrency.
EU sets the pace for global standards in the regulation of crypto-assets
The EU regulation on markets in crypto-assets (MiCA) brings crypto-assets, crypto-assets issuers and crypto-asset service providers under a harmonized legal framework covering this industry for the first time. Given the global nature of crypto-markets, it is anticipated that EU-level regulation should be a more effective governance structure than has been the case with national legislation in some member states only.
MiCA can also be viewed as strategic effort by the EU to establish itself as a major and secure international trading hub for crypto-assets, as well as a key global standard-setter in the development of the crypto-asset industry and broader digital financial world.
The EU regulation is part of a larger digital finance package which aims to develop a European approach that fosters technological development and ensures financial stability. The package bridges a gap in existing EU legislation by ensuring that the current legal framework does not pose obstacles to the use of new digital financial instruments.
It also looks to ensure that such new technologies and products fall within the scope of financial regulation and operational risk management arrangements of firms active in the EU. Thus, the package aims to support innovation and the uptake of new financial technologies while providing for an appropriate level of consumer and investor protection.
The EU approved the legislation in May 2023 and it will come into force during mid-2024 to early-2025, or basically 18 months after its publication in the bloc’s Official Journal.
MiCA’s objectives and application
MiCA has broadly defined a crypto-asset as being any “digital representation of a value or a right which may be transferred and stored electronically, using distributed ledger technology or similar technology”. Where a financial instrument falls within this meaning, MiCA will take precedence over other EU financial services legislation. In such case, most business activities related to crypto-assets will fall under MiCA. It is important to note that non-EU crypto-asset enterprises undertaking activities on behalf of EU end-users will also be required to comply with the new regulation.
The new law aims to protect investors by increasing transparency and putting in place a comprehensive framework for issuers and service providers including compliance with the EU’s anti-money laundering rules. However, existing EU legislation in the form of the 5th Anti-Money Laundering and Counter-Terrorism Financing Directive will remain unchanged although rules concerning crypto-assets at the national member state level and those governing non-money-laundering crypto-asset issues will be replaced by the new regulation.
Crypto-asset categories in scope
MiCA regulates three types of crypto-assets including asset-referenced tokens (ART), electronic money tokens (EMT) and other crypto-assets not included under current EU law such as utility tokens and non-pegged tokens including Bitcoin, Solana and Ripple among others.
Both ARTs and EMTs are variants of “stablecoin” and may be categorised as ‘significant’, as opposed to ‘standard’ under MiCA based on a prescribed set of criteria. The European Banking Association (EBA) is tasked with supervising stablecoins, rather than national authorities, as such instruments are subject to stricter regulatory conditions, including capital requirements.
Regulation of crypto-asset issuers and service providers
A principal obligation for issuers of crypto-assets, other than ARTs or EMTs is the notification and publication of a white paper. This acts as a de-facto prospectus for crypto-assets prior to listing on a trading platform or being offered to the public. The white paper contains minimum standards including details of the issuer, the nature of the crypto-asset and conditions surrounding its risks and obligations along with the climate and sustainability impact of the means by which the crypto-asset is issued. No prior authorization from a competent body is necessary to make available a crypto-asset to the public or to list on a trading platform.
MiCA sets out a limited number of exemptions where the white paper does not need to be provided. Moreover, individual holders at the retail level will have up to a fortnight to withdraw an agreement to buy crypto-assets without suffering losses in accordance with consumer protection norms.
Crypto-asset service providers will be required to be authorised in the EU, and thereby effectively benefiting from EU passporting rights across member states. They will need to uphold a high-level reputation and retain sufficient skills for undertaking their duties. Service providers should also maintain rigorous policies in dealing with client issues and to avoid or report on conflicts of interest that arise.
The law also lays out a market abuse regime. This involves an obligation to prohibit insider trading and inside information in addition to any market manipulation. Service providers are required to adopt policies and systems that prevent and detect any market abuses.
Territorial requirements for service providers
Crypto-asset service providers, authorised by MiCA, will be required to register as legal persons. Each provider must have a registered office in a Member State where they perform some part of their crypto-asset services. They will also need to maintain their place of effective management in the EU, and at a minimum, one of their directors is an EU resident.
Non-EU crypto-asset service providers should be aware that MiCA will not have a separate regime for third-country enterprises. Instead, non-EU persons soliciting EU-based clients or promoting crypto-asset services, in the EU, will therefore have to be authorised in the same way as their EU counterparts. The European Securities and Markets Association (ESMA) will develop guidance, sometime within the first 18 months of MiCA’s coming into force, regarding the conditions under which a third-country provider is deemed to solicit EU-resident clients.