Assessing the European Commission’s Regulation of Markets in Crypto-assets

Based on broad public consultations and the Digital finance outreach, the European Commission adopted a digital finance package on 24 September 2020, including a digital finance strategy and legislative proposals on crypto-assets and digital resilience with the aim of a competitive EU financial sector that gives consumers access to innovative financial products, while ensuring consumer protection and financial stability.

At first glance, the package can be deemed a huge and mostly smart step towards integrating distributed ledger technology into the existing EU legal framework. However, the devil is in the detail. Below, we’ve identified some provisions with no claim of completeness regarding MiCA, which need further clarification to allow for a uniform applicability throughout the Capital Markets Union thus fulfilling the ultimate aim of the digital financing package.

Our critical remarks mainly aim at industry experts and professionals as well as relevant stakeholders involved in the legislative process of MiCA.

Definition and scope of “advice on crypto-assets” in Article 3(1), point 9(h) as well as Article 3(1), point 17

“Providing advice on crypto-assets’ means offering, giving or agreeing to give personalised or specific recommendations to a third party, either at the third party’s request or on the initiative of the crypto-asset service provider providing the advice, concerning the acquisition or the sale of one or more crypto-assets, or the use of crypto-asset services.”

Questions arising:

• The question arises what the exact scope of “advising on the use of crypto-asset services” should be
• In general, the regulation of “advice” seems to be mainly rooted in considerations to ensure consumer protection (see also recital 63), however given the vague definition of “use of crypto-asset services” consulting services to e.g. prospective crypto-asset service providers could likely be deemed as a crypto-asset service itself
• Additionally, Article 73 does not seem to explain “use of crypto-asset services” in more detail which supports the question of scope
• DIRECTIVE 2014/65/EU (hereinafter referred to as “MIFID II”) does not regulate “advising on the use of investment services” hence why should the mere advice on the use of crypto-asset services be regulated?

Possible solutions:

• As a possible solution one could consider to delete the provision “or the use of crypto-asset services”
• Alternatively, one could consider to specify the scope in more detail e.g. in Article 73 in such way that “advising on the use of crypto-asset services” primarily is applicable in the case of advice to retail clients on a professional basis (meaning against compensation)

Definition of “asset-referenced token” in Article 3(1), point 3

“‘Asset-referenced token’ means a type of crypto-asset that purports 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 assets;”

Questions arising:

• The question arises how to measure “purports to maintain a stable value”?
• When trying to differentiate “asset-referenced token” from e.g. a “collective investment scheme token” or “derivative token” which both would not fall under applicability of MiCA, the criterion “purports to maintain a stable value” likely will be the main deterministic provision. Personally, we are concerned that we will likely need detailed judicial precedence and/or some kind of formal test criteria to achieve a clear answer whether the criterion “purports to maintain a stable value” is prevalent enough to qualify the respective token as being an “asset-referenced token” under MiCA
• Additionally, the “purpose of maintaining a stable value” could turn out to be non-static and might change during the token lifecycle. How to deal with such a changing purpose from a regulatory perspective?
• Finally, the question arises on how to interpret “stable value”? Stable value will always need to be measures in certain accounting units, by varying the accounting unit the concept of stability changes as well. E.g. 1 gram of gold measured in EUR as accounting unit might not seem to be stable, however when measuring 1 gram gold measured in silver might likely turn out to look quite stable.

Possible solutions:

• Clarification that the “stable value” concept refers to a stable value in fiat money terms.
• Clarification on how to measure or test the “stable value” concept.
• Clarification on how to deal with a changing nature of a token during the lifetime.

Definition and scope of “issuer of crypto assets” in Article 3(1), point 6

“‘issuer of crypto-assets’ means a legal person who offers to the public any type of crypto-assets or seeks the admission of such crypto-assets to a trading platform for crypto-assets;”

Questions arising:

• Are natural persons excluded from the definition of an issuer? Consequently, are private individuals prohibited to issue crypto-assets or are they merely not subject to MiCA?
• Contrary to the case of issuing financial instruments whereby only the issuing entity is being defined as an “issuer” it seems that MiCA is aiming at the elements of “offering to the public” and “seeking admission to a trading platform” as the central elements of the definition. However, “issuing”, “offering” and “seeking admission to trading” are different activities which should not be combined for regulatory purposes.

Possible solutions:

• Modified wording: ‘issuer of crypto-assets’ means a legal person who issues any type of crypto-assets or seeks the admission of such crypto-assets to a trading platform for crypto-assets.

Definition and scope of “placing of crypto-assets” in Article 3(1), point 15

“‘placing of crypto-assets’ means the marketing of newly-issued crypto-assets or of crypto-assets that are already issued but that are not admitted to trading on a trading platform for crypto-assets, to specified purchasers and which does not involve an offer to the public or an offer to existing holders of the issuer’s crypto-assets;”

Questions arising:

• Does the element of “marketing” alone already trigger the service of “placing crypto-assets”?
• Differentiation of issuer or issuance (to the public) and placement (excluding an offer to the public) as per MiCA seems to significantly diverge from the corresponding definitions in MIFID II as well as the REGULATION (EU) 2017/1129 (hereinafter referred to as the “prospectus regulation”) and thus are not 100% clear to an ordinary market participant. In the classical securities world (i.e. MIFID II) “placement” is defined as the service of a) a sale of financial instruments, b) in the name of a third-party, c) for the account of that third-party, d) in the context of an issuance, e) under a placement agreement and f) without a firm takeover obligation, whereas “issuer” is defined as being “a legal entity which issues or proposes to issue securities”.
• placement” with “offering”: ‘offering of crypto-assets’ means the marketing of newly-issued crypto-assets or of crypto-assets that are already issued by a person or entity other than the issuer against any form of compensation or benefit be it direct or indirect”

Applicability of MiCA vs. applicability of other financial market regulations / directives as per Article 2, point (2)

However, this Regulation does not apply to crypto-assets that qualify as: (a) financial instruments as defined in Article 4(1), point (15), of Directive 2014/65/EU; (b) electronic money as defined in Article 2, point (2), of Directive 2009/110/EC, except where they qualify as electronic money tokens under this Regulation; (c) deposits as defined in Article 2(1), point (3), of Directive 2014/49/EU of the European Parliament and of the Council49; (d) structured deposits as defined in Article 4(1), point (43), of Directive 2014/65/EU; (e) securitisation as defined in Article 2, point (1), of Regulation (EU) 2017/2402 of the European Parliament and of the Council .

or as per Art. 7, point (3)

“The notification of the crypto-asset white paper shall explain why the crypto-asset described in the crypto-asset white paper is not to be considered: (a) a financial instrument as defined in Article 4(1), point (15), of Directive 2014/65/EU; (b) electronic money as defined in in Article 2, point 2, of Directive 2009/110/EC; (c) a deposit as defined in Article 2(1), point (3), of Directive 2014/49/EU; (d) a structured deposit as defined in Article 4(1), point (43), of Directive 2014/65/EU.”

or as per Art. 16(2), point (d)

“a legal opinion that the asset-referenced tokens do not qualify as financial instruments, electronic money, deposits or structured deposits;”

Questions arising:

• A legal opinion as the foundation for qualifying whether applicability of laws / regulations applies should be avoided by all means. The purpose and applicability of law should be kept as clear as possible already as per rule of law.
• Hence, Iwe recommend a “testing cascade” along the lines of the following questions:
  • Is the crypto-asset at hand a structured deposit?
  • Is the crypto-asset at hand a deposit?
  • Is the crypto-asset at hand electronic money?
  • Is the crypto-asset at hand a financial instrument?
  • Should the answers be NO in all questions above, it will be a “crypto-asset” subject to MiCA!
• The definitions of “deposit”, “structured deposit” or “electronic money” in EU legislation seem to be straightforward. However, the different forms of financial instruments are defined in various sources of law, hence a consistent and coherent overview – for non-equity financial instruments – only seems to be available in the COMMISSION DELEGATED REGULATION (EU) 2017/583 (hereinafter referred to as “RTS 2”).
• It further seems that definitions of the various non-equity financial instruments and their distinction especially from collective investment schemes are not harmonised across EU Member States. This lack of common understanding will contribute to increased difficulties when trying to assess whether one is dealing with a financial instrument or a crypto-asset under MiCA.

Possible solutions:

• Clear definition of the various forms of financial instruments in one juridical act taking into account the provisions of RTS 2. To achieve true harmonisation the preferred way would be the form of a directive.
• Clarification that MiCA applies only, if the Crypto-asset cannot be qualified as one of the exempted forms in Article 2 point (2).

Requirement of crypto-asset issuers to be a legal entity in Article 4(1):

“No issuer of crypto-assets, other than asset-referenced tokens or e-money tokens, shall, in the Union, offer such crypto-assets to the public, or seek an admission of such crypto-assets to trading on a trading platform for crypto-assets, unless that issuer: (a) is a legal entity;”

Questions arising:

• If there is no issuer (e.g. Bitcoin) in the form of a legal entity, issuance of a crypto-asset seems to be prohibited under MiCA. However, the rules governing “placing” as per point 4 above are still applicable. In such a case the questions arise how “issuing” can be prohibited and at the same time a “placement” seems feasible?
• Referring back to point 3 above, regulating the elements “issuing” and “offering” as part of the issuer definition likely does not yield an efficient regulation.

Possible solutions:

• Modified wording: “No issuer of crypto-assets, other than asset-referenced tokens or e-money tokens, shall, in the Union, issue such crypto-assets, or seek an admission of such crypto-assets to trading on a trading platform for crypto-assets, unless that issuer: (a) is a legal entity;

“Offering” should be regulated separately and be possible in the Union, even if the issuer is domiciled outside the EWR/EU, not a legal entity, or if there is no issuer at all.

Consequences of excluding deposits from the scope of MiCA in Article 2(2):

“However, this Regulation does not apply to crypto-assets that qualify as: (a) financial instruments as defined in Article 4(1), point (15), of Directive 2014/65/EU; (b) electronic money as defined in Article 2, point (2), of Directive 2009/110/EC, except where they qualify as electronic money tokens under this Regulation; (c) deposits as defined in Article 2(1), point (3), of Directive 2014/49/EU of the European Parliament and of the Council; (d) structured deposits as defined in Article 4(1), point (43), of Directive 2014/65/EU; (e) securitisation as defined in Article 2, point (1), of Regulation (EU) 2017/2402 of the European Parliament and of the Council.”

Questions arising:

• Based on the provision above, tokenising deposits seems possible without triggering applicability of MiCA. How about vice versa? In principle, a bank could treat crypto-assets as “deposits” on a voluntary basis and consequently, such crypto-assets should no longer be subject to MiCA?
• Should certain crypto-assets be eligible for being treated as “deposit”, the question arises which regulatory capital requirements do apply? Following the principle “same risks same rules” if crypto-assets are being merely accepted by a bank there is no regulatory capital requirement given assets and liabilities in the balance sheet literally are cancelling themselves. However, if crypto-asset deposits should be used for granting loans denominated in crypto-assets the question arises if this can be covered by way of existing regulatory capital requirements or if there is a need for modification.

Possible solutions:

• Clarification whether crypto-assets can be treated as deposits
• Clarification which regulatory capital requirements do apply if a credit institution is reflecting crypto-assets “on-balance-sheet”:
  • For the purpose of maintaining a trading book
  • For the purpose of (long-term) investment
  • For the purpose of accounting for “crypto-asset deposits”
  • For the purpose of granting loans in crypto-assets

Interest prohibition in Article 36:

“Issuers of asset-referenced tokens or crypto-asset service providers shall not provide for interest or any other benefit related to the length of time during which a holder of asset-referenced tokens holds asset-referenced assets.”

Questions arising:

• Does this provision also catch any form of benefit which could be generated out of lending activities of does a lending fee not qualify as “interest” in the meaning of Article 36?
• We are not 100% sure what the exact meanings of “during which a holder of asset-referenced tokens holds asset-referenced assets” or specifically “asset-referenced assets” are. Generally, a holder of asset-referenced token will only hold such token and not the underlying assets.

Possible solutions:

• Modification of the wording: “Issuers of asset-referenced tokens or crypto-asset service providers shall not provide for interest or any other benefit related to the length of time during which a holder of asset-referenced tokens holds such tokens.”

As already stated in the beginning, MiCA is a huge and necessary step towards harmonizing the treatment of crypto-assets throughout the Union. However, given the need to differentiate crypto-assets from already existing financial markets / financial instruments as well as banking regulation, there is room for better definitions and slight amendments to further sharpen the profile of MiCA and hence achieve a better regulatory basis at the legislative level. Personally, we are excited to follow the further fine-tuning of MiCA and its incorporation into European law. We do hope, that based on this article we can contribute to a constructive process of re-assessing certain provisions of the current draft. Despite not being directly part of MiCA we think that especially a coherent list of the various financial instruments and their distinction under European law can significantly contribute to a resilient Capital Markets Union.