As the European Commission launched its long-awaited Digital Finance Strategy in late September, a senior official announced: “The future of finance is digital”.
The Commission sees digital finance as a weapon in its arsenal as it seeks to relaunch and modernise the European economy to recover from the Covid-19 pandemic, and the Strategy sets out the Commission’s strategic objective: to embrace digital finance for the good of consumers and businesses.
The overall package addresses four priorities: tackling fragmentation, facilitating digital innovation, creating a European “financial data space”, and addressing new risks associated with digital transformation, to create a level playing field.
It’s accompanied by various legislative proposals on cryptoassets, DLT and digital operational resilience, as well as a “Retail Payments Strategy for the EU”, and ambitiously addresses issues such as EU-wide digital identities, cloud computing, and AI.
The Commission’s proposals for a ‘Regulation on Markets in Crypto Assets’ (“MiCA”), when implemented, will transform the legal landscape for cryptoassets, including utility tokens and stablecoins.
In this article, we will outline how the MiCA proposals would affect issuers and service providers in the EU, and the UK (following Brexit). MiCA is likely to come into force, in some form, by 2024, following a period of development, and a consultation period which ends on 10 December 2020.
The new legal framework for cryptoassets
MiCA is intended to clarify the application of existing EU rules to cryptoassets, includes a pilot regime for cryptoassets covered by those rules, and (importantly) establishes a new legal framework for cryptoassets which are not covered by the existing rules, such as utility tokens and stablecoins used for payment purposes.
It is intended to provide legal certainty, to support innovation, to protect consumers and investors, and to ensure financial stability (with the final point aimed squarely at stablecoins). MiCA will replace any national regimes which have been implemented to deal with these cryptoassets.
Cryptoassets are defined by the Commission as “digital representations of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology”. MiCA will regulate three categories of cryptoassets:
- Utility tokens which are accepted only by the issuer of the token, available on DLT networks, and intended to provide access to a good or service.
- “Asset-referenced tokens” which reference a basket of currencies, cryptoassets or commodities, and act as a means of payment and store of value.
- Electronic money tokens which reference one fiat currency and are used for making payments, functioning similarly to e-money.
MiCA won’t apply to cryptoassets which are already regulated (as financial instruments such as securities, for example), or central bank digital currencies (CBDCs).
New rules for issuers
MiCA will bring in requirements for issuers of cryptoassets similar to those in place for issuers of securities, by requiring issuers to publish a whitepaper when making a public offer of cryptoassets or seeking admission of cryptoassets on to a trading platform.
Whitepapers will need to include certain prescribed information on the issuance, including information on the underlying investment or project, the rights and obligations that will attach to the cryptoasset, and related risk.
Like traditional prospectuses, there will be a number of exemptions available to issuers. For utility tokens, whitepapers will not need to be approved prior to publication but they will need to be provided to a competent authority, which will have powers to require the issuer to include further information, or to suspend or prohibit an offer or admission.
Consumers who acquire cryptoassets will have a right of withdrawal for a limited amount of time after acquisition, and member states will have to ensure that issuers are liable for the contents of their whitepaper under national civil law.
Asset-referenced tokens and e-money tokens
Asset-referenced tokens, whose value is stabilised by reference to a basket of fiat currencies, commodities, or cryptoassets, are seen as posing increased risks to consumers and market integrity, due to the potential for their widespread adoption. Therefore, issuers of these tokens, as well as e-money tokens, will be subject to much more stringent requirements. Issuers of asset-referenced tokens will need to be authorised by a competent authority (unless their offer is made to certain “qualified investors” only) and for that, they will need a registered office in the EU.
MiCA confirms that e-money token issuers will also be regulated under existing legislation (name the Electronic Money Directive), as e-money issuers, and so will require authorisation. Whitepapers for asset-referenced tokens and e-money tokens will need to be approved and must include additional information including details on the stabilisation mechanism, custody of reserve assets, and rights provided to holders.
Issuers of significant e-money and asset-referenced tokens will be subject to greater requirements, particularly with regard to capital and interoperability requirements and liquidity management policies. Issuers of significant asset-referenced tokens and e-money tokens will be supervised at Union level by the European Banking Authority through a college of supervisors.
Issuers will be required to pay a fee, to pay for this increased supervision.
New rules for service providers
There will also be rules for “cryptoasset service providers” such as crypto-exchanges, custodian wallet providers, trading platforms, persons who advise on cryptoassets, and those who place, or receive and transmit orders for cryptoassets.
Cryptoasset service providers (who are not already authorised) will need to be authorised by a competent authority in a member state in which they have a registered office, and once they are, they will be able to provide services across the EU.
There will be a “reverse solicitation” provision, whereby persons within the EU can receive cryptoasset services from a third-country provider at their own initiative. However, third-country service providers may not market their services within the EU without authorisation. The European Securities and Markets Authority will establish a register of authorised cryptoasset service providers, which will include all whitepapers published by issuers.
There will be certain requirements for cryptoasset service providers regarding their complaints handling policies, prudential requirements, safeguarding and other areas. There will also be requirements which are specific to the type of service provided. For example, firms which provide advice on cryptoassets will need to assess their client, including their ability to bear losses.
How will this impact UK issuers and cryptoasset service providers?
While it is important to note that MiCA is currently only a proposal, UK cryptoasset service providers will need to follow developments closely. MiCA as currently drafted means that service providers from third-countries (as the UK will be in a few short months) will need to have a registered office within the EU in order to be able to obtain authorisation and offer services to consumers in the EU. There is no provision for services to be provided into the EU, by third-country firms, without such authorisation. Of course, this will not only impact UK service providers, it will have global effect.
As for regulation in the UK, it is likely that UK regulation will follow MiCA (and the related DLT regulation) closely, as well as incorporating other global initiatives such as the Financial Action Task Force requirements. The UK will want to maintain its competitiveness in the cryptoasset market. Given that MiCA will confer a degree of credibility on EU cryptoassets and service providers, the UK will be keen to replicate if not exceed this credibility.
Whatever happens, given the growing importance of digital finance worldwide, it is unlikely that the global trend towards increased regulation of cryptoassets will be reversed.
Charlotte Hill is a partner at international law firm Taylor Wessing and heads the Financial Services Regulatory group in London. She has a particular focus on advising FinTech businesses such as digital challenger banks, payment services providers, electronic money institutions, cryptoassets businesses, and digital wealth managers.
Katie Fry-Paul is an associate in the Financial Services Regulatory group at Taylor Wessing. A physics graduate, she has a particular interest in all things “tech”, and advises a broad range of firms including cryptoasset businesses, payment service providers, and other FinTechs on their regulatory obligations.
Taylor Wessing played a leading role in advising the UK government on its landmark support programme for innovative companies, the Future Fund, and is now running its inaugural “FinTech Bootcamp” for businesses conducting regulated activities in the UK.
Other articles in our City AM series: The Digital Currency Crossroads: CBDCs across borders, and the UK approach, The Financial Action Task Force’s latest mission… Global Stablecoins.