Level playing field: EU’s MiCAR gets the nod

August 2023  |  FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

August 2023 Issue

As cryptocurrencies and other cryptoassets have grown more popular and widely accepted, the regulatory focus around them has also increased. This focus has intensified recently following a spate of corporate collapses in the crypto space. The growth of cryptoassets recorded in the retail space and growing institutional adoption created a rapid rise in market capitalisation and greater volatility. Fraud and scams have proliferated, in addition to mismanagement of customer funds, leading to a marked loss in consumer trust in the crypto space.

These factors have brought closer scrutiny from regulators. With a clear direction of travel emerging, companies in the crypto space must prepare themselves for greater regulatory oversight.

A choppy start

In many respects, the European Union (EU) is leading the way. According to Chainanalysis, nearly 22 percent of the global crypto industry is based in central, northern and western Europe. Until recently, the regulatory response had been quite fragmented.

As Verena Ritter-Döring, a partner at Taylor Wessing, points out, the evolution of cryptoassets regulation in the EU started back in 2020, when the fifth EU Money Laundering Directive (AMLD5) introduced the first rules explicitly applicable to cryptoasset service providers. “This framework ensured that crypto exchanges and wallet providers complied with EU requirements on anti-money laundering (AML) and combating the financing of terrorism (CFT),” she says. “Back in the day, the driving force was to prevent the use of cryptoassets for money laundering and terrorist financing purposes. However, lawmakers and regulators across the EU soon identified other investor-related risks that also needed to be addressed.

“Some EU member states – such as Malta, and later France and Germany – have therefore gone a step further and introduced bespoke regimes to regulate cryptoasset service providers,” she adds. “These national frameworks were not developed in a harmonised way, which led to divergences that prevented crypto companies from operating across the EU based on a single set of rules. With the aim of resolving these problems, the European Commission came up with the Markets in Cryptoassets Regulation (MiCAR), which is primarily intended to create a common regulatory framework for cryptoassets, applicable across all 27 EU member states.”

According to Laura Prosperetti, counsel at Cleary Gottlieb Steen & Hamilton LLP, the evolution of cryptoasset regulation in the EU has been driven by increasing recognition of the potential risks and rewards associated with those assets, together with the awareness that the existing EU financial sector regulation did not capture all types of cryptoassets, but only a small minority falling under the definitions of electronic money or financial instruments.

“The European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and several national authorities started to issue warnings to consumers about the risks and the unregulated nature of virtual currencies and cryptoassets,” says Ms Prosperetti. “At the same time, between 2018 and 2020, several member states, including Italy, Germany and France, started to extend the scope of financial regulation to cryptoassets and market players, leading to a potentially unlevel playing field and regulatory fragmentation across the EU.”

Enter MiCAR

Approved by the European Parliament in April 2023, MiCAR aims to create a comprehensive regulatory framework for certain cryptoassets, namely stablecoins and other cryptoassets that are not governed by existing financial EU law, such as utility tokens and specific forms of non-fungible tokens (NFTs). It covers trading platform admissions, public offerings, transactions and services related to the types of cryptoassets specifically targeted by the regulations.

Ultimately, MiCAR seeks to provide legal certainty, adequate consumer and investor protection, and ensure market stability – bringing greater transparency and a more level playing field to the EU crypto market.

At present, the regulatory framework concerning cryptoassets across the EU is patchy at best, with different member states at different stages of implementing AMLD5. Unlike AMLD5, which also covers certain cryptoassets under the term ‘virtual currencies’, MiCAR  has been designed to correct the national fragmentation arising from AMLD5 and establish a uniform regulation of those cryptoassets that fall outside the scope of existing EU financial legislation.

It has been designed to maximise harmonisation across the bloc; as an EU regulation, it is binding in its entirety and applies directly across all EU member states.

MiCAR’s scope may be hindered by the fact that many cryptoassets already fall under existing regulatory regimes and national implementing laws, but it presents a solid jumping-off point in the process of establishing a harmonised, pan-European regulatory framework.

MiCAR sets out a number of requirements for cryptoasset issuance. For instance, cryptoasset issuers must publish a white paper for investors containing specific information about the cryptoasset to be issued. MiCAR will also regulate the liability of cryptoasset issuers. It is important to note that MiCAR does not contain any provisions targeting the technologies underlying crypto structures, such as blockchain technology, nor does it require or prohibit certain cryptoasset designs.

“MiCAR introduces common rules applicable to issuers and offerors of cryptoassets as well as cryptoasset service providers, such as exchanges and custodians,” explains Dr Ritter-Döring. “By reflecting the main principles of the EU Prospectus Regime anchored in the EU Prospectus Regulation, MiCAR introduces transparency and information requirements for issuers as well as a bespoke authorisation regime for cryptoasset service providers that follows some of the main authorisation principles seen in other EU regulations like the Markets in Financial Instruments Directive (MiFID) II.

“MiCAR will not apply to decentralised finance (DeFi) exchanges, provided that such protocols function in a fully decentralised manner. Nonetheless, the regulators will apply a ‘substance over form’ approach, and DeFi structures that have centralised entities or persons controlling or operating them will likely experience intense regulatory scrutiny,” she adds.

Violations of MiCAR may result in severe administrative fines and other measures. Under MiCAR, fines for natural persons can reach up to €700,000, while legal entities may face fines of up to €5m or 3 percent of their annual turnover. For more severe violations, fines of up to €15m or 15 percent of annual turnover may be imposed.

National competent authorities in the EU member states will oversee regulated entities under MiCAR and their compliance with its requirements, notes Dr Ritter-Döring. “Some entities will also be partially subject to oversight from the EBA, such as issuers of significant asset-referenced tokens,” she says. “It is expected that non-compliance with the requirements will trigger administrative fines and other practical measures, such as a formal request from the supervisory authorities for an entity to change its processes, which, in the event of non-compliance, may lead to that entity losing its licence.”

Currently, MiCAR is expected to enter into force in the summer of 2023, 20 days after its publication in the Official Journal of the European Union, and will be directly applicable in all EU member states after an 18-month transition period, with certain exceptions, such as the regulation of electronic money tokens (EMTs) and asset-referenced tokens (ARTs), which will apply after 12 months. By the end of 2025, the EU hopes to have a harmonised regulatory framework for crypto-related products and services in place across the bloc.

As a result, crypto businesses operating in the EU will be required to take a number of additional steps to ensure they are in compliance with MiCAR. Obtaining regulatory authorisation, implementing strict AML measures, and complying with organisational as well as disclosure requirements and custody rules, will be key measures.

“Companies will need to dedicate sufficient time and resources to ensuring compliance with MiCAR,” suggests Dr Ritter-Döring. “The requirements are quite complex, and prospective cryptoasset service providers should not underestimate them. They should by no means consider them similar to the light-touch registration requirements for crypto companies that can be seen in some other jurisdictions, especially offshore.”

It is imperative that market participants prepare for the implementation of the MiCAR rules in 2024, particularly as European supervisory authorities will soon start developing detailed technical standards for implementing the new rules. Market participants will be consulted on these standards and should follow developments closely.

The picture elsewhere

Undoubtedly, crypto regulation has been on the docket for some time, but different countries are at varying stages of development with respect to implementing it. Most jurisdictions fall into one of several categories: those which have yet to establish a position regarding regulation; those that have essentially de facto criminalised cryptoassets and exchanges at a state level; those that are looking to cryptoassets as a potential avenue to avoid measures that restrict orthodox fiat currency movements such as financial sanctions; and those that allow the transacting of cryptoassets but have varying degrees of regulation.

The regulatory landscape in the UK is very different to the EU; indeed, the UK has only recently begun to explore cryptoasset regulation, and will adopt a phased approach starting with stablecoins and broadening to unbacked cryptoassets later on. This gradual approach means it could be some time before the UK has a final set of rules in place. Likewise, in the US, regulators are currently employing existing securities rules while deliberating on introducing new rules specifically targeting cryptoassets.

“We see many jurisdictions developing their own bespoke frameworks on cryptoassets, which is quite a positive sign for the crypto industry in general,” says Dr Ritter-Döring. “The UK, for instance, is developing a new regulatory framework on cryptoassets, applying a slightly different approach to the EU, but nonetheless aiming to provide a high level of regulatory certainty for entities operating there.

“Some other countries, like the United Arab Emirates (UAE) and Hong Kong, are also very proactive in this field, and are attracting many international companies with their new regulatory frameworks on cryptoassets. So it will be interesting to see how things develop in the future. A high level of regulatory certainty is a key precondition for the proper functioning of the crypto industry, therefore recent developments in the majority of key jurisdictions are welcome,” she adds.

Given the paucity of cryptoasset regulation around the world, it is possible that the EU’s framework could become a benchmark for other countries thinking about their own approach. Going forward, MiCAR could define the competitiveness of the EU in the global crypto market.

“MiCAR is indeed a pioneering and comprehensive regulatory framework for cryptoassets within the EU, which aims to address the challenges of the cryptoasset industry by promoting market integrity and investor protection,” notes Ms Prosperetti. “As the first of its kind, it sets a significant precedent and has the potential to become a global standard for cryptoasset regulation.

“Lawmakers around the world, including those in emerging markets, can benefit from looking at MiCAR to enhance their own regulatory frameworks for cryptoassets,” she continues. “Moreover, aligning non-EU legislation with MiCAR could reduce the regulatory burden of making cross-border offerings of cryptoassets into the EU, fostering smoother interactions and facilitating participation in the inherently borderless crypto market.”

As such, the MiCAR regulatory structure not only unifies the EU cryptocurrency market but also offers the bloc an advantage in its expansion, in contrast to other jurisdictions where clear regulations are not yet in place, such as the US and the UK.

Road to regulation

Recent volatility and the bankruptcy of a number of exchanges has highlighted the inherent risk and instability within cryptocurrency markets. This, in turn, has intensified the sense of regulatory urgency. MiCAR promises to enshrine a more comprehensive framework for crypto issuers and service providers, increasing transparency and driving compliance with AML rules.

It is an important step on the longer road to wider cryptoasset regulation. Across the EU, through the introduction of MiCAR, alongside existing financial services regulation such as MiFID and the Distributed Ledger Technology (DLT) Pilot Regime, the hope is that a more level playing field will emerge. Greater regulatory oversight will provide peace of mind to consumers and investors as the crypto space continues to evolve. Regulators in other jurisdictions will be watching closely.

© Financier Worldwide

BY

Richard Summerfield