The bankruptcy of FTX on 11 November has shocked many investors and traders who used it. While investigators have started examining where the cryptocurrency exchange platform went wrong, everyone now seems to agree on the need to regulate a sector that has lost nearly 10% of its total value in less than two weeks.
In terms of regulation, Europe recently took a number of actions. Following approval of the regulation by the EU Parliament, MiCA is expected to come into force in the first quarter 2023 and will create a single EU-wide framework for all players in the crypto-asset sector. However, a transitional period of 12 or 18 months is likely to be established and therefore the regulation is not expected to fully take effect until end of 2024.
Through the regulation, the EU intends to impose rules on all players in the crypto sphere whether or not already covered by a financial sector regulation. Beyond, the aim of MiCA is not only to protect consumers, but also to help guarantee Europe’s economic and monetary sovereignty and combat money laundering and terrorist financing. The new regulation will also provide actors established in one Member State with a passport to operate throughout the EU.
Faced with the challenges posed by the rise of the crypto ecosystem, often referred to as the “Wild West” to illustrate the absence of rules, the EU wants to cover the entire spectrum. MiCA will therefore apply to issuers of crypto assets, including ARTs (asset-referenced token, for example a stablecoin linked to different underlying assets) and EMTs (E-money token, for example a stablecoin linked to a fiat currency). Relevant service providers in crypto-assets (exchanges, custodians, portfolio managers, investment advisors, etc.) are also in scope of the regulation and will have to be authorized to provide their services in the EU. Togheter, they will be referred to a new category of players defined under the name of “Crypto Asset Service Providers” or CASPs.
The EU is once again a frontrunner
Similar to MiFID and AIFMD, the EU is once again the first major jurisdiction to impose a set of rules relating to crypto assets. MiCA is also comprehensive in order to ensure consumer and investor protection. “Service providers will, for example, be liable in the event of cybersecurity incidents and operational and technical problems resulting in the loss of clients’ assets,” observes Marc Mouton, Partner of Banking and Financial Services for Arendt & Medernach. “Overall, the rules it imposes are similar to MIFID, although they will be less onerous.” MiCA, for example, will not classify customers and vary obligations according to their profile.
Overall, the rules MiCA imposes are similar to MIFID, although they will be less onerous.
As it is a regulation and not a directive, MiCA will be directly applicable in national law and will not require transposition. EU member states will therefore have no room for manoeuvre in their application of the rules. As regards supervision, the general rule is to delegate it to a national regulator. However, “significant” ARTs and EMTs will be placed under the eye of the European Banking Authority.
“It is obvious that becoming a recognised player in the financial sector entails organisational, prudential, administrative and technical requirements,” admits Natasha Deloge, Head of Innovation Division at the Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg regulator. MiCA’s benefits will be significant for the recognition of the sector, and not only related to obtaining a European licence that will allow crypto players to benefit from finally harmonised rules in the EU space. “The field of crypto-assets was very poorly regulated until now,” continues Deloge. “Obtaining a licence will give them more credibility with consumers and democratise the sector. The trust they will gain from traditional players will open the doors to new markets.”
Obtaining a licence will give them more credibility with consumers and democratise the sector. The trust they will gain from traditional players will open the doors to new markets.
Are the requirements too restrictive?
To continue the parallel with the MIFID directive, there is a risk that certain requirements are too restrictive for smaller companies and could lead to consolidation in the sector. MiCA insists on the notion of minimum substance, while leaving it to national regulators to specify the thresholds. They will concern both the staff hired at the head office level, capital requirements – for example, stablecoin issuers will have to have sufficient reserves, partly in deposits, to be able to repay clients at any time – and governance (having qualified management).
Once the new regulation is in place, there will be an obligation to create a legal entity on European territory and to have a management of at least 4 or 5 people in key functions: with double management positions imposed for anti-money laundering, compliance, risk. This cost will be easier to cover for the large companies in the sector, most of which were in fact asking for such a regulation. In terms of capital, MiCA classifies CASPs into three categories and defines minimum requirements for each: €50,000, €125,000 and €150,000.
Once regulation is in place, a virtuous circle will be able to develop: financial institutions that refused to look at an unregulated crypto market will start to take an interest.
MiCA will bring a number of cryptos out of the grey area in which they operate.
“We should expect the bar to be set at a level that allows for natural selection, and this is probably what Europe wants,” says Thomas Campione, Blockchain & Crypto-assets Leader at PwC Luxembourg. “So for some, it will be painful. But once regulation is in place, a virtuous circle will be able to develop: financial institutions that refused to look at an unregulated crypto market will start to take an interest.”
This should notably be the case for traditional financial players. As they are already largely regulated, generally speaking, under MiCA there will be no additional approval require for them to enter the crypto asset market. A simple notification will suffice. “MiCA will bring a number of cryptos out of the grey area in which they operate and rebalance the whole market according to the principle ‘same service, same risks, same rules’,” analyses Nadia Manzari, partner at Schiltz & Schiltz. For her, MiCA will offer new opportunities for more traditional financial operators by allowing them to diversify their investment products from crypto-assets.
MiCA is an important step to better control an industry that has grown very quickly and without regulatory constraints. FTX’s bankruptcy is the latest in a series of bankruptcies that have shaken the crypto world this year. Further tightening of the screws will be needed to protect investors.