Regulators in the UK and EU are looking to extend their regulatory reach to include crypto assets in all their guises.

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John Ahern

Crypto assets are a broad universe of different types of products. Popular types of crypto assets are exchange tokens, such as bitcoin and other cryptocurrencies, which are intended to be used as a method of payment. These cryptocurrencies are only regulated in the UK for money-laundering purposes but not otherwise. The reason they are not regulated is because they are not regarded as money in the same way fiat currencies are.

Other crypto asset types may already be within the remit of the regulators if they confer certain rights, such as to own a position, to be entitled to repayment of a certain sum, or if they establish an entitlement to participate in future profits. An example of such a crypto asset is a security token.

However, whether or not a crypto product amounts to a ‘financial instrument’ – in which case activity in relation to it would be regulated in the UK and in the EU – depends on how it is structured. In a digital world, there is considerable scope to structure innovative products in a manner that falls outside the regulatory remit.

Growing importance

In recent years, investment activity in crypto assets has increased significantly. Financial services regulators are concerned about the potential use of crypto assets in financial crime and the significant risks they raise in the context of market integrity given their volatility. The UK’s Financial Conduct Authority, for example, estimates that the number of consumers holding crypto assets has risen to 2.3 million. There is a clear desire on the part of regulators to bring this asset class within the regulatory perimeter.

While the UK has not proposed concrete legislative measures to include crypto assets more comprehensively in the regulatory remit, it has established a taskforce to bring the various government and regulatory stakeholders together to assess the impact of crypto assets and distributed ledger technology in the UK and to consider appropriate policy responses. There is continuing dialogue between the regulator and the government on the appropriate regulatory response to this market. We can anticipate that there will be legislative changes to widen the regulatory reach, but they will also be focused on maintaining the UK as an attractive centre for financial innovation.

Meanwhile, in September 2020, the European Commission adopted an extensive programme for digital finance that aims to improve the competitiveness of the bloc’s fintech sector. At the same time, the EU hopes to mitigate the risks posed by the fintech sector to the bloc’s markets. The digital framework proposals include a proposal for a Markets in Crypto-Assets Regulation (MiCA).

This draft regulation contains a broad definition of what constitutes a crypto asset, and so will capture a comprehensive array of these products that appear to occupy a gap in the regulatory systems of EU member states. In short, a crypto asset is defined as “digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology”.

However, the following crypto assets are divided into:

  • those which are financial instruments for the purpose of Markets in Financial Instruments Directive (MiFID) II;
  • those that qualify as electronic money under the Electronic Money Directive;
  • those that are deposits for the purpose of the Deposit Guarantee Schemes Directive;
  • those that are structured deposits for the purpose of MiFID II; and
  • those that are a securitisation for the purpose of the Securitisation Regulation.

In common with many EU regulatory developments in recent years, there is an extra-territorial dimension to the application of the draft regulation. Accordingly, issuers of relevant crypto assets from outside the EU may nevertheless be subject to the proposed regulation if the assets are capable of being subscribed for in the EU.

Regulatory scope

MiCA, as proposed, establishes regulatory frameworks for ‘e-money tokens’, ‘asset-referenced tokens’ and crypto assets – the latter being a broad catch-all but also subject to the categories above.

E-money tokens are a type of crypto asset the main purpose of which is to be used as a means of exchange and that purport to maintain a stable value by referring to the value of a fiat currency that is legal tender. Asset-referenced tokens are 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.

Services provided in relation to the crypto assets subject to the proposed regulation are regulated services and are not dissimilar (broadly) to the kinds of services in relation to traditional financial instruments covered by MiFID II – such that custody and administration, advice, executing orders, receiving and transmitting orders, placing and operating a trading platform are regulated services. In addition, exchanging crypto assets for other crypto assets and exchanging crypto assets for fiat currency are regulated services.

As the regulation will be directly applicable (it will apply in each member state without the need for implementing measures in each state), it seeks to achieve a harmonised approach throughout the EU in relation to the regulation of crypto assets, thereby reducing the opportunity to achieve regulatory arbitrage between jurisdictions in the bloc.

John Ahern is partner in the financial services practice at law firm Covington.

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