At a time when the number of crypto assets and their users continues to multiply, many jurisdictions are adopting measures to address regulatory gaps, in a bid to mitigate risks.
Developing regulation in this space is far from challenge-free. For instance, it is difficult to tailor the design of prudential and conduct of business requirements to the diverse range of activities and business models that are adapting in a rapidly and continuously evolving market.
The application of regulation in this space is also not without challenge for both supervisors and industry participants, and timely actions are needed to help manage the transition from paper to practice.
Latest developments
In June 2022, the European Council and European Parliament reached a provisional political agreement on the European Commission’s landmark proposal on the Markets in Crypto Assets (MiCA) regulation, and a final text is expected imminently.
MiCA provides a holistic approach to the regulation of crypto-asset issuance and crypto-asset service provision. In particular, it sets out detailed requirements for the issuance of asset-referenced and e-money tokens (so-called stablecoins), and crypto-asset service provision (such as custody services and the operation of trading platforms).
For the largest asset-referenced and e-money tokens, an EU-level supervision system will apply, with the European Banking Authority (EBA) responsible for supervising issuers of significant tokens — with significance defined by features such as the number of token holders, the number and value of transactions, cross-border activity, and interconnectedness with the financial system. MiCA is expected to enter into force in 2023, with asset-referenced and e-money token provisions coming into force 12 months after, and the rest 18 months after.
Readying for application
The agreement on MiCA marks the beginning of a new phase as both the financial sector and supervisory authorities turn their attention to readiness for application.
For firms active in the sector, there is a need to gain an early understanding of the new regulatory obligations and to adopt a ‘compliance by design’ philosophy as crypto-asset products and services come to market in the transition phase. Particular attention is needed to ensure the proper marketing of products and customer profiling to ensure consumers have the skills they need to understand crypto-asset features and any potential value provided to them. Firms should also pay close attention to the prudential requirements on issuers of asset-referenced and e-money tokens, particularly the stringent requirements regarding reserve and redemption rules.
Firms should pay close attention to the prudential requirements on issuers of asset-referenced and e-money tokens
As repeatedly highlighted by the EBA, firms should also be very mindful of supervisors’ expectations regarding the mitigation of money laundering, terrorist financing and sanctions evasion risks, and of upcoming obligations under the EU’s flagship Digital Operational Resilience Act.
For supervisory authorities, there is a clear need to enhance abilities to understand crypto-asset products and services, including their regulatory classification, distribution channels and interconnectedness, both within and beyond the traditional financial sector. Improvements to market monitoring capabilities are necessary, not only for the purposes of perimeter monitoring (i.e. ensuring that those firms carrying out activities have the appropriate authorisations), but also with respect to the application of conduct of business rules — a particular challenge as crypto-asset products and services are increasingly marketed via non-traditional channels, such as social media.
Managing the transition
So, how can industry and supervisors manage the transition? First, continuous dialogue regarding the drivers for crypto-asset use and business models is critical to ensure that both emerging regulatory and supervisory approaches are fit-for-purpose in mitigating risks without inadvertently impeding responsible innovation. It is also useful for supervisors to proactively articulate upcoming regulatory requirements. For instance, roundtables and workshops could facilitate firms in navigating the new regime. Innovation hubs and regulatory sandboxes also continue to provide good venues for this dialogue and opportunities to spot early areas where further guidance may be needed to facilitate consistent application.
Second, there is the need for training and, if necessary, recruitment to ensure supervisors and firms have the skills they need to monitor and mitigate risks. Particularly important is the need to understand those sources of risks and risk-transmission channels with the potential to be more elevated in the crypto-asset sector. Examples include the risk of cyber attacks, money laundering and contagion risks from one type of crypto asset (or crypto-asset service provider) to another.
Third, there is the need for technological investments, for instance in blockchain intelligence tools for compliance and risk management. Some supervisors are already investigating the feasibility of blockchain-based ‘embedded supervision’ applications to enhance their supervision capabilities in this space. Additionally, supervisors are increasingly turning their attention to monitoring tools for supervision at a macro level — enabling a better understanding of interconnectedness within the crypto-asset sector, and between the crypto asset and the traditional financial sector.
Fourth, the public and private sector both have a role to play in enhancing consumer financial education, so that consumers are better equipped to make more informed choices about whether to access crypto-asset products and services or not.
Fifth, there is the need for timely dialogue and enhanced coordination between supervisors on a cross-border basis, bearing in mind that although regulation may require certain types of firms to be established, or at least registered, in the relevant jurisdiction, some crypto-asset systems will still involve a distributed footprint in terms of governance and functionalities.
Ongoing work
To support capacity-building by supervisory authorities in the EU, the EBA will continue its actions to facilitate EU-wide monitoring and assessment of emerging crypto assets and use cases, and to promote supervisory convergence at the national level. Where immediate risks are identified, the EBA will continue to act as needed, as demonstrated by our warning to consumers, jointly with the other European supervisory authorities, in March 2022.
In 2023, the EBA will begin to deliver the extensive technical standards and guidelines assigned to it under MiCA, for which the EBA will initiate early industry outreach — including round tables and at least one discussion paper — in addition to the conventional consultation process. Crucially, the EBA will also begin the build-up of its new supervision function for issuers of significant asset-referenced and e-money tokens.
International dialogue and policy convergence
This edition of The Banker is being published as the International Monetary Fund (IMF) and World Bank hold their international meetings, marking an opportune moment to reflect on the importance of ongoing dialogue and policy convergence at a global level.
As Tobias Adrien, Dong He and Aditya Narain at the IMF have remarked, there is an undeniable case for a globally consistent approach to the regulation of crypto-asset activities to secure the effective mitigation of risks and avoid regulatory arbitrage. International standard-setters, such as the Financial Stability Board and the Basel Committee on Banking Supervision, are already moving in this direction on regulatory and supervisory approaches to so-called ‘global stablecoins’ and on the prudential treatment of banks’ exposures to crypto assets.
Going forward, I would expect to see further initiatives emerge at the international level as the market continues to evolve. I look forward to continuous knowledge exchanges on these important developments as we work to ensure the benefits of the technologies that can be leveraged to enhance the efficiency and reach of the financial system whilst mitigating the risks.
José Manuel Campa is chair of the European Banking Authority.
