ESMA Consults on Crypto Asset Classification Criteria under MiCAR

Executive Summary

One of the tasks delegated to the European Securities and Markets Authority (ESMA) under the Markets in Crypto-Assets Regulation (MiCAR) is to distinguish crypto-assets from financial instruments under the Markets in Financial Instruments Directive and Regulation (together, MiFID II). This has proved challenging, due to the lack of precision in MiFID II and the various interpretations given by Member States to concepts like "transferable securities." ESMA is consulting on proposed guidelines; but, in light of the porous boundaries of MiFID II, they will not be creating a definitive list of crypto-assets which belong to MiCAR or should be treated as financial instruments.

There are three main take-aways from the consultation:

• The boundary between MiCAR and MiFID II is fixed conceptually, even though MiFID II glosses over the different ways that EU Member States treat financial instruments. The starting point is that crypto-assets are likely to come within the scope of MiCAR if they are not financial instruments under MiFID II – taking account of the fact that some crypto-assets, such as genuine Nonfungible Tokens (NFTs), are excluded from MiCAR. There can be edge cases due to the inconsistent approaches of Member States, but ESMA is not setting out to address that now.
• Each crypto-asset must by assessed on its own merits, looking at how it is constituted and used. ESMA is not undertaking a classification exercise, which will allow market participants to determine with certainty whether any particular crypto-asset is a financial instrument under MiFID II.
• A financial instrument is a financial instrument, whether it is on paper, takes the form of a PDF, or is represented by a digital token. The Markets in Financial Assets Regulation (MiFIR) has already been amended to clarify that financial instruments can include those which are on distributed ledger technology (DLT). Technology does not determine the outcome of the classification process – market usage does.

Guidelines

ESMA has developed nine guidelines for the classification of crypto-assets as financial instruments. Each is summarised below.

Guideline 1: General

• The classification of a crypto-asset as a financial instrument should be the result of a case-by-case assessment. The form of the crypto-asset is secondary to its substance, and the principle of technological neutrality applies.

Guideline 2: Classification as transferable securities

• Crypto-assets should be classified as financial instruments under MiFID II when they meet the following three criteria for "transferable securities":

(i) not being an instrument of payment;

(ii) being "classes of securities"; and

(iii) being negotiable on the capital market.

• To illustrate, these criteria apply to shares but not to bank money; to bonds but not to payment cards; to securitised derivatives but not to cheques.
• In order to be treated as a "class," ESMA considers that four criteria have to be met by crypto-assets:

(i) being interchangeable;

(ii) being issued by the same issuer;

(iii) having similarities; and

(iv) providing access to equal rights.

• ESMA proposes that the negotiability of a crypto-asset should be assessed broadly, including crypto-assets which are capable of being traded on capital markets or transferred. Fungibility is an essential element.
• The concept of a "capital market" is not defined in legislation but ESMA suggests a broad view should be taken, to include both trading on trading venues and over-the-counter trading. The function of capital markets being to raise capital for issuing firms, that is another consideration proposed by ESMA.
• Crypto-assets which are similar to investment certificates like Exchange-Traded Notes should be regarded as transferable securities.

Guideline 3: Conditions and criteria for the classification as money-market instruments

• A crypto-asset would function as a money-market instrument under MiFID II if it:

(i) has a legal and residual maturity as described in the Money Market Funds Regulation;

(ii) exhibits stable value and minimal volatility; and

(iii) aligns returns with short-term interest rates.

• Treasury bills, certificates of deposit, and commercial paper are examples of money-market instruments under MiFID II. ESMA suggests that the applicable condition is that:

The crypto-asset should serve as a representation of a credit balance, either resulting from funds retained in an account or from temporary situations stemming from standard banking transactions, which a financial institution is obligated to repay as per [the Deposit Guarantee Directive].

• Short-term government debt and short-term negotiable debt obligations issued by a bank or corporation to raise funds in the international money market should also be considered money-market instruments under MiFID II, notwithstanding that they are tokenised.

Guideline 4: Conditions and criteria for the classification as units in collective investment undertakings

• ESMA proposes that crypto-assets should be treated as units in collective investment undertakings if the crypto-asset itself qualifies as a unit and the issuer qualifies as a collective investment undertaking. Just because an arrangement involves a pool of assets, it is not necessarily to be treated in the same way as a fund – a point that will be particularly relevant to crypto staking arrangements which are currently outside of the scope of MiCAR.
• ESMA notes that, in order to meet these criteria, it is not enough that the crypto-asset represents a shared interest in a capital pool. To be a unit in a collective investment undertaking for MiFID II purposes, it is also necessary that the unit-holder does not have direct, day-to-day control over the management of the pooled assets and that the project does not have a general commercial or industrial purpose.

Guideline 5: Conditions and criteria for the classification as derivative contracts

• MiFID II describes a range of derivative contracts that qualify as financial instruments. These include simple forwards and options, as well as exotic derivatives, with diverse underlyings, which can be settled by delivery or in cash. When a crypto-asset is a "digital representation" of a contract that fits into one of the categories in MiFID II, then it should be treated as a financial instrument.
• ESMA notes that it is undertaking further work to assess the question of "crypto-assets bearing rights similar to derivatives, but which would be settled in crypto-assets, EMTs or ARTs instead of cash."

Guideline 6: Conditions and criteria for the classification as emission allowances

• A crypto-asset that grants an explicit emission right and is tradable, endorsed by the EU or Member States under the EU Emissions Trading Scheme Directive, could be a financial instrument under MiFID II. ESMA notes, however, that "most crypto-assets differ from emission allowances as they typically symbolise value, project stakes, or service access."

Guideline 7: Conditions and criteria attached to the crypto-asset's classification in MiCA

• There are types of crypto-assets that should not fall under MiFID II; eg, utility tokens, which provide access to functionality on a DLT-based system. The true characterisation of utility tokens depends on the rights that attach to them and the ways that they are used.

Guideline 8: Conditions and criteria attached to NFTs

• NCAs and market participants should consider NFTs as "distinct and irreplaceable" when the rights they provide and their characteristics are distinguishable from other crypto-assets. The analysis should be substantive and not rest solely on the technical features of the crypto-asset. 

Guideline 9: Conditions and criteria attached to hybrid crypto-assets

• NCAs and market participants should adopt a hierarchical approach in the classification of hybrid crypto-assets. The first step is to assess whether a crypto-asset meets the criteria of a financial instrument. If it does, then it falls outside of MiCAR and under MiFID II, so further analysis is not required for classification. The analysis should be based on substance over form, taking account of the range of characteristics.

Next Steps

ESMA is consulting on its approach through 29 April 2024. A final report is expected before the end of 2024.