EU Moves Forward on MiCA Regulation

The European Parliament voted on 20 April 2023 to approve the Markets in Crypto Assets Regulation (MiCA). The new rules were quickly heralded as a comprehensive regulatory framework for issuers of certain crypto assets tied to distributed ledger technology (DLT), as well as intermediaries, market operators and custodians providing market infrastructure to support their trading. Politicians and market participants alike took to social media to signal their approval.

Innovative Regulatory Architecture

Notwithstanding the triumph of being the first cryptoassets regulatory architecture, at almost 600 pages in length and years in the making, MiCA suffers from the familiar features of European financial services legislation: it is as vague in places as it is prescriptive in others; its implementation leaves important issues to Level 2 technical standards that will take significant time to develop; and it aims to draw market actors into the EU to conduct business. Arguably, something is better than nothing, and this holds even more sway in the nascent area of crypto assets; however, experience shows that there will need to be considerable engagement with the European Commission and supervisory authorities over the next 18 months, as MiCA is phased in, to address the alignment of legislation and business practices so that it can become fully effective. Emerging areas like DeFi, crypto asset lending, and NFTs, which have not been fully addressed by the rules, will be looked at more closely during this time.

Legal Certainty and EU Harmonisation

The significance of MiCA is that it creates a first-of-its-kind common regulatory framework for crypto assets markets in the EU. Several Member States already have laws to support and regulate the issuance of and intermediation in crypto assets on a national basis, such as Germany, but MiCA will provide a rule-set that will apply across the Union and facilitate cross-border provision of crypto-assets related services. The political advantage for the EU is that it steals a march on the UK, Asia Pacific and the US, which are at earlier stages of the legislative process. Whether international harmonisation and cooperation will follow remains to be seen; but, at least within the 27 Member States of the EU, issuers and investors will enjoy greater legal certainty and market supervision than has been the case. Crypto asset service providers – including custodians, platform operators and intermediaries like brokers, portfolio managers and advisors – will be able to compete on a level playing field within the Union. They will also be able to build their businesses to meet regulatory expectations with a level of clarity that none of the US, Asia Pacific or the UK are able to offer yet.

Opportunities and Challenges for Market Participants

MiCA requires a level of professionalism that many issuers and crypto asset service providers have not yet achieved. White papers for relevant token offerings, for example, can no longer be bare marketing tools or engineering documentation --- they will need to provide much more detailed and carefully-prepared assessments of the risks to investors and set out relevant facts with a level of care more usually seen in a prospectus for securities. Minimum capital requirements will need to be held by crypto asset service providers, and their compliance functions will need to address matters like payments for order flow, fairness in order execution, and front-running with a level of care much closer to investment firms under MiFID II. Operators of trading platforms will need to demonstrate operational resiliency, standardise their fee schedules, meet pre- and post-trade transparency requirements, and implement controls to detect or prevent market abuse. The experience of MiFID II suggests that this will be a significant project requiring the engagement of all parts of the firm, from operations centres to board rooms. This is particularly so for firms that have been operating in a largely unregulated space since their inception and where the 'delta' and regulatory uplift is likely to be more significant compared with already-regulated financial market participants.

Issuers of security (eg, financial instruments) tokens, as well as operators of trading venues and relevant intermediaries for them, are already governed in the EU by MiFID II. Investment funds are also subject to their own rules, including UCITS and the AIFMD/R. Accordingly, care will need to be taken to ensure that firms are authorised under and comply with the requirements of the correct regime. The focus of MiCA is on markets related to "asset-referenced tokens" (ie, stablecoins), "e-money tokens," and other tokens – such as "utility tokens" – which do not fall into other, existing, regulatory regimes. This taxonomy does not align perfectly with other jurisdictions, and some refinement can be expected over time with coordination between the European Supervisory Authorities to address any unintended consequences under EU law.

Cross-Border and Third Country Rules

In the meantime, UK issuers or crypto asset service providers wishing to engage with investors or clients in the EU will need to prepare for the new regime. Since the withdrawal of the UK from the EU, "third country" rules on access and cross-border services have applied to securities, derivatives, investment funds, and insurance businesses. A set of challenges for UK-based firms is expected to arise in the crypto asset markets, as well. In order to achieve effective supervision, MiCA requires crypto asset service providers to have a registered office in a Member State in which they carry out substantive business activities, while their place of effective management (and at least one director) should be in the Union. Although a "reverse solicitation" rule will allow EU investors to proactively seek services from the UK or other third countries, there are known challenges in using such a rule to operate cross-border business. Planning and preparations to effectively manage business with investors or clients in both the UK and the EU will require some care.

In the opposite direction, the UK has signalled only that it is looking at defining a cross-border regime for services provided to UK residents. It is unknown how that will be applied, but a "reverse solicitation" mechanism is one of the options being looked at. Taken together, there is a risk – and, in fact, a likelihood – that the UK and EU will continue to restrict regulated financial business between them moving forward. Attention will need to be paid to avoid the fragmentation of liquidity in ways that impacts investors and, at the same time, the integrity of the developing markets in crypto assets.

MiCA is expected to be published in the Official Journal in the summer of 2023. Most of its provisions are expected to come into effect in January 2025, but certain arrangements concerning "asset-referenced tokens" and "e-money tokens" will apply 12 months after the rules come into force. The hard work is really only just beginning.