Reports from Esma and the EBA suggest that the EU is moving closer to creating its own regime for regulating crypto-assets potentially forcing member states, which take an early lead in this area, to revise their own crypto rules. By Katerina Katsiami, associate in Harneys regulatory practice in Cyprus, and Thomas Gray, senior associate in Harneys banking and finance practice in the Cayman Islands.  

On January 9 2019, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) published reports to the European Commission on the suitability of current EU legislation to crypto-assets and initial coin offerings (ICOs) regulation with consequences for national regimes.

The EBA’s report highlights several concerns regarding crypto-regulation. The key points are as follows:

  • The EBA report provides a detailed definition of ‘crypto-assets’ adding clarity on the term and the instruments intended to be regulated by the EU in this context.
  • The EBA acknowledges money laundering risks posed by crypto-assets because crypto-related ‘financial’ services are not perceived as being subject to regulation under the banking, payment services and electronic money framework set out in the Capital Requirements Regulation (CRR); the Second Payment Services Directive (PSD2) or the Electronic Money Directive (EMD).
  • There is a lack of clarity on the treatment of crypto-assets under current EU regimes which has led to misalignment (which could lead to misunderstandings) between them. For example, crypto-assets are not recognised as money or commodities, or subject to any other classification under CRR, but may be recognised as “electronic money” under EMD and as “funds” under PSD2.
  • The EBA outlines the applicability of current accounting and prudential regulatory frameworks relating to crypto-assets. The main issue, and what is being seen on a global basis, is that the current regimes, designed pre-2017, do not contemplate crypto-asset technology. At the time it was viewed as a very emerging technology which was not relevant.
  • The EBA report notes the lack of clarity of international and national accounting standards as to whether crypto-assets would be recognised as an intangible asset giving rise to a corresponding lack of clarity as to the consequential prudential regulatory treatment under CRR.
  • As regards valuations of crypto-assets, the EBA report suggests that a “conservative approach” should be taken for exposures, pending further regulatory developments and the outcome of the Basel Committee on Banking Supervision (BCBS) analysis, with the view being that work should be done in coordination with the BCBS and other international standard-setters.
  • Finally, the EBA has urged the Commission to address the possibility of an EU-wide regulatory approach on crypto-assets. The report also advised the Commission to consider the Financial Action Task Force’s (FATF) recommendations of October 2018 and to take steps to promote consistency in the accounting treatment of crypto-assets.

ESMA’s report follows a request by the Commission in its 2018 fintech Action plan calling European supervisory authorities to assess the suitability of the current EU regulatory framework on ICOs and crypto-assets. It acknowledged that the gaps in the current regulatory regime on crypto-assets arise due to their ambiguous legal status and, in particular, whether they are recognised as “financial instruments”.

ESMA acknowledges that under certain circumstances some crypto-assets may qualify as “transferable securities” or other types of financial instruments within the meaning of the Markets in Financial Instruments Directive (MiFID) II. To reach this conclusion, ESMA has been cooperating with national competent authorities (NCAs) and has noted that while transposing MiFID II into national law, the interpretation of the term “financial instruments” differs between NCAs resulting in regulatory and supervisory issues.

The report also outlines that many financial rules under secondary legislation including the Prospectus Directive, the Transparency Directive, MiFID II, the Market Abuse Directive, the Short Selling Regulation, the Central Securities Depositories Regulation and the Settlement Finality Directive will apply to those crypto-assets which qualify as financial instruments and transferable securities under MiFID II.

The report highlights the existence of ambiguities in the current regulatory regime of crypto-assets which should be addressed by the Commission and calls for greater clarity in respect of the types of services that may qualify as custody/safekeeping activities under the EU financial services framework as well as the concepts of settlement and settlement finality which apply to crypto-assets.

ESMA acknowledges that there is currently no legal definition of “crypto-assets” in EU financial securities laws, although the Fifth Anti-Money Laundering Directive (5AMLD) does introduce a definition of “virtual currencies” as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.

Despite this, the report confirmed the risk which exists in case the wider regulation of crypto-assets may result in a more reckless adoption and use of same. As a result, ESMA recommends warning buyers about the risks of those crypto-assets which do not qualify as financial instruments.

ESMA also highlighted the importance of risk disclosure and anti-money laundering requirements in relation to providers of crypto-to-crypto exchange services providers and providers of financial services for ICOs.

NCAs across the EU should take particular heed of the EBA and ESMA reports when rushing to put in place their own regimes. They may soon have to make significant alterations to their regimes to comply with eventual EU regulation. These reports suggest such regulation is on its way.

A Speakers’ Corner is an area where open-air public speaking, debate and disclosure are allowed. The original and most noted is in the north-east of Hyde Park in London

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