MiCA and eWpG: Overview and Summary of the latest regulatory developments for digital assets in the financial industry
A comprehensive summary of what 2020 brought in going towards the massive adoption of digital assets in the financial industry.
2020 has been an unusual year for everyone. The global economy has been shocked unprecedentedly, but the markets’ resilience has set a pace for the necessary transformation that the financial industry needs: digitalization.
This urgency has been pivotal for digital assets, and this year has been of particular importance for this increasingly relevant asset class. Big innovations for the industry, derived from the use of Distributed Ledger Technology (DLT), have been central topics of conversations among experts and market players. Thus, the regulatory perspectives have been promptly developing in response to the market’s evolution.
Progressively, different jurisdictions have introduced a more coherent and comprehensive framework of legal and regulatory perspectives regarding digital assets. Recent publications by the UK Financial Action Task Force (FATF), the Financial Stability Board (FSB), the German Federal Ministry of Justice and Consumer Protection, jointly with the German Federal Ministry of Finance, and the EU regulatory authorities — amongst many others — have helped build an evolving consensus on the importance of embracing these technological improvements for the industry.
Choosing DLT as the underlying technology deployed to support digital assets has the potential to reshape traditional capital markets’ practices and roles. Particularly considering the shared structure that can be managed and controlled jointly by separate entities at the time. This, although it leaves behind the redundancy of reconciliation processes, implies a fundamental transformation of the core systems currently supporting financial market infrastructure. Thus, it essentially casts legal and regulatory implications. In particular, the technical component and the shared responsibility that requires clear rules and standards in terms of infrastructure, security, and governance (Cambridge Centre for Alternative Finance — CCAF, 2020).
Information carries power, and we are committed to delivering digital success. For us, 2020’s regulatory developments empower further the business opportunities within the financial industry, and we want to spread the information about the upcoming changes that will arise with these legal enhancements.
Here we are presenting an overview of the European development towards digital assets. This year, both the German and the European Commission’s regulators acknowledged further the issuing, custody, delivery, and transferability of digital assets.
Early on in the development of the cryptocurrency investments and the DLT-supported transactions, Germany has paid close attention to consumers’ needs. Almost ten years ago, from December 2011, the Federal Financial Supervisory Authority (BaFin) recognized Bitcoin (extended to other cryptocurrencies) as financial instruments (units of account). With this, the German regulators ensured consumer protection, requiring a license for service providers of transactions involving payment, as they were covered as banking / financial services.
In September 2019, after the BaFin authorized the first STO (January 2019), the German Government released a Blockchain Strategy including the potential technological developments of the financial sector. With more legal certainty for trading platforms and crypto custodians, this strategy focused on opening the regulatory path for electronic securities and the public offering of certain digital assets (crypto tokens).
This year there was a rapid development in the German financial sector driven by several pieces of legislation that are opening the primary markets to digital processes backed on DLT.
In January 2020, the German regulators amended the Banking Law (Kreditwesengesetz — KWG), specifically defining crypto assets as financial instruments. With this amendment, Germany introduced mandatory licensing for the custody of crypto assets and crypto keys, specifying the necessary observance of Know-Your-Customer (KYC) and Anti-Money Laundry (AML) rules in all transactional procedures.
Later, in August, the draft bill for digital securities (Gesetz zur Einführung digitaler Wertpapiere — eWpG) addressed the digitalization of bearer bonds (Inhaberschuldverschreibungen), a broadly used financial instrument.
This piece of legislation opens the door for the potential issuance of all types of financial instruments as security tokens. Starting next year (end of 2021), the German market will be able to legally adopt tokenization. It presents new possibilities for issuing securities without issuing deeds (“Wertpapierurkunde”) and through digital registries. Hence, it paves the way towards fully scriptless securities.
Although the presented draft only addresses bearer bonds, most of the commonly issued security tokens have the character or equity-like investments: They aim to participate the investors in the growth of the company’s value and do not usually offer them voting rights nor a fixed rate. For which this type of digital securities can be understood as profit participation certificates (Genussscheine). Profit participation certificates are regularly bearer bonds.
Many business cases of tokenized securities can be done entirely compliantly thanks to this new regulatory advancement. In Germany, bearer bonds can be, in general terms, (i) Bundesanleihen; (ii) Wandelanleihen; (iii) Pfandbriefe and (iv) Zertifikate. Through these instruments, one of the most critical benefits of tokenization fulfills perfectly its purpose: generating liquidity for the issuer.
Further, issuers will be able to decide whether the security will be issued through a Central Security Depository (CSD) or an Electronic Security Depository (ESD). The term electronic security depository or crypto registry refers explicitly to a decentralized and immutable ledger system, recognizing DLT as a registry for crypto securities.
For these new digitally issued securities, the German regulators also introduced a clear enacting legal framework. Custody of such securities will fall under the new crypto custody license regime (“Kryptoverwahrgeschäft”). Additionally, a CSD license is not required.
Maintaining an Electronic Security Depository (ESD) and providing related services will fall under the German Banking Act (“Kreditwesengesetz — KWG”) and hence will require service providers to obtain a license. Based on our understanding, this also means controlling Smart Contracts (owning the private keys) representing the digital security or crypto security on, e.g., a permissionless platform such as Ethereum.
Moreover, the new regulation requires settlement finality for transactions. However, it is not explicitly mentioned how the current Proof-of-Work algorithms will be interpreted under the new law.
The most interesting aspect of this draft is the concept that issuers can decide whether they want to appoint a Central Securities Depository (CSD) or Electronic Securities Depository (ESD). The magnitude of potentially applying this to stocks and transfer agents of Investment fund units is unprecedented.
Ensuring investor protection, digital issuing of securities will completely revolutionize the market, allowing for more significant traction and lower transaction costs. Partnering with technology providers that can guarantee not only the required infrastructure to follow the specific business-logics for security issuing and lifecycle management but also a compliant investor onboarding including KYC/B, according to Anti-Money Laundry Directive (AML), MiFiR, and the Money Laundering Act (Geldwäschegesetz — GwG), its crucial.
Now, more than ever, taking the opportunity can mean taking the lead in the years to come or let it pass and stay behind. micobo continually works to develop and improve the tech infrastructure needed to unfold all the potential of tokenized assets.
In February 2018, the European Securities and Markets Authority (ESMA) got involved in the digital assets discussion. The European authority stated that the common supervisory lay is technology-neutral, for which rules mandating financial instruments should also be extended to digital securities (“substance over form”).
After a long open consultation period, the European Commission (EC) released a proposal of a new Digital Finance Package that aims to transform the European economy in the coming decades, improving the financial industry through the use of technology.
The package published in September 2020 has as objective the improvement of the competitiveness of the continent’s Fintech sector while mitigating economic risks and ensuring consumer protection.
Importantly, this novel European regulatory framework also includes a comprehensive crypto-asset package, comprising two legislative proposals that are of direct relevance to stakeholders in the European blockchain industry.
- Regulation on Markets in Crypto Assets (MiCA), which creates a pan-European regulatory regime for crypto-assets and related services.
- The pilot regime for market infrastructures based on distributed-ledger technologies, which creates a safe space for testing innovative DLT-based financial market infrastructures in the European Union (EU) for five years (sandboxing). This innovative approach aims to test trading and settlement transactions in financial instruments using crypto-assets.
With this regulatory development, the Digital Assets’ ecosystem can grow strongly with institutional support.
The EC’s proposed package enhances the current digital assets ecosystem by:
- Creating a bespoke regulation that covers all crypto and digital assets previously in the grey area, whether they qualify as financial instruments (under some stricter national regimes), or as e-money, or were previously unregulated. The regulation in particular creates clear rules for Initial Coin Offerings and Initial Exchange Offerings alike.
- Providing a pragmatic, innovation-friendly regulatory regime that calibrates transparency requirements and administrative complexities according to risks. The proposed legislation is therefore significantly lighter for utility tokens and payment tokens than certain stablecoins that are significant enough to affect market integrity and monetary sovereignty.
- Clarifying which regulations apply to which types of crypto and digital assets (taxonomy). The proposed regulation creates a clear framework for all types of crypto-assets. Notably, the regulation recognizes that crypto-assets can be a vast variety of things, from an access key to a service to a payment tool, to a digital representation of a security, to some hybrid thereof.
- Introducing harmonization within the EU member states. The regulation pulls an initiative to arrange all existent regulations, to create a comprehensive and cohesive framework for the single market. Among others, it introduces an EU passporting to open operations in all EU territory once a service provider has a license in one of the member states.
Further, the European Central Bank (ECB) officially released its intention of developing a digital Euro, after years of research on the feasibility of Central Bank Digital Currency with their Stella project. This development is a keystone for fully digital capital markets infrastructure.
Markets in Crypto-Assets Regulation (MiCAR) — MiCA Summary
As a regulation, this legislation piece will directly apply to all member states once the trialogue process is completed, contrary to the usual “softer” measures taken as directives that need to be implemented internally in each member state. Acting on the different national responses towards digital assets creating wide market fragmentation, the EC opted to create an alike “MiFiD/MiFiR framework” for crypto-assets to harmonize the regulatory requirements for digital assets within the EU.
The 168-page document focuses strongly on regulating gaps in the existing legal frameworks. This ambitious EU-wide legislation rules hitherto unregulated crypto-assets and stablecoins, as well as crypto-asset service providers, introducing a passport for providing crypto-asset services across the European single market.
The most important goal set by the Commission with this regulation is to ensure European consumers safe access to digital assets (DLT-based/crypto) without compromising market stability. Importantly, the regulators of the single market are recognizing the need for more cutting edge investment products, and are aware of the competitive advantages that it brings, while being careful with the potential risks of assets like stablecoins.
The MiCA regulation proposal comprehensively covers:
- the regulation of crypto-assets to be offered to the public or admitted to trading on a trading platform in the EU (Title II-IV)
- the regulation of crypto-asset service providers (Title V)
- a market abuse regime for crypto-assets admitted to trading on a trading platform operated by a crypto-asset service provider (Title VI)
- a mechanism for the oversight of material acquisitions in respect of issuers of asset-referenced tokens (stablecoins) crypto-asset service providers (Title VII).
The regulation draft states in its Article 3 (2) a broad legal definition for the concept of “crypto-asset”: “a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.” With this, the EU legislators aim to avoid a regulatory overlap by taking out crypto-assets that are otherwise regulated as financial instruments, e-money, deposits, structured deposits, or securitizations (Article 2).
Further, it establishes a crypto taxonomy framework that clarifies the previous classifications given by the ESMA and European Banking Authority (EBA). The MiCA regulation proposal introduces 28 digital asset-related definitions (Article 3). With this, it also establishes separate frameworks in respect of three distinct categories of crypto-assets: e-money tokens, asset-referenced tokens, and other crypto-assets.
a digital representation of value or rights that may be transferred and stored electronically, using distributed ledger technology or similar technology.
“distributed ledger technology.”
a type of technology that supports the distributed recording of encrypted data
type of crypto-asset which is intended to provide digital access to a good or service, available on DLT, and is only accepted by the issuer of that token.”
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.
“electronic money token” (“e-money token”)
a type of crypto-asset, the main purpose of which is to be used as a means of exchange and that purports to maintain a stable value by referring to the value of a fiat currency that is legal tender.
“crypto-asset service provider.”
any person whose occupation or business is the provision of one or more crypto-asset services to third parties on a professional basis.
The MiCA regulation proposal also casts an exhaustive definition of the financial services providers relative to digital assets. Which determines specifically which FinTech firms would need to comply with this new regulation (Article 3):
(9) ‘crypto-asset service’ means any of the services and activities listed below relating to any crypto-asset:
(a) the custody and administration of crypto-assets on behalf of third parties;
(b) the operation of a trading platform for crypto-assets;
( c)the exchange of crypto-assets for fiat currency that is legal tender;
(d) the exchange of crypto-assets for other crypto-assets;
(e) the execution of orders for crypto-assets on behalf of third parties;
(f) placing of crypto-assets;
(g) the reception and transmission of orders for crypto-assets on behalf of third parties
(h) providing advice on crypto-assets;
Crypto-asset issuers meeting the conditions laid down in the applicable regime scheme will be permitted to offer/sell these crypto-assets to the public or admit them to trading anywhere in the EU. Vice versa, anyone worldwide who issues crypto-assets that could be subscribed to in the EU could be subject to these legal conditions (Title II).
Following a cohesive financial regulatory framework, it extends legal requirements from the traditional financial instruments. For instance, just like the mandatory prospectus before the issuance of securities to the public, issuers of all MiCA crypto-assets will be required to first publish a whitepaper (in English or an EU state’s official language), which must contain the core information on the characteristics, rights and obligations, and underlying technology and project (Articles 5–8).
The burden of the whitepaper shall not apply where the digital securities are to be offered to only qualified investors or less than targets only qualified investors or less than 150 investors per member state; do not exceed 1 million Euros (USD 1.17m) in a one year period, trades free crypto-assets (“airdrops”), unless recipients have to provide personal data or the issuer earns Commission or benefits from other parties; issues mining rewards or issues crypto-assets already previously available in the EU (excluding stablecoins) (Article 4.2):
(a) the crypto-assets are offered for free;
(b) the crypto-assets are automatically created through mining as a reward for the maintenance of the DLT or the validation of transactions;
( c) the crypto-assets are unique and not fungible with other crypto-assets;
(d) the crypto-assets are offered to fewer than 150 natural or legal persons per Member State where such persons are acting on their own account;
(e) over a period of 12 months, the total consideration of an offer to the public of crypto-assets in the Union does not exceed EUR 1 000 000, or the equivalent amount in another currency or in crypto-assets;
(f) the offer to the public of the crypto-assets is solely addressed to qualified investors, and the crypto-assets can only be held by such qualified investors.
MiCA also introduces a new authorization requirement for anyone seeking to provide crypto-asset services in the EU, as stated in Article 3.9. For instance, in relation to custody, trading, exchange, brokerage, promotion, or advice around digital assets matters.
These service providers have to be authorized in an EU member state for the services it wishes to undertake. For this purpose, it needs to establish a registered office in that state. An authorization provided by one EU member will be valid across the EU (passport).
A list of general specifications, as well as the particular additional requirements related to the specific services they offer, must be complied with by approved service providers.
By 2024, the plausible year on which this regulation will come into force, many FinTech players will have to adapt and start adopting robust measures to comply with all the specifications.
Anti Money Laundry Rules
Last but not least, within the European single market, all financial participants need to comply with the anti-money laundry rules in place. Relative to the digital assets’ sphere, these extend their applicability, for which money laundering regulations must be implemented in the same way as for fiat money, both at EU/EEA level and in Switzerland. These rules have been fed by the FATF recommendations, reflecting on the content of the 5th EU Anti-Money Laundering Directive, which has also been implemented into national law by the respective EU member states.
This legal revision certainly shows the potential of business conducting in the realm of digital assets. The institutional and regulatory backup that has been forming in recent years confirms new technologies’ potential to empower the financial industry.
micobo is committed to delivering the best technological solutions for the new era of digital capital markets.
Reach out to learn what tokenization is on blockchain and how it can benefit your business.
micobo GmbH is a leading European software company for Security Token Offerings and Blockchain Software Development (DLT). micobo provides fully compliant software solutions for Security Token Offerings and advises on structuring DLT- and Blockchain-based Securities.
Luisa Blandon (email@example.com).