The European Securities and Markets Authority (ESMA) published its advice on Initial Coin Offerings (ICO) and Crypto-assets to the EU institutions which outlines the regulatory implications, gaps and issues in the rules when crypto-assets qualify as financial instruments and the risks that are unaddressed when crypto-assets do not qualify as financial instruments.
Based on the work of analysing the different business models with National Competent Authorities (NCAs), ESMA has identified the risks and potential benefits and how would they fit in the existing regulation framework.
Where crypto-assets qualify as MiFID financial instruments
- The Prospectus Directive (PD) and the Transparency Directive (TD) requires publication of a prospectus before the offer of securities to the public or the admission to trading the securities and disclosure of periodic and ongoing information about the issuers respectively. These rules apply where instruments are transferable securities, hence can be apply to ICO where the crypto-assets are offered to the public.
- In terms of trading platform, ESMA identified 3 categories of platforms. The preliminary view is that ‘platforms trading crypto-assets with a central order book and/or matching orders under other trading models’ are likely to qualify as multilateral systems and should operate under Title III of MiFID 2 as Regulated Markets (RMs) or under Title II of MiFID 2 as Multilateral Trading Facilities (MTFs) or Organised Trading Facilities (OTFs). Where the operators are ‘dealing on own account and executing client orders against their proprietary capital’, they would qualify as broker/dealers. Platforms that are used to ‘advertise buying and selling interests and where there is no genuine trade execution or arranging taking place’ may be considered as bulletin boards and fall outside of MiFID II scope.
- ESMA also discussed their view and advice on how crypto-assets apply to the Market Abuse Regulation, the Settlement Finality Directive and the Central Securities Depositories Regulation, Safekeeping and record-keeping, AIFMD and AMLD on money laundering and terrorist financing.
- ESMA points out that the existing regulatory framework was not designed with these instruments in mind, NCAs face challenges in interpreting the existing requirements and may cause inconsistency and create the risk of regulatory arbitrage.
- ESMA believes greater clarity around the types of services/activities and greater certainty around the concepts of settlement and settlement finality are needed. Moreover, risks of the underlying technology require new/enhanced requirements from the general novel cyber security risks to the more specific ensuring the protocol and smart contracts activities meet the minimum reliability and safety requirements.
Where crypto-assets do not qualify as MiFID financial instruments
- Where crypto-assets do not qualify as MiFID financial instruments, ESMA identified the most significant risks are potentially stemming from fraud, cyber-attacks, money laundering and market manipulation. To provide a protective and supportive approach to these instruments, ESMA believes that implementing a bespoke regime for specific types of crypto-assets is an appropriate action. ESMA believes the priority is that AML rules should apply to all activities involving crypto-assets and EU policymakers are advised to review the scope of AML requirements to take into account the providers of crypto-to-crypto exchange services and providers of financial services for ICOs. Also, an appropriate risk disclosure requirement should be in place, so that investors would be aware of the potential risks.
Some follow-up work will be needed on how the existing regulatory framework brings crypto-assets into scope and what requirements could be considered for crypto-assets outside the current regulatory framework. Since ESMA believes international cooperation is required, they will continue monitoring market developments and engage with global regulators.
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Please Note: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.