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A Tale of Three Regulators: the EBA, ESMA and FCA guidance on cryptoassets

A Tale of Three Regulators: the EBA, ESMA and FCA guidance on cryptoassets

  • United Kingdom
  • Financial services and markets regulation
  • Financial institutions

14-02-2019

Introduction

In the space of three weeks, three regulators published guidance documents on cryptoassets. The most recent is the FCA’s consultation paper on the extent to which cryptoassets fall within the regulatory perimeter. This followed on the heels of the EBA and ESMA publishing their latest advice on the topic, following a call by European Commission Vice President Dombrovski for a deeper analysis of the future of the crypto space. The guidance these regulatory bodies have issued is inevitably coloured by the roles they play in the regulatory landscape, leading to subtle differences in approach:

• FCA’s Guidance on Cryptoassets (23 January 2019), click here.

• ESMA’s Advice on Initial Coin Offerings and Crypto-Assets (9 January 2019), click here.

• EBA’s Report with advice for the European Commission: Crypto-assets (9 January 2019), click here.

Categorising cryptoassets

All three documents seek to advance an approach to classification of crypto-assets as an asset class, though the EBA advice is more confident in its explanation.

A common theme of recent publications by major regulatory bodies has been an attempt to categorise digital assets, though not always to the same level of success. While the three authorities all tend seek to divide crypto assets into three categories, based on token functionality, they take overlapping but slightly different approaches to what these categories should be:

(1) The EBA / ESMA “Payment Token” is defined in a very similar way to the FCA’s “Exchange Token”, and this token type is recognised by each of the regulators as tokens providing a means of exchange

(2) The EBA / ESMA “Investment Tokens” are most similar to the FCA’s “Security Tokens”, however whereas the EBA / ESMA focus on whether the token provides rights, the FCA focuses on whether these meet the definition of a Specified Investment or a Financial Instrument

(3) All the regulators refer to “Utility Tokens”, which are commonly agreed as being tokens which enable access to a product or service

Same difficulties, different regulatory approaches

The different regulatory authorities each consider their competency to regulate cryptoassets, however do so from different perspectives.

The FCA, reflecting its role in protecting consumers and markets, starts by analysing the potential harm that cryptoassets could have to both of these. The FCA then seeks to set out guidance to firms regarding interaction between different token types and the regulatory perimeter.

The EBA’s focus is on the extent to which cryptoassets could fall within the scope of existing EU legislation in line with its own competencies. Therefore, the EBA analyses whether crypto-assets qualify as either ‘electronic money’ within the scope of EMD2 or as ‘funds’ under PSD2.

ESMA’s focus is on the extent to which cryptoassets might be classified as financial instruments under EU financial securities law.

The regulatory map

All the regulators examine cryptoassets against the broader regulatory map. In particular it is worth noting the following areas:

EMD2

The authorities assessed whether there may be cases in which a cryptoasset qualifies as e-money according to the criteria found in Article 2 (2) EMD2 and concludes that there are circumstances in which this will be the case.

Where a cryptoasset is electronically stored, has monetary value, represents a claim on the issuer, is issued on receipt of funds, is issued for the purpose of making payment transactions and is accepted by persons other than the issuer then it would be considered e-money and be subject to existing regulatory practices.

PSD2

Tokens are considered not to fall under the definition of ‘funds’ found in PSD2, as they are not banknotes, coins or scriptural money. Therefore they consider PSD2 would only apply to firms using cryptoassets qualifying as e-money to carry out payment services listed in Annex I to PSD2.

MiFID II

ESMA has endeavoured to determine whether any cryptoassets might be considered ‘financial instruments’ under MiFID. To this end ESMA has undertaken a survey and considered that the proportion of tokens in scope might represent between 10 - 30% of cryptoassets – a rather large variance. This broadly aligns with the FCA’s analysis which determines that its category of ‘Security assets’ are ‘Specified Investments’, thereby falling within the regulatory perimeter. It is important to note here that the term ‘Specified Investment’ will capture more than is captured under MiFID, leading to subtle distinctions in approach.

For those cryptoassets within scope the implications are far reaching. EU securities laws are complex and touch on a huge range of matters. Trading platforms in particular should consider whether MiFID II requirements apply.

MLD and other AML laws

All of the authorities consider that AML laws will touch on cryptoassets and recommend that AML regimes are updated to take proper account of emerging technologies.

Other relevant areas

The following legal provisions might apply to tokens within the regulatory perimeter: the Prospectus Directive, the Transparency Directive, the Market Abuse Regulation and Short-Selling Regulation, the Settlement Finality Directive and the Central Securities Directive and AIFMD (should, as some authorities suggested, certain assets be considered units in collective investment undertakings).

The bigger picture

According to the authorities existing EU regulations would therefore only apply to cryptoassets considered to be e-money or financial instruments, leaving a potentially large class of assets outside the scope of EU law. Both go on to make a case for legislation at the EU-level, due to burgeoning divergence in the treatment of crypto-assets by different Member States.

One of the key drivers of ESMA’s advice is to fill in the gap between the treatment of financial instruments and cryptoassets which fall outside the regulatory framework. This makes sense, particularly with regard to trading, settlement and custody, and to the extent that the framework applies to ICOs and other similar forms of fund raising. However, if the regulatory regime is applied more broadly, to the conduct of tokens in general, then, given that there are different types of tokens fulfilling different purposes, there is a risk that the regime favours some tokens over others. In addition, for tokens which act as vouchers to an underlying asset, there is a risk of regulatory arbitrage between selling the underlying asset and a token representing that asset.

The FCA approach is broadly in alignment with the European position, however given that particularly post-Brexit there are indications of a possible divergence of approach. It may well be that companies can capitalise on this from a regulatory arbitrage perspective.

Next Steps

The FCA, concerned with consumer protection, will consult on a possible ban on the sale of derivatives referencing certain types of cryptoassets and its current consultation period will close on the 5th April.

Both European supervisory authorities have called upon the European Commission to consider the possibility of harmonisation. ESMA advocates for a bespoke regulatory regime to apply to cryptoassets outside the scope of existing EU rules, details of what this would look like are not yet forthcoming.

Firms should also note that Her Majesty’s Treasury (HMT) will be publishing a consultation paper in early 2019 on exploring legislative change to potentially broaden the FCA’s regulatory remit to bring in further types of cryptoassets.

How Eversheds Sutherland can help

We have an award winning crypto assets practice, with our work being “Highly Commended” at the Financial Times Innovative Lawyers Europe awards 2019, and were runners up for the Banking and finance Team of the Year with the British Legal Awards (Legal Week).

Since advising on the first successful initial coin offering in the United Kingdom, we have been at the forefront of advising firms on crypto assets, blockchain and the FCA sandbox process, and were the only law firm to submit evidence to the Commons Select Committee.

We take a flexible approach to providing advice, taking a cross-sectoral and practical approach tailored to the diverse needs of our clients.

For more information contact

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