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The Chimera of Legal Certainty under the proposed Regulation on Markets in Crypto-Assets (MiCA)

The European Commission published its new Digital Finance Strategy (DFS 2020) on 24 September 2020 and it provides a very broad and comprehensive framework for future reforms to further the development of digital finance in the EU. As part of the DFS 2020, the European Commission also presented a daring and ambitious draft Regulation on Markets in Crypto-Assets (MiCA). Aside from other risks which were identified by the Commission, to substantiate the need for an EU regulation, one of the biggest issues cited in the official impact assessment document was legal certainty.

“Without certainty, start-ups and developers working in this field will not be able to attract the required investments. For instance, the potential mis-qualification of some utility tokens as “financial instruments” under MiFID2 can be unattractive for developers seeking to innovate. Similarly, without clarity on applicable rules, incumbent financial institutions and market infrastructures are unlikely, and sometimes unable, to pursue developments in this field[1]

MiCA thus, is heralded as the possible solution for the above impasse and aims to cover utility tokens, payments tokens, asset-backed tokens and stable coins including significant/global stable coins. Truth be told, MiCA is also the EU’s knee jerk response to Facebook’s Libra proposal of June 2019 and the intended legal certainty, unless amended, will remain a chimera.

Under MiCA we have a five-pronged regulatory approach being suggested:

  1. Rules applicable to crypto-assets similar to or even potentially being, payment instruments and e-money, including stable coins,
  2. Rules applicable to all the other crypto assets that are not already within the scope of existing EU financial markets legislation, including utility tokens,
  3. Rules for an adapted crypto assets prospectus regime, with the issuing of e-money tokens, asset-referenced tokens and the other crypto-asset services,
  4. Providing a negative scope for the non-applicability of investment and securities tokens, as these will be covered by existing EU financial and securities law (including the Prospectus Regulation, the MiFID, UCITSD and AIFMD),
  5. Stepped supervisory approach including a supra national approach, to the effect that while supervision of crypto-asset service providers will rest with national competent authorities, supervision of significant asset-referenced and e-money tokens will rest mainly with the European Banking Authority (EBA).

Lets start with the suggested definitions. Article 3 sets out the terms and definitions including ‘crypto-asset’, ‘issuer of crypto-assets’, ‘asset referenced token’, ‘e-money token’, ‘crypto-asset service provider’, ‘utility token’ and others. The definitions, particularly ‘crypto-asset’ are open ended and  offer no concrete guidelines or a systematic harmonised approach that each competent authority in the EU will need to follow. To this end, as MiCA stands, it will be left to each member state to interpret these and in certain instances  ( example as is then case for crypto assets) only apply their tests ex-post or rely on the findings of legal opinions by third parties. This is a serious shortcoming, as failure to ensure that the asset determination is harmonised and accurate, subject as well to ex-ante review may result in abuse and also incorrect treatment of such assets and give rise to divergent determinations between member states, wrong determinations by the industry, uncertainty on AML application, risks of ex-post reclassification of tokens, and also forum shopping within the EU.

The above is further exacerbated, as MiCA does not clearly delineate between usage tokens subject to MiCA and investment tokens subject to EU securities law. It is also worth noting that the definitions we have under EU securities law are also problematic. This was also as highlighted by European Securities & Markets Authority (ESMA) in an advise to the EU Commission in January of last year[2]. ESMA found serious concerns with the divergent definitions and use of financial instruments, transferable securities, financial, commodities and derivatives under MiFID II & MiFIR.

Thus, simply providing a negative scope for the application of these provisions under MiCA (with the existing problematics and also without having a specific exclusion that any tokens or crypto assets as might be captured by MiCA will not be captured by the EU Financial and securities law) will not imbue any legal certainty, but on the contrary, it will add to the nebula of uncertainty in the market and have a severe impact on market integrity.

Certainty here and harmonised coherent determinations are crucial because they will also potentially effect whether an issuer, should look at the Prospectus Regulation, whether he needs to prepare a white paper under MiCA, what kind of white paper is needed, (as requirements of a whitepaper will vary depending on the type of token) , for example in case of e-money tokens or other crypto assets there is no pre-approval by competent authorities. In the case of a whitepaper relating to asset-referenced tokens it must be approved by the relevant national competent authority as part of the licencing process, prior to publication. Unless this is resolved, it will also have a detrimental effect on the envisaged passporting rights under MiCA in the EU.  Ultimately as I will also expand hereunder, in instances where there is no ex-ante mechanism for a competent authority to assess the correct categorisation of the token, the users and consumers will also be affected and they will ultimately bear the brunt.

One must also be very cautious on the prudentiary regime, being promoted under MiCA. Whilst the proposed regulation imposes an obligation on issuers of crypto-assets to publish the white paper with mandatory disclosure requirements, this will not apply in the following instances as provided in Article 4(2), where :

(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.

In such instances there is also no need to have a legal entity established (my emphasis). Similarly, in instances of issuers of crypto-assets, other than asset-referenced tokens or electronic money tokens, established in a third country there is no requirement for a legal entity to be established in the EU when providing the services in the EU.

Whilst I can understand that this is a nascent industry and innovation should not be stifled, we must also calibrate the risks vs opportunities when imbuing proportionality into a regulation. The crypto asset industry which is now subject of a proposed regulation under MiCA, has been fraught over the past years with a myriad of fraud cases, failed ICOs and lost investments because of the unregulated and highly volatile sphere of crypto. To this end I cannot agree with the justification put forward under MiCA, that this is required because it reduces the administrative burden for the competent authorities.[3]

Added to the above, consumers and users will also be affected, if the current proposal of not mandating at least a legal entity in the cases cited before subsists. Without a legal entity in the EU, the target of supervision is stultified and the possibility of intervention by the competent authorities is severely hampered. This will also handicap the rights of consumers and users in the EU, leaving limited and/or disproportionate access to remedies or enforcement of liabilities.

Whereas MiCA takes several inputs, including the notion of the white paper from the Prospectus Regulation, MiCA here is also departing from certain tenants under the same Regulation. Contrary to the requirements under the Prospectus Rules in certain instances, the white paper under MiCA is not subject to ex-ante preliminary checks or approval by the competent authorities. MiCA also introduced lower thresholds for the exemption of publication of the white paper. Whilst the Prospectus Regulation exempts issues of transferable securities from publishing the prospectus if the volume of the issuance of transferable securities does not exceed EUR 8 million, under MiCA this has been reduced to EUR 1 million.  As I mentioned earlier, the justification for this measure stems from the need not to over burden the competent authorities, its not risk based and also unjustly discriminates issuers of transferable securities.

I also fail to see how consumers’ rights and legal certainty will be ameliorated with MiCA when as mentioned before, the respective competent authorities in certain instances will not assess or approve ex-ante a determination of a token nor their white papers. As I mentioned earlier, this will open the flood gates for multitude divergent interpretations on tokens and assets as well as the ex-post modifications of these tokens and assets by the competent authorities, when they are already issued to consumers and users and when they are in circulation. We will also have the same scenario with those white papers who did not necessitate any form of ex-ante vetting or approval, as these can also be altered ex-post  by any competent authority during their life time, potentially affecting the rights of consumers and users as well as their perceived investments.

If MiCA is not amended, I fear that legal certainty here is more of a chimera, and the only certainty we can vouch for is a fragmented and destabilised market, which will stifle innovation and result in great detriment for consumers and users potentially leaving them in a catch twenty-two situation.

Dr Ian Gauci is the Managing partner at GTG Advocates, Afilexion Alliance & Caledo Group. He lectures Legal Futures and Technology at the University of Malta.

This publication is provided for your convenience and does not constitute legal advice.

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[1] COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets and amending Directive (EU) 2019/1937 Pg.12

[2] ESMA, Advice – Initial Coin Offerings and Crypto-Assets, 9 January 2019, ESMA50-

157-1391.

[3] Pg 9 of the proposed MiCA regulation.