On February 26, 2019, Steven Maijoor, the Chair of the European Securities and Markets Authority (ESMA), delivered a keynote speech to the 3^rd Annual FinTech and Regulation conference in Brussels.  In his speech, he highlighted ESMA’s recent initiatives in the crypto-asset and distributed ledger technology (DLT) space and noted ongoing areas of focus.

• Media hype vs. reality. Maijoor noted that while there have been many interesting projects relating to DLT in financial markets, firms have yet to deliver on the technology’s promise.  Despite the media hype, whether firms will succeed in developing “killer apps” that revolutionize the financial markets and the degree to which they will displace traditional operators remains to be seen.  ESMA’s job, Maijoor noted, is to “remain objective, with an open mind but a critical eye” and to ensure that the technology is governed by a “clear regulatory framework” that supports “investor protection and orderly markets.”
• ICOs – potential benefits but severe risks.  Echoing ESMA’s prior statements on initial coin offerings (ICOs), Maijoor noted that ICOs offer “potential benefits as a new channel through which innovative businesses can raise capital.”  At the same time, however, they carry “severe risks … as they operate at the fringes of the regulated world” and cause harm to investors who too often “invest without understanding the risks” or are “taken in by outright scams.”
• Defining an EU regulatory framework for crypto assets. Maijoor highlighted ESMA’s January 2019 Advice to the European Commission, Parliament and Council, which discussed gaps and issues in the European regulatory framework for crypto assets and ICOs.
  • Legal qualification of crypto assets. ESMA’s starting point in the Advice was to examine the legal qualification of crypto assets under existing regulations.  In connection with the Advice, ESMA undertook a survey of EU national competent authorities asking them for their assessment of whether six recent examples of crypto assets would qualify as “financial instruments” under the Markets in Financial Instruments Directive (MiFID).  Maijoor noted that “most … national authorities agree” that “some crypto-assets, such as those with attached profit rights, are likely to qualify as MiFID financial instruments.”  On the other hand, many other crypto assets are likely to fall outside the current rules.
  • Crypto assets that qualify as “financial instruments”. Where crypto-assets qualify as “financial instruments”, Maijoor noted, “they should be regulated as such.” In many cases, “ICOs have raised large volumes because they have evaded certain regulatory requirements” and it remains to be seen whether the phenomenon will be sustainable once it is “brought within the regulatory remit.”  At the same time, Maijoor observed that existing regulation, while “meant to be technology neutral … was not designed with these new instruments in mind” and that there may be areas where the “nature of crypto-assets” requires “potential interpretation” or that specific requirements be “reconsidered” in order to ensure effective regulation.  ESMA’s January 2019 Advice examines in detail the potential implications of characterizing a crypto asset as a MiFID financial instrument under the Prospectus Directive, the Transparency Directive, MiFID, the Market Abuse Regulation, the Short Selling Regulation, the Settlement Finality Directive, the Central Securities Depositories Regulation, the Alternative Investment Fund Managers Directive, the Directive on Investor Compensation Schemes, and the Fifth Anti-Money Laundering Directive.
  • Crypto assets that fall outside the “financial instruments” definition. Where crypto-assets do not qualify as MiFID financial instruments, Maijoor noted that the absence of regulation “leaves consumers exposed to substantial risks.” To address these risks, ESMA’s Advice called for an extension of anti-money laundering rules to activities involving crypto-assets.  Moreover, “appropriate disclosure requirements” regarding the issuer, rights attached to the crypto-assets and related risks are needed to “ensure that consumers understand the risks of crypto-assets prior to investment.”
  • Bespoke regimes are premature. In its January 2019 Advice, ESMA noted that some Member States are considering “bespoke” rules at the national level for crypto-assets that do not qualify as financial instruments.  Noting that bespoke regimes would not provide a level playing field across the EU, ESMA’s Advice called for an EU-wide approach.  In his speech, Maijoor reiterated ESMA’s belief that efforts to create bespoke regimes are “premature” and may “risk legitimizing crypto-assets and encouraging greater participation” at a time when the phenomenon is still too novel, making it difficult to design a framework that adequately protects “the integrity of the capital markets” and is “flexible enough to capture the variety of risk factors” associated with different types of crypto assets.
• Unsolved problems: keys, forks and coding errors. Maijoor highlighted the application of custody and safekeeping rules to private keys, risks associated with “forks” and coding errors in the DLT protocol and smart contracts, as three particularly challenging areas ESMA believes require further examination.
• Looking ahead. ESMA will continue to monitor crypto assets and DLT developments to work with national authorities to “support a convergent approach to the supervision of crypto-assets” including their “legal qualification.”  ESMA will also actively cooperate with regulators internationally via IOSCO and the FSB as it believes international cooperation is required to address the global phenomenon.  Maijoor also highlighted ESMA’s forthcoming “EU Innovation Network” initiative, to be launched in April 2019.  Through this initiative, ESMA hopes to facilitate sharing of best practices and promote regulatory convergence in response to the DLT and other initiatives of national innovation hubs and regulatory sandboxes.

+ + +

Maijoor’s remarks, following on the publication of the ESMA Advice and the EBA Report on crypto-assets in January 2019, further emphasize the focus of EU regulators on the crypto-asset market.  Where the initial response to crypto-assets among EU regulators took the form of generic consumer warnings, EU regulators are increasingly turning their focus to clarifying which crypto-assets fall within or outside existing EU regulations.

For crypto-assets that fall within existing EU regulations, structuring ICOs to comply with the existing regulations will present challenges, and the regulators have put down a marker for possible future enforcement.   For crypto-assets that fall outside existing EU regulations, the question remains open whether or how quickly the EU will move in the direction of developing an alternative, bespoke EU regulatory framework for crypto-assets.

Pending action at the EU level, some countries in Europe are moving ahead with plans to fill the regulatory void by adopting bespoke regulations at the national level.  Malta adopted bespoke regulations for ICOs and DLT-related activities in July 2018, Gibraltar adopted a DLT regulation in January 2018 and announced plans in February 2018 to adopt ICO regulations, and bespoke regimes are currently under consideration in France and Liechtenstein.  France’s proposed regime, embodied in a draft law currently under consideration by the French parliament and highlighted by the head of France’s Autorité des marchés financiers in a speech at the Brussels conference, would adopt an innovative ‘optional regulation’ approach centered around an optional AMF visa/approval for ICOs and an optional crypto asset service provider license (mandatory licenses would be required for certain specific services). By offering a tailored and more flexible framework than the existing EU regulation for financial instruments, France aims to fill the legal vacuum with a new regime that achieves investor protection, while avoiding an overly-prescriptive framework that inhibits innovation.

The degree of success these bespoke national efforts will have in promoting a vibrant ICO market remains to be seen, particularly in the absence of a guarantee that the determination by one EU national regulator that a crypto-asset is not a financial instrument under existing EU regulation will not be reopened by regulators elsewhere in the EU.  As the survey of EU regulators accompanying the ESMA Advice makes clear, a clear consensus has yet to emerge among EU national competent authorities as to which crypto-assets qualify as financial instruments or the criteria for making that determination.  In ESMA’s survey of EU regulators, of the 29 regulators that responded to the survey, 8-9 believed that three of the six sample crypto-assets were financial instruments, four believed that none of the sample crypto-assets were financial instruments, and 15-16 declined to offer a view.