Mark Caruana Scicluna & James Debono
Background
Following endorsement by the European Council in October 2022, the Markets in Crypto-Assets Regulation (MiCA) is now on track to create a harmonised, regulatory landscape for crypto-assets in the European Union (EU). MiCA, the first pan-national legislation worldwide for crypto-assets, applies to issuers of crypto-assets and service providers undertaking MiFID-like and other activities in relation to crypto-assets.
Whatever the perception, it is evident that crypto markets are an integral part of the international financial system. MiCA illustrates the EU’s objective to promote innovation while focusing on consumer protection, market integrity and financial stability. As a regulation, MiCA will be directly applicable throughout all EU member states – but Malta is not envisaging any major headaches given the framework introduced by the Virtual Financial Assets Act (VFA Act), way back in 2018. Service providers in Malta are expected to transition effortlessly from their current VFA licence to the new MiCA-compliant licence, giving our jurisdiction a competitive edge.
Classification under MiCA
Crypto-assets are defined in MiCA as a digital representation of a value or a right that may be transferred and stored electronically using distributed ledged technology (DLT) or similar technology. MiCA distinguishes between three categories of crypto-assets: (1) asset-referenced tokens (ARTs), (2) e-money tokens (EMTs) and (3) other crypto-assets.
Both types of stablecoins, namely ARTs and EMTs, require authorisation and the establishment of the issuer in the EU. Stablecoins are crypto-assets pegged against a reference asset (whether FIAT-backed, crypto-backed, commodity-backed, algorithmic or hybrids thereof). As with service providers, the authorisation of issuers will allow “passporting” across the EU. This means that if an issuer is authorised by the Malta Financial Services Authority (MFSA), the authorisation in Malta will be valid across the EU without the need of any additional authorisation in other EU member states.
MiCA is clear that the framework does not apply to assets falling within existing EU financial services legislation, particularly financial instruments covered by MiFID II, or even deposits, structured deposits, funds under PSD2 or insurance and pension products.
Asset-Reference Tokens (ARTs)
ARTs are defined as a type of crypto-asset that “is not an electronic money token” and that purports to maintain “a stable value” by “referencing to any other value or right or a combination thereof, including one or more official currencies”. MiCA highlights that ARTs could be widely adopted to transfer value or as a means of exchange and thus represent a more significant threat to market integrity and the protection of retail investors.
The issuer of an ART needs to be established in the EU and its whitepaper requires approval by the national competent authority, such as the MFSA, prior to being offered to the public. This does not apply when an ART will be offered solely to “qualified investors” (being, per se professional clients under MiFID II) or when the offer to the public is below a set threshold. The requirements of the whitepaper, and other sections of MiCA, shed further light on the characteristics of ARTs, particularly that:
- ARTs may lose their value in part or in full;
- ARTS may not always be transferable;
- ARTs may not be liquid;
- the holders of ARTs have a redemption right at any moment;
- redemption proceeds may be satisfied by funds other than e-money or in kind (that is, the asset referenced by the token);
- redemptions cannot be subject to any fees;
- yield/ interest is prohibited to reduce the risk that ARTs are used as a store of value; and
- ARTs require the establishment and maintenance of an “asset reserve”, which is segregated from the issuer’s estate and from the reserve of assets of other tokens.
The European Securities and Markets Authority (ESMA) has been mandated to publish guidelines on the criteria and conditions to distinguish between crypto-assets under MiCA (particularly, ARTs) and financial instruments under MiFID II. This is essential given that certain features of ARTs resemble those of financial instruments. While it is quite evident that tokens such Dai and PAX should qualify as ARTs, legal certainty will be necessary for the industry to understand whether regulatory implications arise under MiCA, MIFID II or otherwise in respect of other “non-conventional” or “security-like” tokens.
E-Money Tokens (EMTs)
EMTs are crypto-assets which aim to “maintain a stable value by referencing to the value of one official currency” and which should not be treated as deposits. To minimise regulatory arbitrage, MiCA aims to capture all crypto-assets which either classify as e-money (as such term is defined in Article 2(2) of EMD2 or Directive 2009/110/EC) or which share similar elements or a comparable function thereto. Akin to e-money, EMTs also emerge as digital alternatives to banknotes and coins, which are also commonly used for payment purposes.
Locally, the Financial Institutions Act (Chapter 376 of the laws of Malta) implements EMD2 which, in turn, defines e-money as “electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions as defined in point 5 of Article 4 of PSD2, and which is accepted by a natural or legal person other than the electronic money issuer”.
In a report published back in 2019, the European Banking Authority (EBA) had confirmed that for a DLT asset to qualify as electronic money, it must fulfil the below cumulative elements:
- be electronically stored;
- have monetary value;
- represent a claim on the issuer;
- be issued on receipt of funds;
- be issued for the purpose of making payment transactions; and
- be accepted by persons other than the issuer.
In this regard, MiCA adopted an all-encompassing approach to mitigate the possibility of bypassing EMD2 rules by ensnaring tokens analogous to e-money but which do not necessarily satisfy all the above cumulative elements set out by the EBA, and by setting a common set of regulatory obligations applicable for both types of tokens. While the regulation only allows credit institutions or electronic money institutions authorised under EMD2 to issue EMTs, it also mandates the same issuers to inter alia publish a crypto-asset white paper and notify it to their competent authority. Furthermore, MiCA imposes on such issuers the obligation to grant redemption rights to EMT holders, wherein each token would give rise to a claim against the issuer representing the underlying currency referencing the EMTs, and which could be exercised at any point in time, at par value. It is also key to note that under MiCA, so as to ensure that EMTs are used as a medium of exchange, as opposed to a store of value, there is a general prohibition on EMT issuers to grant interest in relation to EMTs, be it positive or negative interest.
Other Crypto-assets
This is a catch-all that comprises “all other crypto-assets” falling outside the two categories above (ARTs/ EMTs), including utility tokens, which are defined as crypto-assets that are only intended to provide access to a good or a service supplied by the issuer of the token. Issuers or offerors of these types of crypto-assets will not need to be authorised by the MFSA. However, a white paper and notification to the MFSA will be necessary prior to offering these crypto-assets to the public or seeking admission on a trading platform – unless certain exemptions apply.
Significant ARTs and EMTs
It is worth mentioning that, if an ART or EMT is classified as ‘significant’, specific provisions and additional regulatory burdens will apply. Here, the EBA will exercise supervision jointly with the relevant national competent authority. The classification of an ART or EMT as ‘significant’ will be based on transaction volume and frequency metrics.
Non-Fungible Tokens (NFTs)
Unique and non-fungible tokens (“NFTs”), including digital art and collectibles, are excluded from MiCA. However, whenever issued in a large series or split into fractional parts, these tokens may be considered to be fungible and fall within MiCA (or possibly MiFID II).
In a recent consultation document published by the MFSA in anticipation of MiCA, the Maltese Regulator, while seeking feedback from stakeholders prior to implementing changes to the VFA legislative infrastructure, has expressed its view that the conventional characteristics of NFTs (that is their uniqueness and lack of interchangeability) may act as a barrier for NFTs to be used for investment or payment purposes. The MFSA therefore asserts that regulating NFTs would deviate from and slightly jar with the objective which the VFA framework is seeking to achieve namely the regulation of issuances and MIFID-type services within the context of assets which are similar to traditional financial instruments. It is anticipated that, following the consultation exercise, the local regime would likely follow the logic behind MiCA and exclude NFTs from its supervision.
What’s next?
Following formal approval by the European Parliament and the Council, MiCA will be published in the EU’s Official Journal and enter into force after 20 days. A transitional period of between 12-18 months is subsequently envisaged for MiCA to become applicable. While MiCA is expected to take effect in 2024, the attention will be on the regulatory technical standards and guidelines to be issued by the EBA and ESMA.
Legal certainty, including a potential test similar to the “financial instrument test” established by the MFSA, will be key for the classification of crypto (and other) assets.
Since the previous tentative plan for the European Parliament to vote on MiCA during December 2022 has not been attained, it is anticipated that the supranational legislator will decide on the regulation during Q2 of 2023.
Mark Caruana Scicluna is a senior associate within Ganado Advocates’ investment services and funds team
James Debono is an associate within Ganado Advocates’ banking and finance team, assisting institutional as well as start-up clients on various regulatory matters, particularly in the fintech space, particularly payment and e-money institutions, credit institutions, blockchain and crowdfunding platforms