Crypto-asset regulation in the EU

The combination of increased digitalization in financial services and geopolitics have increased the focus on crypto-asset regulation not only in the EU but globally. This has been the case for regulators, supervisors, policy-makers, retail and institutional investors alike. But there seems to be a consensus that a clear and technology agnostic regulatory framework would be welcomed by all concerned.

The EU’s main proposed legislation, known as the regulation of Markets in Crypto-assets(MiCA)[1], is now progressing at pace in the EU’s legislative institutions (the European Parliament and the Council of the EU) but a lot of work remains before the legislation can be finalized and ultimately applied. Below we look at recent developments at the EU level and what financial institutions should be looking out for soon.

Where we stand now in the EU

Regulating crypto-assets has been a key concern for EU institutions in the last couple of years. This started with the European Commission (“Commission”) when it proposed MiCA and the Distributed Ledger Technology pilot regime (DLT pilot regime) in Q3 of 2020 with the aim to bring all crypto-assets and service providers within the perimeter of the EU’s financial services regulatory framework. The chart below provides a good illustration of how different crypto-assets could fall within the EU’s current regulatory framework according to the Commission and it also emphasizes the respective scopes of both MiCA and the DLT pilot regime.

Source: Digital Chamber of Commerce

MiCA constitutes an expansion of the EU’s regulatory perimeter with important and complex associated policy considerations such as consumer protection, money laundering, financial stability, and monetary sovereignty to name a few. As co-legislators, both the European Parliament and the Council of the EU will need to come to a common agreement for MiCA to be finalized and applicable throughout the EU.

In months preceding the start of the war, a number of supervisors in Europe, such as the European Central Bank, the European Systemic Risk Board, and the European Securities Markets Authority (ESMA) had published on related issues such as money laundering risks, transaction transparency, financial stability risks and consumer protection to add to the European policy debate and regulatory considerations surrounding crypto-assets.

But then geopolitical tensions arising in Europe and successive waves of sanctions have led to a new sense of urgency towards regulating crypto-assets. This arguably has been a catalyst for MiCA, as major jurisdictions (including the EU) focused on enhancing oversight and supervision of the crypto-asset market.  

Regulating with a sense of urgency

With sanctions in full force, work in the European Parliament accelerated. So far, Members of Parliament (MEPs) have agreed to include more environmentally friendly technologies, such as proof-of stake, to the EU’s Taxonomy for sustainable activities. Though this element has been resolved, concerns over the energy impact of crypto-assets are here to stay and the matter is expected to be considered by regulators and supervisors globally. On 14 March 2022, white smoke came out of the European Parliament as MEPs in the committee leading on MiCA agreed on their position.

But the journey isn’t over yet. As the EU’s co-legislators, the European Parliament and the Council of the EU, prepare to enter into negotiations to come to a common agreement, key divergences between both parties need  solving. Notably the issue of supervision, while the European Parliament believes ESMA would be best suited for supervision, the Council would favor the European Banking Authority (EBA) for the role. At the heart of this dispute lies a fundamental debate on the classification of crypto-assets as securities or as potential alternatives to cash and therefore used mainly for payments. Compromises will certainly be found but the outcomes of these negotiations will be determinant for the future of the European market in crypto-assets and its participants.

What is happening elsewhere?

While we have focused primarily on developments at EU level, it is also important to note that when it comes to crypto-asset regulation and supervision other related and significant developments are also taking place elsewhere. The implications of some of the initiatives listed below should also be top of mind for the financial services sector as they could have important operational ramifications.

• A potential global tax transparency framework proposed by the Organization for Economic Co-operation and Development (OECD) to facilitate the exchange of tax information on transactions in crypto-assets
• A Securities and Exchange Commission (SEC) staff interpretive guidance on the accounting expectations when safeguarding crypto-assets for users which could have hidden consequences
• A playbook from the Basel committee regarding considerations on the prudential treatment for banks’ crypto-asset exposures to mitigate potential financial stability risks
• The European Parliament’s recent vote on disclosures requirements to combat anti-money laundering as part of a larger anti-money laundering framework reform taking place in the EU
• The EU’s ongoing work on the creation of a digital euro to provide a digital form of central bank backed currency for euro-area citizens to use alongside cash

Looking ahead

Crypto-assets regulation is progressing fast. Financial services firms should monitor the following to keep pace with developments:

• Policy statements around sanctions from the Commission but also from executive branches in the US and UK
• Specific EU jurisdictions potentially front-running the conclusion of the MiCA negotiations by introducing their own local crypto-asset laws. Possibly creating a risk of  regulatory arbitrage
• Indications of a move towards more cross-border and global collaboration between regulators as they attempt to align on regulatory approaches and priorities to shape a more global view
• Regulators and supervisors ramping up their internal resources to deal with an ever growing and complex crypto market
• The issuance of guidance or clarifications and reminders of short to medium term supervisory expectations. With a focus on risk management, anti-money laundering controls and prudential requirements
• Further consumer protection warnings from supranational and local supervisors
• The progression of the debate around environmental concerns linked to the mining of crypto-assets

Next steps in the EU

• European Parliament and Council of the EU continue negotiations to discuss a common agreement on MiCA in Q2 of 2022
• A similar timeline is expected for the DLT Pilot Regime
• Expected agreement on a common approach before the end of the French EU presidency (1 July 2022)
• EU’s AML reform package could be completed by Q4 2022, including new disclosure requirements with regards to cross-border crypto-asset transactions

[1] While we focus on MiCA, please note that the EU’s DLT Pilot Regime for market infrastructures has also been progressing at pace at the EU level.