This Week in Policy (7/20)

This Week in Policy (7/20)

Ciao appassionati di fintech! Need a hint? Well, what is the singular of cannoli? And where do they come from?

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This week’s post is Part 2 of 2 of our deep dive into the Transfer of Funds Regulation (TFR) and the Markets in Crypto Assets (MiCA), the two landmark crypto legislations that were politically approved in the EU on June 29th and June 30th, respectively. Last week, we discussed MiCA’s origins as well as (1) its scope, (2) the white paper obligation it imposes on issuers of crypto-assets, and (3) its detailed regulation of stablecoins. This week, we continue to look at the salient topics covered (or not covered) by MiCA before we shift gears to TFR. Again, note that the discussion here is based on what has been reported by news outlets and insiders to the negotiations since the text of these two draft legislations has not yet been made public.

4. CASPs:

The 2020 MiCA creates a detailed regulatory regime for crypto-asset service providers (or CASPs), which are defined as “any person whose occupation or business is the provision of one or more crypto-asset services to third parties on a professional basis.” MiCA provides an expansive list of such services, which includes the custody and administration of crypto-assets on behalf of third parties, the operation of a trading platform for crypto-assets, and the exchange of crypto-assets for fiat currency or other digital assets. To provide any of these services, a CASP would have to register and obtain authorization from the national competent authorities (CAs) of any of the EU Member States. Once authorized, the CASP would be able to provide its services throughout the EU under a “passporting” mechanism that is already used in other regulations of EU markets. All authorized CASPs would be listed on a central register held by the European Securities and Markets Authority (ESMA), the EU analog of the Securities and Exchange Commission (SEC) of the U.S.

What is new under the 2022 MiCA is that CASPs that serve more than 15 million active users will be classified as “significant” CASPs (remember our discussion of “significant” stablecoin issuers from last week?). Significant CASPs will still be supervised by the national CAs of the EU country in which they are registered, but ESMA will have “intervention power” to restrict or completely prohibit such CASPs whenever the provision of their services would threaten market integrity, investor protection, or financial stability. ESMA will also hold a public blacklist where the names of non-compliant CASPs will be registered for investors and the general public to take notice.

How does this compare to the crypto regulation proposed in the U.S., specifically the Lummis-Gillibrand bill (LGB)? The main difference is that the LGB adopts an asset-based approach to crypto regulation, meaning that the type of crypto-asset (whether it is considered a commodity or security) determines not only the legal obligations of the crypto-asset issuer or service provider, but also the regulator that has competence over the crypto-asset. By contrast, MiCA adopts a unified approach to crypto regulation: all crypto-asset issuers and all CASPs abide by more or less the same rules. The only exception under both MiCA and the LGB is stablecoins, which are subject to a distinct regulatory regime given their unique nature and function.

In your opinion, how does MiCA’s unified approach to crypto regulation, particularly with respect to CASPs, compare to Gary Gansler’s proposal of a “one rule book” that would apply to all crypto trading, regardless of whether they are securities or commodities?

5. The Environment:

Although a complete ban on cryptocurrencies mined or validated through proof-of-work (think of crypto “mining”) was considered, EU negotiators, specifically members of the European Parliament's Committee on Economic and Monetary Affairs struck down the prohibition by 32 to 24 votes. As a compromise, though, the 2022 MiCA requires significant CASPs (and crypto-currency issuers) to disclose the type of blockchain consensus they use (proof-of-work v. proof-of-stake) in their white papers. MiCA also directs ESMA to study and report on the environmental impact of crypto-assets.

Here, we see significant convergence between MiCA and the LGB: both impose no ban on mining and direct a regulatory agency to study the environmental footprint of crypto, although MiCA creates a more transparent system by requiring significant CASPs and crypto-asset issuers to publish information about their consensus mechanisms in their whitepapers.

6. Investor protection:

While both the 2020 MiCA and the LGB provide for the segregation of clients’ assets from those of CASPs or crypto-asset issuers, which aims to protect clients’ assets in case of bankruptcy or insolvency, the 2022 MiCA makes crypto exchanges liable for the damages or losses resulting from “hacks or operational failures that they could have prevented.”

7. What is not in MiCA?

Unless they meet the definition of “crypto-assets,” decentralized finance (DeFi) protocols and non-fungible tokens (NFTs) are excluded from the 2022 MiCA. Nonetheless, MiCA mandates a report along with new regulatory initiatives on these issues to be submitted within 18 months of its entry into force.

What about TFR?

The original TFR dates back to 2015 when it was adopted by the EU to enhance the traceability of transfers of “conventional” funds, i.e., banknotes, coins, scriptural money, and electronic money. The 2015 TFR enforced Recommendation 16 of the Financial Action Task Force (FATF), known as the travel rule, which requires payment service providers to collect and share data on the originator and beneficiary of transfers above USD/EUR 1,000. In June 2019, the FATF extended the travel rule to crypto-assets. In response, in July 2021, the European Commission proposed an updated version of TFR that addresses crypto-assets.

The recent 2022 TFR goes beyond Recommendation 16 as it requires originator and beneficiary data to be collected and verified for any transfer between two regulated CASPs, regardless of value. Transfers between unhosted wallets, those not affiliated with a crypto exchange, and CASPs that are above EUR 1,000 will be covered: CASPs will have to verify that unhosted wallets are owned and controlled by their owners. Accordingly, only transfers between two unhosted wallets will be exempt from the 2022 TFR rules. In the U.S., by contrast, the LGB does not lay out any detailed rules on anti-money laundering or combating the financing of terrorism for the transfers of crypto-assets.

Why do you think TFR goes beyond the FATF’s requirements? And do you think the U.S. might follow in the EU’s footsteps?

Join me in conversation on Twitter or LinkedIn or leave a comment below.

See you next week!