Europe takes page from Gary Gensler’s crypto playbook: ‘Something we don’t want to happen here’

Europe’s landmark crypto rulebook may take a bigger bite of securities laws than experts first expected.

The European Securities and Markets Authority released a new report this week that may rope in some crypto firms under the EU’s securities rules – not just the bloc’s bespoke crypto laws, known as MiCA.

The securities categorisation could lead to a more litigious regulatory environment, warn legal experts. This is not unlike Gary Gensler’s tactics at the US Securities and Exchange Commission, which critics say boils down to regulation by enforcement.

“It could slow down some projects in Europe,” Andrea Pantaleo, a lawyer specialised in crypto regulation and litigation at DLA Piper, told DL News.

Some are also warning crypto and DeFi organisations will struggle to comply more with securities laws than with new Markets in Crypto-Asset regulation.

MiCA, which will go live later this year, has been celebrated as an example of a law designed to bring clarity to the industry that could lure more businesses to Europe.

That hard work to create a tailor-made framework may lean more heavily on existing securities laws.

US hostility

ESMA’s recommendations on assessing crypto on a case-by-case basis resemble the open interpretation of securities adopted in the US.

While the EU has more complex categories for what makes a security, the American classification, known as the Howey Test, also provides a broad definition of what a security is.

“That’s why [US regulators] are litigating so many service providers,” Pantaleo said.

The US Securities and Exchange Commission has sued major crypto firms — like Binance, Coinbase, Ripple, and Kraken — for allegedly violating securities laws.

“This is something that we don’t want to happen here because we have a regulation, we should have defined and clear rules,” he added.

A crypto issuer or firm would need to be in closer contact with the national authorities to determine whether they are handling securities.

These national authorities will be able to interpret the guidelines as they like.

“So the question is, what is remaining under MiCA?” Pantaleo said.

MiCA vs MiFID

The ESMA report recognises that there is “no commonly adopted application of the definition of ‘financial instrument’ under MiFID in the EU.”

That means “practical consequences may emerge” when classifying crypto assets under MiCA.

One challenge for firms is to figure out under which category they fall amid different criteria available from different laws, according to Elizaveta Palaznik, an independent consultant specialised in European crypto law.

Another consequence is regulatory arbitrage, or firms taking advantage of the differences between how each country applies the regulation. Some countries could be more strict in the way they regulate crypto assets compared to others.

And if the terms are not defined under MiFID, “it means that each country can interpret it the way they want. And it means that under MiCA those national authorities might do the same as well,” Palaznik said.

Tougher rules

ESMA’s consultation seeks input on which crypto assets would fall under the bloc’s bespoke crypto rules — MiCA — and which ones would be regulated under existing securities laws — the Markets in Financial Instruments Directive II, or MiFID II.

The two laws are similar, but MiFID has much tougher implications for firms that handle financial instruments.

MiCA was designed to govern crypto issuers and service providers. Financial regulators are currently ironing out the implementation details in batches and asking the industry to comment on their guidance. The regulation will come into force in parts, starting in June.

MiFID, on the other hand, governs securities markets and investment intermediaries. It requires firms to comply with harder requirements on internal policies, capital and governance requirements.

“Just because an asset is issued on a blockchain doesn’t guarantee that it will fall under MiCA.”

—  Elizaveta Palaznik, an independent consultant specialised in European crypto law.

And, as ESMA points out in a footnote if a crypto asset classifies as a financial instrument, it would also have to comply with a host of other laws on market abuse, transparency, prospectus requirements, short selling and systemic risks.

For example, utility tokens could be classified as financial instruments if they grant users “voting rights which would lead the investor to participate in the company’s decision-making process,” according to the report.

This is a common process in DeFi communities, which use tokens to enable participation in protocol governance through a decentralised autonomous organisation.

ESMA’s guidelines are not final, as companies and people can submit their comments until April 29.

Case-by-case

The ESMA report proposed that how crypto assets are classified and their compliance requirements should be determined on a “case-by-case basis.”

That means that each country’s national authorities can decide whether a crypto asset is a financial instrument that would fall under MiFID or MiCA.

Criteria around the design and rights attached to the crypto-asset would help determine that.

Generally, if a crypto asset behaves like bonds or shares, it would no longer fall under crypto laws described in MiCA. That includes, for example, if a security is “transferable,” or tradeable on capital markets.

That would exclude certain tokens that cannot be traded, like loyalty programme awards or so-called soulbound tokens.

“Just because an asset is issued on a blockchain doesn’t guarantee that it will fall under MiCA,” Palaznik said.

The case-by-case approach comes down to the fact that the definition of financial instruments under MiFID is also left open to interpretation. “These guidelines are not set in stone,” Palaznik added.

ESMA offers an extra category of a so-called “hybrid token” if an asset falls into more than one category. “It’s good that they did this,” she said, as it offers a deeper, bespoke analysis for the industry to follow.

Have a tip about crypto in Europe? Contact the author at inbar@dlnews.com