Matthew Elderfield is a former Alternate President of the European Banking Authority
The shape of the EU and UK crypto regulation is now clearer than before. We have one agreement in Europe on the regulation of crypto asset markets (Mica), financial services and markets invoice is being read by the UK parliament and the new UK Financial Conduct Authority rules come for high-risk investments. What does this mean for the scope of regulation, investor protection, supervision and enforcement?
The UK will start by regulating some crypto assets and service providers, while the EU is pretty much going all out. Mica has a broad definition of “crypto asset”, but the UK is dipping its toe in the water with a narrower “digital settlement asset”. This essentially covers stablecoins used as a means of payment, but not (for now) crypto assets as investments. This choice appears to be about facilitating innovation, and the FCA’s caution, as explained by its outgoing president. The EU’s broader investment approach means that issuers of new crypto assets (with important exceptions such as purely mined coins) must publish and be responsible for a prospectus-like whitepaper setting out their plans.
Differences in regulation extend to service providers. The UK is likely to focus on fewer services, such as exchange and custody. The broader definition of Mica covers trading, advice, transmitting orders, and more, as well as crypto-to-crypto and crypto-to-fiat custody and exchange.
The UK’s next planned move is to legislate on crypto investment risk warnings. Investors need to have a clear idea of what protection they get (or don’t get). UK consumers have learned the hard way (in the London Capital & Finance minibond scandal) that the scope of regulation can be confusing. The new FCA rules now state an admirably blunt and prescriptive risk warning: “This is a high-risk investment and you are unlikely to be protected if something goes wrong.” Hopefully this will quickly spread to cryptocurrency investments, and be matched by EU regulators.
Since crypto assets are not protected by deposit insurance or other compensation schemes, the effectiveness of supervision is key. Mica and the UK will impose liability on service providers for custody losses, such as cyberattacks on digital wallets. But keeping an eye on client asset segregation is quite difficult in the non-crypto world. And small-cap service providers may not have pockets deep enough to offset losses. Supervisors must be sharp.
The Autorité des Marchés Financiers of France raised some Eyebrows recently, when he announced that he would oversee Binance, the world’s largest crypto exchange, under French pre-Mica law. Binance has been scolded by various regulators, including in July when he was fined €3 million for the Dutchand last summer when the FCA completed that “it is not capable of being effectively supervised”. The AMF clearly thinks differently.
The FCA concern concerned Binance’s unwillingness to share information about its complex corporate structure. An opaque structure was at the heart of the BCCI bank scandal in the late 1980s: the post-BCCI directive it requires banking structures to be sufficiently transparent so that they can be effectively supervised.
The United Kingdom sensibly applies this principle in its conditions for supervision. Mica needs detailed rules to require this and the AMF needs Binance to review its corporate structure. National supervisors such as AMF will continue to supervise service providers under Mica, but the European Securities and Markets Authority will be able to intervene with “significant” providers and the European Banking Authority will have direct supervisory powers for stablecoin issuers for the first time.
The EBA president is concerned about his ability to get the right staff as authority expands from his rule-making and stress-testing mandate. Rightly so: EBA and Esma ask for money from cash-strapped national authorities and the European Commission, with the latter monitoring their staffing plans. The EBA and Esma need more flexibility to make sure they are not outbid by cryptocurrency firms.
What about the app? The US Securities and Exchange Commission has cracked down on crypto scams and insider trading, arguing that many crypto assets are securities subject to existing regulations. The FCA reached the same conclusion in the 2019 guidance, but no enforcement action has yet been taken. Mica will give fine powers to the EBA and national authorities, but in the meantime large fines in the EU have been rare.
Consumers will continue to be scammed until both UK and EU authorities start taking some enforcement cases under their existing powers, and not just wait for new ones.