At present, funds operating within the EU which seek to encompass crypto assets into their offering face a challenging and fragmented regulatory environment. This is now set to change with the introduction of the MiCA regulation (Markets in Crypto-assets), which is expected to come into force in 2024 and will enable crypto-asset service providers to operate throughout the EU with one license and a common set of rules. This article looks at the implications of MiCA for crypto funds.
The regulation of investment services in traditional finance is relatively harmonized throughout the EU, covered by legislation such as MiFID I and II. In addition, the so-called “passporting” of licenses means that once an investment service provider gains regulatory approval in one EU jurisdiction, it can operate and market its services to customers throughout the 28-country block.
In contrast, EU crypto regulation is a fragmented patchwork of national laws and guidance that vary greatly from country to country. While some countries, like Malta for instance, have introduced extensive regulatory frameworks for crypto assets, in many others, their status is unclear. In March 2018, the EU published its FinTech Action plan which found that most crypto assets were not covered by existing EU regulation.
This situation has not only created bureaucratic and legal headaches for crypto funds operating in Europe, it has also led to a degree of investor uncertainty, which has likely depressed institutional participation in the asset class. MiCA is intended to expand the scope of EU regulation to encompass the crypto assets not covered by previous legislation and afford crypto consumers and investors similar protections and recourse as in traditional financial markets.
The new EU crypto regulation sets out a number of activities related to crypto assets that will be covered by MiCA, divided into two categories. As you might expect, the first category covers services like cryptocurrency trading platforms, exchanges, and custody solutions. It is the second category, however, that is likely of most relevance to crypto funds. In particular, it defines the receipt “or transmission of orders for crypto-assets”, “execution of orders for crypto-assets on behalf of third parties”, “the provision of advice on crypto-assets” and “placing of crypto-assets” as activities covered by the legislation.
Any person professionally engaged in any of these activities is deemed to be a crypto-asset service provider (CASP), which implies that crypto funds are within scope. Indeed, legal commentators have noted that the definition of a CASP has been broadly defined under MiCA regulation in order to make sure that it will cover any new crypto asset business models that may emerge in future too.
While the increased regulatory certainty provided by MiCA is clearly a positive, it will impose certain obligations on crypto funds when it comes into force in 2024. Much of the legislation deals with the regulation of stablecoin and e-money operators; however, here is an overview of the aspects of the MiCA regulation which have greatest relevance to crypto funds.
Client advice and information
When advising potential investors about crypto assets, CASPs need to obtain information about the client and make an assessment about “their experience, knowledge, objectives and ability to bear losses”. An advisor needs to warn the client of the risks involved, prepare and store a report summarizing the client’s needs and what advice was given. In addition, advisors employed by a CASP need to have “the necessary knowledge and experience to fulfil their obligations”. These requirements underline the importance that high-quality, impartial market information will play in a more regulated crypto industry.
Capital requirements & prudential safeguards
All CASPs will be subject to minimum capital requirements, which will vary between €50,000 and €150,000 depending on what type of crypto asset service they provide. Most crypto funds are likely to come in at the lower end of this scale, unless they also offer custody or exchange services. If the minimum capital requirement is less than 25% of the fund’s fixed overheads for the preceding year, however, then the latter sum needs to be held in reserve as a prudential safeguard. These safeguards can either take the form of own funds, or an appropriate insurance policy.
Order transmission and execution
In cases where a CASP is transmitting or executing crypto asset transactions on behalf of clients, it needs to ensure that all orders are executed in a “prompt and proper” fashion and implement an order execution policy. In effect, this introduces best execution requirements for digital assets.
MiCA requires all CASPs to register with a competent authority in their jurisdiction. The application needs to include a description of the service provider’s program of operations, internal control mechanisms, risk assessment procedures, business continuity plan, and proof that they meet the relevant prudential safeguards. Authorities will have 25 days to assess whether the application is complete and a further 3 months to review it in more detail and approve or reject the application. The good news is that firms which are already authorized under MiFID to provide financial services for traditional assets can provide equivalent services for crypto assets without needing to separately register as a CASP.
A central register of approved CASPs will be maintained by the European Securities and Markets Authority (ESMA). In addition, according to Ernest Urtasun, an MEP who was involved in the negotiations, ESMA will also maintain a list of CASPs in non-EU countries who are not compliant with its cryptocurrency legislation and will have “far-reaching powers” to act against them. As a result, transacting with custodial wallets or exchanges not under the auspices of MiCA will likely become a compliance risk for European crypto funds in future.
Finally, a number of the regulations are aimed at preventing deceptive practices and market manipulation. CASPs are barred from accepting inducements of any kind, including discounts or non-monetary benefits, to route orders through particular trading platforms or exchanges. Inside information, insider dealing and market manipulation are explicitly prohibited too, with fines of up to €5,000,000 or 3% of annual turnover in the case of breaches.
MiCA aims to put European cryptocurrency regulation on a similar footing as traditional assets. This means that cryptocurrency investors will be afforded additional protections and safeguards.
As a result, portfolio managers providing advice and updates to clients will be under increasing regulatory pressure to ensure the accuracy and reliability of the data they present. However, presenting a coherent overview of a fund’s performance poses operational challenges in the current and foreseeable crypto market.
Unlike traditional assets, the crypto sector is decentralized by nature. For this reason, crypto orders are transmitted across many exchanges, brokers and OTC desks. Indeed, this will become a requirement under the newly introduced best execution provisions. To ensure that a sufficient proportion of assets are ready and available to be allocated while also seeking to manage counterparty risk, cryptocurrency holdings tend to be stored on multiple different exchange wallets and custody solutions simultaneously.
Nuant enables funds and managers involved in managing crypto investments and strategies to seamlessly connect wallet and exchange accounts from major providers including Coinbase, Fireblocks, Ledger, and Kraken among many others to produce one single portfolio view in realtime. This overview dashboard unifies the underlying assets to create trusted and advanced in-depth analytics for risk-management and decision-support needs. By leveraging both on-chain analytics and market data, it provides a comprehensive view of the market that enables portfolio managers to communicate with confidence about market conditions and trends to their clients. Nuant can also govern the client's assets based on either the fund's or the client's specific prospectus or mandate
In addition, Nuant’s in-built wallet and token intelligence tools enable fund managers to efficiently perform due diligence on prospective assets, tokens, wallets, funds or transactions to meet both client-onboarding requirements as well as investment research and mandate compliance needs. For instance, Nuant will automatically flag tokens or wallets that have been involved in suspicious activity. Once MiCA is rolled out in 2024, Nuant intends to expand this functionality to enable EU-based crypto fund managers to automatically flag custodial wallets not registered with ESMA. This will enable fund managers to focus on their strategy while automating and streamlining their compliance procedures.
Scheduled to come into effect in 2024, MiCA will be the most extensive piece of regulation covering crypto assets in the EU, the world’s third largest economy. It represents an important milestone for EU crypto regulation, enabling service providers to operate with one license throughout the union.
Due to its size, the EU often plays an influential role when it comes to market regulation, so other regions may follow with similar measures, as was the case with UCITS regulation for Funds and the wider GDPR, for instance. Indeed, EU commissioner Mairead McGuinness signaled that the EU aims to spark a wider regulatory move, stating “We're glad that we're leading on this… [but] we do think there needs to be international cooperation because it's important that we don't regulate on our own.”
Thus, more extensive crypto legislation is likely to become the new normal and crypto funds that can quickly adapt to MiCA will be well positioned to compete in the EU and globally in future. Nuant provides crypto funds with the compliance tools and data they need to communicate reliably, transact prudently, and remain compliant at all times.
Ernest Urtasun [@ernesturtasun] (2022) ‘ESMA will establish a register of third country CASPs’, Twitter. Available at: https://twitter.com/ernesturtasun/status/1542591825260810240 (Accessed: 15 September 2022).
European Commission (2014) Markets in Financial Instruments (MiFID II) - Directive 2014/65/EU. Available at: https://ec.europa.eu/info/law/markets-financial-instruments-mifid-ii-directive-2014-65-eu_en.
European Commission (2018) FinTech Action plan: For a more competitive and innovative European financial sector, COMMUNICATION FROM THE COMMISSION. Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52018DC0109&from=EN.
European Commission (2020) Markets in Crypto-assets, and amending Directive (EU) 2019/1937, REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL. pg 18, 27. Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52020PC0593&from=EN.
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Schickler, J. (2022) EU Agrees on Landmark Crypto Authorization Law, MiCA, CoinDesk. Available at: https://www.coindesk.com/policy/2022/06/30/eu-agrees-on-landmark-crypto-authorization-law-mica/.
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Willkie Compliance (2022) How the MiCA Regulation Will Impact the Crypto-Asset Market in Europe and Beyond | Insight. Available at: https://complianceconcourse.willkie.com/articles/insights-2022-20220801-howthemicaregulationwilimpactthecryptoass.