- The NCAs survey revealed that a broad agreement exists within the EU on qualifying certain cryptoassets as financial instruments, there are however some differences in the national definitions of what constitutes a financial instrument.
- There is also broad agreement that so-called pure utility tokens would likely fall outside of the existing rules.
- An EU-wide response makes sense because it provides a harmonized framework across Europe, and allows investors and firms to operate across borders.
- AML requirements should apply to all types of cryptoassets and there should be appropriate risk disclosure in place so that investors understand the risk before committing funds.
- If an STO is a security that is like a traditional financial instrument, then existing rules should apply. ESMA’s technologically-neutral approach means that the same rules should apply to the same activities according to the same risk. This is especially true if the investment is high-risk, regardless of the technology used to issue an investment.
- Considering the technological development, in certain instances, the rules will need clarification, interpretation, and requirements for adoption.
- Having more elaborate regulation at this stage is premature, considering that it is an early stage and the business models are still evolving.
In recent years cryptocurrencies have really come into their own. Are they something ESMA has gravitated towards?
We started looking at virtual currency when they first emerged, then we moved to the underlying technology because we saw that there was potential there. Then, when ICOs started, which was almost two years ago now, we started looking at them too, and then, as the ecosystem around ICOs was developing with trading platforms, wallet providers etc., we started looking at the entire phenomenon. We’ve been working closely with our member states and various stakeholders on these topics and the advice is the outcome of the work that we’ve started more than a year ago.
What information were you using for your report, is it difficult to find reliable information on ICOs, given that they go under the radar sometimes?
I think you’re absolutely right, having extensive and reliable data is a challenge, because some of these activities are outside of the regulatory scope, so it’s difficult for the regulators to have detailed information. We try to have contact with the industry, academics, also information coming from the national regulators through inquiries they were receiving. We try to collect information from various sources but bearing in mind that the information that we had might be incomplete, patchy and that we should be careful about it.
Did you find the industry generally willing to work with the regulators?
It varies, you have different players, and some of them are aware that operating in the regulated space brings benefits to them and they are keen on understanding which rules may apply to them and how they should comply with them. But we shouldn’t ignore the fact that some other players may see incentives in staying outside of the regulated space. We know, for example, that with ICOs, there has been many frauds and these people, obviously, don’t want to speak to the regulators, but there are also other players, that want to do this right and are keen on engaging with us.
The ESMA report mentions a survey you did of the member states’ national competent authorities (NCAs), how comprehensive was this survey and what were the findings?
What was really important for us was to better understand the legal status of cryptoassets in the EU because this determines what set of rules is likely to apply and hence the level of protection for investors. The survey aimed at understanding the way the member states would qualify cryptoassets under the national transposition of crypto rules. What’s important is that we used real cases, we used a set of cryptoassets that have been issued via ICOs, to make sure that by using real examples we could understand how national competent authorities in the 28 member states in Europe would qualify cryptoassets.
The main outcome of the survey is that some cryptoassets are likely to qualify as financial instruments, there was a broad agreement on that, but there are also a number of cryptoassets that would stay out of the regulated space. We also found that there was a broad agreement on the key characteristics of those assets that would qualify as financial instruments, but there were also some differences in the national definitions of what’s a financial instrument.
Does this array of definitions make creating an EU-wide regulation an impossible task, or are you trying to unite member countries to agree on a definition?
When we look at the details of those real-life examples, I think, although there were sometimes some differences, there was also much common ground. Like those cryptoassets that have profit rights attached, it was a majority view among the NCAs that they were likely to qualify as financial instruments. So, I think there is common ground here. There is also common ground that so-called pure utility tokens would likely fall outside of the existing rules. On the differences side, there are a few countries that may have taken a slightly different route, for instance, we know that some of them have a restricted list of examples to define what’s a financial instrument, but there are not many countries like that and they may consider some adaptation to address these issues. In the end, there is a lot of common ground; there are some differences that we and the NCAs are aware of, and we will work together to see how we can address them.
Some EU countries are actively competing to become crypto-friendly destinations. Does this competition help test out the regulatory environment and give you more real-life examples of how an EU-wide approach could be structured?
We understand the intentions of those countries, which is to provide both protective and supportive approach when the cryptoassets are outside of the existing regulated space, but I think our concern, as an EU regulator, is that this does not provide for a harmonized framework across Europe, and it isn’t good for investors and firms, because it prevents them from operating cross borders. We think that the EU response makes sense and what we advise for is that when those cryptoassets are not captured by the existing rules, EU policymakers should consider ways to address the risks. As a priority, we believe that AML requirements should apply to all types of cryptoassets, and there should be appropriate risk disclosure in place so that investors understand the risks before committing funds.
It seems as though STOs are overtaking ICOs as a form of fundraising, and they try to fit in into existing regulatory modes. Do you think this trend will continue and is it a positive one?
I think, regarding branding and the way those things are called, things are moving and we should be careful with what terms are used and what they cover. Yes, there have been some shift from using the term ICO to the term STO, but what is important to us as regulator is to understand ‘ok, what are those people aiming to do, what is the economic value that they may bring, what are the potential benefits and where are the risks?’ If the objective is to issue a security-type instrument using a new technology, we can think of a number of benefits, but then again, if it’s a security that is like a traditional financial instrument, then the existing rules should apply, because we are talking about something that looks and behaves like what we already have.
ESMA is trying to take a technology-neutral approach with rules that can accommodate new technologies as they come up. I imagine this must be a difficult task, won’t you be eventually forced to focus on the unique features of these new financial products?
When we say that the regulation should be technologically-neutral, what we mean is that the same rules should apply to the same activities, according to the same risk, same approach, same principles. Meaning that if some activity poses risks to investors, and we designed the rules to mitigate those risks, then as long as the risks prevail, the rule should remain valid. For example, investors need to understand risks before they commit funds to an investment, and this is especially true if the investment is highly risky, and the technology you use to issue this investment has nothing to do with that.
That being said, we also realize that new technologies may help mitigate certain risks so we, as regulators, need to stay alert to those developments, to make sure that our rules address the risks in a relevant manner. So, in the case of cryptoassets, we know that the underlying technology, the way the safekeeping, the settlement, the custody of those assets is undertaken, may be different, and so the rules that we have may not be entirely suited to the way the technology operates – and that’s also an important message from the advice, we believe that in certain instances the rules will need clarification, potential interpretation and also sometimes we will need to adapt some of the requirements.
Is there a timeline for EU-wide regulations you’re thinking about and is there pressure to meet a certain deadline?
ESMA has done a lot to highlight where there might be regulatory issues for consideration. But those issues are mostly beyond ESMA’s jurisdiction; we are not policy makers; our advice will allow EU policymakers to start considering those issues and see whether they think it is relevant to address them and how they might do that. And then there will be an element of how the market evolves in the coming weeks and months.
Coming back to STOs, what would you say are some of the main legal obstacles across different legal jurisdictions in Europe? Are they easy projects to launch, what are they facing in the individual countries?
If you really want the process of an STO to be successful, you need to have the whole ecosystem running, you need secondary markets for those offerings as well. To me, the issuance stage is not so much the issue, things like having proper disclosure in place are pretty straightforward. When it becomes tricky is the secondary markets and the whole post-trading space. How do you make sure that you will have proper safekeeping of those instruments? How do you ensure that there is settlement finality for the consumers? Record of ownership, safekeeping – there are a lot of challenges there.
Also, what we’ve seen so far with the ICOs, mostly they are using decentralized, fully-open networks like Ethereum, and I think those networks are not really suited to the financial industry yet. So, the governance issues, privacy issues, who is liable, how do you deal with potential operational errors – all those things haven’t been addressed yet.
The report suggests a hands-off approach to those issues until the industry becomes bigger and so do the concerns. Do you agree with that course of action?
I think that investors should realize that these are really high-risk, speculative investments. We made that clear in our warning back in February 2018. And then, in the advice, we say that AML rules should apply because there are also a lot of questions about that. But we think that having something more elaborate at this stage is premature, considering that it is an early stage and the business models are still evolving.
I think what the advice clarifies is that some of these cryptoassets are financial instruments, and if that’s the case, then a full set of rules should apply – although there may be a need for some clarification of some of the rules. Let’s put it simply – if cryptoassets are financial instruments, then they should comply with the rules; if they aren’t, then they are different animals in the zoo and are outside of our regulatory perimeter. We believe that there are material risks to the investors when these instruments aren’t regulated and those risks should be made clear to the investors, there should be disclosures in place. But when it comes to elaborate regimes, at this point it’s premature.