Key Takeaways
- The EU's approval of new laws governing crypto assets and updated transfer rules for decentralized finance will improve regulatory visibility for market participants and establishes the region at the forefront of digital finance regulation.
- The laws build on the EU's wider digital finance initiative and could have a positive impact on crypto asset adoption but may lead to the exit of some service providers, particularly due to requirements associated with greater disclosure.
- The EU's comprehensive legislation of crypto assets, coupled with the weight of the resulting unified European market, could influence regulation elsewhere.
The European Union's regulation of crypto and digital assets has taken a step forward with the progress of new laws aimed at harmonizing rules, reducing legal uncertainties, and creating a safer common market for crypto asset issuances and trading.
That progress was delivered on April 20, when the regulation on Markets in Crypto-assets (MiCA), which regulates issuance and trading of crypto assets, secured approval from the European Parliament, enabling it to be passed into law, likely in July. At the same time, the European Parliament agreed an update to the Regulation on Transfers of Funds (TFR) aimed at improving the traceability of crypto asset transfers, which has particular relevance for decentralized finance (DeFi) transactions.
The new rules should help contain risks that are linked to digital currencies and assets. They will also provide a legal framework that will aid in the assessment of those risks, including those ultimately related to credit quality. S&P Global Ratings believes the new rules could bolster confidence in crypto and digital assets, encouraging a broader adoption of the new instruments and technologies by retail and institutional users
Part Of A Wider Digital Framework
The MiCA and the TFR updates will come into force in each of the 27 EU member states during 2024 and 2025. The transition period should give issuers of tokens and crypto asset service providers sufficient time to fully digest and implement the laws. During that time, the European Securities Markets Authority (ESMA) will take the lead in terms of technical guidance and monitoring of the implementation of the new rules, while the European Banking Authority (EBA) will have responsibility with regards to significant stablecoin issuers.
We expect that the clarity offered by MiCA could, of itself, help foster greater trust in the crypto asset ecosystem. Yet both MiCA and TFR are also part of a wider effort by the EU to create a comprehensive legal framework aimed at making Europe a global leader in technology regulation, fostering digital innovation, and protecting consumers.
The guiding force of that framework is the EU's Digital Finance Package (DFP). Introduced in September 2020, it defined four strategic priorities:
- Reduction of legal fragmentation across member states to create a Digital Single Market.
- Adoption of regulation that fosters digital innovation.
- Promotion of data-driven finance through the establishment of standards to support the digital transformation of financial services.
- Improvement of the digital operational resilience of the financial system.
MiCA Delivers Needed Clarity
MiCA will harmonize EU rules on crypto assets, replacing various national policies. The key areas addressed include asset category rules covering issuance, admission to trading, and the operation of all token offerings, and a section setting out rules for crypto asset service providers (CASP).
MiCA defines three categories of assets and sets out strict regulatory requirements for the issuers of such assets. Those categories are:
- Asset-referenced tokens (ART), which are backed by a basket of currencies, commodities, crypto assets, or other single non-fiat assets.
- E-money tokens (EMT) which are backed by a single fiat currency.
- Other crypto assets, including utility tokens providing access to determined goods or services from a specific issuer, such as a utility token of centralized exchanges. Bitcoin and other fully decentralized currencies also fall within this category.
We understand that MiCA's scope doesn't include some digital assets, such as crypto assets that qualify as financial instruments and central bank digital currencies (CBDCs). The regulation also doesn't cover nonfungible tokens (NFTs), although we note that certain NFT issuers could be covered by the regulation if NFTs are issued in "large series or collection", which is the case for many NFT projects. We expect ESMA will provide clarity on that subject in the coming months. DeFi projects are also beyond MiCA's scope unless a project is deemed to be not fully decentralized. We expect that proving evidence of full decentralization could be difficult given that many opaque DeFi projects are steered by developers and a management team, which suggest a degree of centralization. Discerning the line between true decentralization and the appearance of decentralization is likely to prove a key challenge when it comes to enforcing MiCA.
A Quality Check For CASPs
We consider that MiCA will address a major crypto industry issue by strengthening investor protection, particularly for retail investors (see "Regulating Crypto: The Bid To Frame, Tame, Or Game The Ecosystem", published on July 14, 2022). The new legislation notably introduces new requirements on issuers of crypto assets and for CASPs, including the need to register with national competent authorities and a requirement to notify ESMA in its role as the EU-wide regulator. MiCA also subjects CASPs and crypto issuers to own funds requirements, demands the publication of a white paper containing pre-specified disclosures, and compliance with certain governance and transparency rules.
For EMT and ART issuers, the legislation requires the definition of an orderly wind-down plan, of the issuer, as a means to reduce risk for investors. Furthermore, ARTs and EMTs classified as significant (according to criteria including a large customer base, high market capitalization, or a high number of transactions) are also subject to more stringent requirements. They include higher capital requirements and the need to establish, maintain, and implement a liquidity management policy. MiCA also targets risks from market abuse, notably related to market manipulation and insider dealing. Failure to comply with MiCA in order to adequately protect investors carries potentially hefty penalties. They can include substantial fines as well as the withdrawal or suspension of the authorization for a crypto platform to operate.
TFR's Implementation Promises Challenges
We consider the approval of the TFR update to be a positive contribution to anti-money laundering (AML) and counter-terrorism financing (CTF) initiatives as they relate to crypto asset transfers. The law requires all CASPs to conduct thorough Know Your Customer (KYC) verification and to report any suspicious transaction to the relevant regulators.
TFR defines rules for money transfers through its demands on intermediaries to collect and share data on transactions. That requires CASPs to share between each other information on both the payer and payee of un-hosted wallets, with the aim of ensuring full traceability of transactions. It is likely that some CASPs won't be in a position, or will be unwilling, to collect the required data, especially considering the complexities and associated costs. Furthermore, we consider that TFR could ultimately force European CASPs to cut ties with un-hosted wallets, which typically serve as the entry point to DeFi products.
We think that could have an impact on the competitiveness of European DeFi services and may prompt some users to abandon European CASPs in favor of operators in jurisdictions with lighter-touch regulations. We thus view the TFR update as a demonstration that the European authorities are willing to support sound market conduct, even if that comes at a cost.
Europe's Crypto Initiatives Could Shape Global Standards
We think that with both the approval of MiCA and the TFR update the EU's could contribute to the shaping of global regulatory standards on crypto assets. The EU's progress compares favorably to the U.S., where legislation remains in its early phases. The approach also contrasts with China, which remains wedded to an outright ban on all types of crypto assets.
The EU's common requirements for crypto issuers and CASPs will create the largest, unified crypto market in the world by both population and economic power. And we expect the new rules may foster greater confidence and support crypto asset adoption in the EU.
That lead could be extended still further, given the European Central Bank's (ECB) recent positive comments on the potential for a central bank digital currency (CBDC), dubbed the digital euro. An EU-wide digital currency would be another pillar of the European digital ecosystem. We understand that the ECB will end its current investigation phase for the digital euro, in Autumn 2023. A decision, in conjunction with competent authorities, will then be made on moving to the next project phase, which will focus on the technical solutions and business arrangements required to introduce a digital euro--possibly within the next few years.
Related Research
Regulating Crypto: The Bid To Frame, Tame, Or Game The Ecosystem, July 13, 2022
This report does not constitute a rating action.
| Primary Credit Analysts: | Cihan Duran, CFA, Frankfurt + 49 69 3399 9177; cihan.duran@spglobal.com |
| Clement Collard, Paris +33 144207213; clement.collard@spglobal.com | |
| Secondary Contacts: | Alexandre Birry, Paris + 44 20 7176 7108; alexandre.birry@spglobal.com |
| Rebecca Mun, London + 44 20 7176 3613; rebecca.mun@spglobal.com |
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