The Digital Finance Package, which was originally adopted in September 2020, is finally coming to life this spring. The package aims to make the financial sector in the EU more competitive and give consumers access to innovative financial products while ensuring consumer protection and financial stability. One key aspect of the Digital Finance Package is that it included proposals for a Regulation on Markets in Crypto-assets (“MiCAR”) and a pilot regime for market infrastructures based on distributed ledger technology (“DLT Pilot Regime”).
The DLT Pilot Regime entered into force last summer and became applicable on 23 March 2023. The vote to accept MiCAR, on the other hand, is due on 19 April at the European Parliament and, if approved, the regulation is expected to become applicable in 12 months for stablecoins and in 18 months for other parts of the regulation after the date of publication.
While MiCAR will apply to persons that are engaged in the issuance of crypto-assets or provide services related to crypto-assets in the EU, the DLT Pilot Regime is an optional legal framework market infrastructures may apply for to enable them to test distributed ledger technology (“DLT”). In this alert, we will further address these creative instruments and provide practical guidance to market parties on what steps they should take next.
The Regulation on Markets in Crypto-assets (MiCAR)
MiCAR, the first all-in-one crypto regulation in any jurisdiction, is largely based on existing EU financial services regulation, such as the Prospectus Regulation, the Market Abuse Regulation and the Markets in Financial Instruments Directive (“MiFID II”), which have been adapted to the specific features of services related to crypto-assets.
MiCAR will regulate the issuance of and trading in crypto-assets as well as the management of the underlying assets. As such, MiCAR will address crypto-assets that are not currently governed by existing regulations, including utility tokens and stablecoins, and establish a legal framework for crypto-asset service providers (“CASPs”).
Investor protection measures are also introduced under MiCAR, such as the obligation for CASPs to provide sufficient information to investors and the right for investors to withdraw investments within a certain timeframe. MiCAR also introduces a number of transparency requirements and on-going obligations that must be met by CASPs.
What constitutes as a crypto-asset under MiCAR?
MiCAR will define crypto-assets as “a digital representation of value or rights which may be transferred and stored electronically, using DLT or similar technology”. Accordingly, MiCAR will introduce three subcategories for crypto-assets:
- e-money tokens (“EMTs”), meaning a token purporting to maintain a stable value by referring to the value of a fiat currency;
- asset-referenced tokens (“ARTs”), meaning a token purporting to maintain a stable value by referring to the value of several fiat currencies, one or more commodities or crypto-assets, or a combination of these; and
- other crypto-assets not covered by existing EU law, such as utility tokens, which are crypto-assets intended to provide digital access to a good or a service.
EMTs and ARTs are known as stablecoins, and a significant proportion of MiCAR will focus on regulating stablecoin issuers as stablecoins may cause significant risks to financial stability and monetary policy. For example, an EMT will automatically be deemed to be offered in the EU and therefore be subject to MiCAR rules when it references a union currency. Certain stablecoins may be classified as significant, in which case they are proposed to be supervised directly under the European Banking Authority.
What entities are considered crypto-asset service providers (CASPs) under MiCAR?
Any person whose business is the provision of one or more crypto-asset services to third parties on a professional basis will be considered a CASP under MiCAR. CASPs will be required to seek authorisation from the national competent authority (“NCA”) of the Member State where they have their registered office.
Authorised CASPs may passport their authorisation and provide services on a cross-border basis in other Member States as well. It should be noted, however, that MiCAR does not include a separate third-country regime and, therefore, third-country service providers with no registered office in the EU will be able to provide crypto-asset services in the EU only based on reverse solicitation.
Under MiCAR, issuers of crypto-assets must be legal entities and publish a white paper with detailed information about the issuer, the crypto-asset, the offer terms, and the risks associated with the investment. The white paper will need to be filed with the relevant NCA, but it does not need to be pre-approved by it.
What kinds of crypto-assets are excluded from the scope of MiCAR?
The issuers of crypto-assets and CASPs must independently identify whether a crypto-asset is considered a financial instrument and, if it is, MiCAR does not apply. In addition to financial instruments, certain digital assets such as central bank digital currency and decentralised finance (due to its characteristics as a fully decentralised service without any intermediary) will be excluded from the scope as well.
Interestingly, non-fungible tokens (also known as NFTs, i.e. the unique digital identifiers used to certify ownership and the authenticity of digital assets) may be excluded from the scope unless they fall within the relevant crypto-asset categories, and they are basically therefore fungible with other crypto-assets and not unique.
How should your organisation prepare for the introduction of MiCAR?
In purely practical terms, all issuers of crypto-assets that do not qualify as financial instruments should be ready for when MiCAR becomes applicable, which will likely be in the near future. Consequently, if your organisation is an issuer of crypto-assets, you must ensure that your organisation is a valid legal entity and remember your obligation to publish a white paper when issuing crypto-assets.
On the other hand, the issuers of ARTs and EMTs are required to apply for authorisation in addition to publishing a white paper. Furthermore, CASPs are required to apply for authorisation (after which they are added to ESMA’s register of CASPs). Credit institutions and investment firms, however, can provide crypto-asset services equivalent to the services and activities for which they are already authorised without separate authorisation under MiCAR.
The DLT Pilot Regime
While MiCAR applies to EMTs, ARTs, and other crypto-assets not covered by existing EU law, such as utility tokens as explained above, the DLT Pilot Regime applies to crypto-assets that qualify as financial instruments under MiFID II (“DLT financial instruments”). The existing financial services legislation in the EU has not been designed with DLT or crypto-assets in mind and, as such, contains provisions that can potentially preclude or limit the use of DLT in the issuance, trading, and settlement of DLT financial instruments.
What are the objectives of the DLT Pilot Regime?
DLT is a type of technology that supports the distributed recording of encrypted data. A distributed ledger is an information repository that keeps records of transactions and is shared across, and synchronised between, a set of DLT network nodes using a consensus mechanism. The EU has identified DLT as an innovative technology that can bring various benefits for securities trading and post-trading.
As such, the first key objective of the DLT Pilot Regime is to facilitate the development of a secondary market for securities in digital form. It should be noted that, in connection with the DLT Pilot Regime, the definition of “financial instruments” under MiFID II has been amended to provide that financial instruments can also be issued by means of DLT. With this amendment in place, DLT-related financial instruments are now included in the scope of MiFID II as well.
The second key objective is to help inform European regulators as to what, if any, changes need to be made to the current regulatory framework.
What qualifies as a DLT market infrastructure?
The DLT market infrastructures under the DLT Pilot Regime include:
- DLT multilateral trading facilities (“DLT MTF”), which are multilateral trading facilities operated by an investment firm or a market operator that only admit DLT financial instruments to trading;
- DLT securities settlement systems (“DLT SS”), which are securities settlement systems operated by a central securities depository (“CSD”) that settle transactions in DLT financial instruments and allow the initial recording of DLT financial instruments or the provision of safekeeping services in relation to DLT financial instruments; and
- DLT trading and settlement systems, which refers to a DLT MTF or DLT SS that combines services performed by a DLT MTF and a DLT SS operated by an investment firm, market operator, or a CSD.
We note that DLT MTFs are particularly interesting to issuers who want to benefit from the liquidity and greater visibility and legal certainty of admitting their DLT financial instruments to trading on an established trading venue in Europe. DLT MTFs may also interest investors who wish to diversify their portfolios with DLT financial instruments.
What financial instruments can be included in the DLT Pilot Regime?
The following financial instruments can be admitted to trading and settled on the DLT:
- shares if the issuer has a market capitalisation of less than EUR 500 million;
- bonds and other forms of securitised debt excluding derivatives if the issue size is less than EUR 1 billion. However, corporate bonds issued by issuers whose market capitalisation does not exceed EUR 200 million are excluded;
- units in collective investment undertakings if the market value of the assets under management is less than EUR 500 million.
The aggregate market value of all DLT financial instruments that are admitted to trading or recorded on a DLT market infrastructure may not exceed EUR 6 billion at the moment of admission to trading or the initial recording of a new DLT financial instrument. If the market value subsequently reaches EUR 9 billion, the DLT market infrastructure must activate a transition strategy under which its operations will be transferred or reversed to traditional market infrastructures. The transition strategy must also be used in the event that the DLT Pilot Regime is discontinued.
How to apply for a specific permission to operate a DLT?
Investment firms, market operators, and CSDs will need a specific permission to operate a DLT under the DLT Pilot Regime. Entities that are not authorised under central securities depository regulation (“CSDR”) or MiFID II may apply for authorisation under CSDR or MiFID II and, simultaneously, for a specific permission under the DLT Pilot Regime. These entities are only allowed to operate DLT market infrastructures, and their authorisation will be revoked once their specific permission has expired, unless the entities submit a complete request for authorisation under CSDR or MiFID II.
The permission to operate DLT market infrastructure will be granted by the relevant NCA, which in Finland is the Finnish Financial Supervisory Authority (“FIN-FSA”), and the permit will remain valid throughout the EU for a limited period of up to six years.
It is important to note that, once the relevant NCA has granted a specific permission, DLT market infrastructures may be temporarily exempted from some requirements of the EU financial services legislation that could otherwise prevent operators from developing solutions for trading in and the settlement of transactions involving DLT financial instruments.
However, despite these temporary exemptions, the operators of DLT market infrastructures will be subject to various other disclosure and governance requirements. In addition, outside of such exemptions, the full extent of the EU financial services legislation will apply to issuers of DLT financial instruments and to firms conducting activities related to DLT financial instruments.
Are you looking to apply?
The FIN-FSA is already welcoming applications for the DLT Pilot Regime. The guidelines on how to apply are available on ESMA’s website in all official languages. DLT market infrastructures must indicate which regulatory exemptions the applicant is requesting and demonstrate that the exemption is proportionate to, and justified by, the use of DLT and limited to the DLT market infrastructure and does not extend outside the DLT Pilot Regime. The exemptions granted under the DLT Pilot Regime may be tailored to the applicant’s specific business model.
What will happen in the future?
The European Commission and ESMA will present a report containing a proposition on what would be the best next steps for the DLT Pilot Regime going forward by 24 March 2026.
The options include:
- extending the duration of the DLT Pilot Regime by an additional period of up to three years or the scope thereof to cover other types of financial instruments, and/or introducing other amendments;
- making the DLT Pilot Regime permanent by amending existing EU legislation (particularly MiFID II and CSDR); or
- terminating the DLT Pilot Regime.
Borenius’ lawyers Eeva Terho, Jon Jokelin, and Lauri Teräsvuori are available to assist you in any questions you may have regarding this matter, including but not limited to relevant authorisation processes in Finland.