Cryptoassets

The past month has seen several highly-anticipated developments in the cryptoasset space. Although it will still be some time before the technical detail is finalised and come into force, firms that work with cryptoassets can begin to understand the regulatory framework in which they will need to operate.

The EU has published final regulation (PDF 775KB) for its pilot regime for market infrastructures based on distributed ledger technology (DLT). This pilot was proposed as part of the 2020 Digital Finance Package, alongside the Markets in Crypto Assets Regulation (MiCA) and the Digital Operational Resilience Act (DORA).

The pilot sets out a legal framework for the trading and settlement of transactions in cryptoassets that qualify as financial instruments under MiFID II. Non-qualifying cryptoassets (i.e. stablecoins, e-money tokens, utility tokens), are instead addressed under MiCA. Similar to a sandbox approach, the pilot allows for `safe experimentation' and will provide evidence for a potential subsequent permanent regime. To facilitate experimentation, temporary derogations from existing rules (including MiFIR transaction reporting and CSDR settlement requirements) can be requested. Most provisions will apply from 23 March 2023.

Following trilogues (which began in March), the EU has reached provisional political agreement on MiCA proposals. Under this agreement:

• National authorities will be responsible for supervising stablecoins — with the EBA stepping in to supervise the largest
• Stablecoin issuers will be required to:
  • Establish an EU-presence
  • Build up sufficiently liquid reserves
  • Guarantee customers the ability to make claims, free of charge, at any time
• National authorities will authorise cryptoasset service providers (CASPs), with ESMA retaining some oversight of the largest
• Any crypto company servicing digital assets stemming from DeFi will have to comply with the legislation
• ESMA will maintain a register of non-compliant CASPs
• Environmental impact statements will be required (meeting technical standards drafted by ESMA), and the European Commission will report within two years on the introduction of mandatory minimum sustainability standards
• Non-fungible tokens (NFTs), will be excluded from scope except if they fall under existing cryptoasset categories. Within 18 months the Commission will assess whether a legislative proposal is needed for NFTs

Once rules are finalised, they will not apply immediately. Stablecoin requirements will come into force 12 months after MiCA's approval  —  so likely late 2023. The remainder of requirements will likely apply in the first half of 2024.

Aligned with MiCA, the EU has also reached provisional agreement on a new bill aimed at applying AML considerations to the crypto market. The agreement extends the Financial Action Task Force's 'travel rule' (already existing in traditional finance) to cover transfers in cryptoassets. Under the EU's bill:

• Information on the source of the asset and its beneficiary must travel with the transaction and be stored on both sides of the transfer. CASPs must be able to provide this to national regulators, if requested. However, personal data (including name, addresses) should not be sent if there is no privacy guarantee
• There will be no minimum threshold nor exemptions for low-value transfers (as originally proposed)
• CASPs must verify that cryptoasset beneficiaries are not subject to any restrictive measures or sanctions
• For transfers of more than €1000 between a hosted and un-hosted wallet, CASPs will need to verify that these are owned by the same customer

Similarly, in the UK, HM Treasury (HMT) has published a response (PDF 318KB) to its consultation on Amendments to the Money Laundering, Terrorist Financing and Transfer of Funds Regulations. This also aims at ensuring application of the 'travel rule' to cryptoassets. However, unlike in the EU:

• A de minimis threshold of €1000 is included (which may be changed to GBP at a later date)
• Instead of requiring the collection of beneficiary and originator information for all un-hosted wallet transfers, cryptoasset businesses will only be expected to collect this information for transactions identified as posing an elevated risk of illicit finance
• HMT has decided against requiring verification of information collected regarding un-hosted wallet transfers

Subject to parliamentary approval, most measures will come into force on 1 September 2022 (with a 12-month grace period). 

The Basel Committee for Banking Supervision (BCBS) has published its second consultation (PDF 770KB) on the prudential treatment of banks' cryptoasset exposures noting that, while the cryptoasset market remains small relative to the size of the global financial system, its growth has the potential to undermine financial stability. The BCBS had originally proposed to categorise assets into Group 1 (assets that fully meet a set of classification conditions), including tokenised traditional assets (Group 1a) and cryptoassets with effective stabilisation mechanisms, i.e. “stablecoins” (Group 1b) and Group 2 (assets that fail to meet any of the classification conditions i.e. unbacked cryptoassets) — with the latter being subject to more conservative capital treatment. Under the second consultation, this categorisation has been updated and further segmented to reflect additional nuances — including an infrastructure risk add-on, recognition of hedging, and the application of liquidity rules.

However, not surprisingly given recent market events, the BCBS continues with its overall conservative capital treatment of cryptoassets and has introduced a further requirement limiting a bank's total exposures to Group 2 assets to 1% of Tier 1 capital.