Whether looking at market participants, individual states, international standard-setting bodies, supranational entities or central banks, tokenisation is the one trend that still seems to attract much focus.
In effect, the crypto-asset trend (assets tokenised using distributed ledger technology or DLT – commonly named blockchain technology) is benefiting from a renewed interest from the financial community. Having gathered a great deal of attention during the initial coin offerings (ICOs) phase, concerns over investor protection have led many jurisdictions to adapt their legal framework to the tokenisation phenomenon.
For example, France has recently established a voluntary licensing regime for all crypto-assets that do not qualify as financial instruments according to EU law. This new framework provides better investor protection by regulating crypto-assets service providers. It also requires mandatory registration for the services of custody of crypto-assets for a third-party, and buying or selling of crypto-assets.
Germany provides another example. The German regulator has approved a number of security token offering (STOs) since 2019. Last November, landmark legislation was adopted for crypto services. The new rules include a definition of crypto-assets and regulate providers of “crypto safekeeping” services. Companies wishing to store, transfer, and trade crypto-assets must now obtain a license from the German regulator. A grandfathering mechanism was also introduced for firms already safekeeping crypto-assets in Germany.
These country initiatives illustrate one of the main problems DLT initiatives face, namely regulatory uncertainty. As national authorities start to regulate crypto-assets and related services in order to support innovation, crypto regulation risks becoming more and more fragmented from one jurisdiction to another, which could in turn lead to regulatory arbitrage and greater regulatory uncertainty for market participants. This could hinder the ecosystem’s development beyond national boundaries.
The EU is well-aware of the issue. Technology and digitalisation are significantly reshaping the European financial system and transforming the way financial services are provided to EU businesses and citizens. In order to promote digital finance in Europe while adequately regulating its risks, the European Commission has been working on a new Digital Finance Strategy. The Strategy aims to allow the EU to grasp all the potential of the digital age, strengthening industry and innovation, albeit within safe and ethical boundaries.
With the aim of making the EU financial services regulatory framework more innovation-friendly, the Commission published a public consultation in December 2019 on the development of an EU regulatory framework for crypto-assets.
The consultation seeks feedback on 4 main points:
- Opinion of EU citizens via general questions on the use or potential use of crypto-assets.
- Feedback from stakeholders on whether and how to classify crypto-assets - with respect to both crypto-assets that fall under existing EU legislation (those that qualify as “financial instruments” under MiFID II and those qualifying as “e-money” under EMD2) and those that do not fall under existing EU legislation.
- Feedback from stakeholders on crypto-assets that currently fall outside the scope of the EU financial services legislation. This part seeks to assess the need for an ad hoc EU regulatory framework and identify risks and priority policy actions.
- Feedback from stakeholders on crypto-assets that currently fall within the scope of EU legislation, i.e. those that qualify as “financial instruments” under MiFID II and those qualifying as “e-money” under EMD2.
The first step in preparing future regulation is an initiative on crypto-assets. This is expected in Q3 2020 and will be accompanied by a communication on a new Fintech Action Plan, as well as legislative acts on cross-sectoral financial services and cyber resilience.
As to what form EU crypto-asset regulation may take, the consultation seems to open the way for a gradual regulatory approach. One possible outcome could be an experimentation framework at EU level (e.g. through a sandbox mechanism). With this type of framework, national competent authorities (NCAs) could issue targeted exemptions for certain key aspects of EU financial regulation which are unsuited to DLT environments. Such an approach could bring regulatory clarity, while giving more time to regulators to properly assess associated risks as crypto-assets markets continue to mature.
As always when promoting innovation, regulators are faced with the challenge of striking a fine balance between too little regulation – with all the risks it might entail for investors; and too much regulation – which could prevent further development of the tokenisation trend in financial services. There is no doubt the Commission will strive to strike a sensible balance between the two in the months to come. How it aims to do so exactly remains to be seen but we should know more on this topic by the end of the year.