On 7 January 2021, HM Treasury (“HMT”) published a consultation and call for evidence on the UK’s regulatory approach to cryptoassets and stablecoins, which sets out HMT’s proposals for a new regulatory regime covering stablecoins and its approach to regulating cryptoassets more generally. The proposals follow HMT’s July 2020 consultation on bringing certain cryptoassets within the scope of the financial promotions regime (see our blog post here).
Last month, the European Commission (“EC”) adopted a new Digital Finance Package, which it published together with a communication entitled “A Retail Payments Strategy for the EU” containing specific policy measures needed in relation to payment services given their key role among digital financial services. The European Parliament (“EP”) subsequently adopted a nonbinding resolution on the EC’s Digital Finance Package on 8 October 2020. Continue reading
HM Treasury has announced the relaunch of its independent Fintech Strategic Review (the Review). The Review, originally announced in March (but delayed due to Covid-19), will aim to identify key priority areas for focus by the industry, policymakers and regulators in order to support the continued growth and mainstream adoption of Fintech solutions in the UK. The Review will be led by Ron Kalifa OBE (the former CEO of Worldpay).
HM Treasury has announced two consultations on possible changes to the UK financial promotions regime:
- a consultation on limiting the scope of firms that can approve financial promotions of unauthorised persons; and
- a consultation on extending the financial promotions regime to include unregulated cryptoassets.
The deadline for responses to both consultations is 25 October 2020.
These consultations reflect the continued focus by the Financial Conduct Authority (FCA) on marketing and the related risks to consumers, particularly following the mini-bond scandal, as well as the continued focus on the regulation of fintechs and cryptoasset technologies. Continue reading
Following Covid-19, the message from the UK financial regulators regarding payments firms and payments innovation has stepped up. Recently, the Bank of England published a speech given by Christina Segal-Knowles (Executive Director, Financial Market Infrastructure Directorate) on 11 June in which she discussed the emerging themes and challenges for payments firms and payments innovation. Continue reading
As consumers use cash to make payments less frequently, and fintech firms offer new forms of money and new ways to make payments, central banks globally are considering how they should respond and whether they too should innovate to meet new payment needs in an increasingly digital economy.
First published on Thomson Reuters Regulatory Intelligence on 13 May 2020
In April, the Financial Stability Board (FSB) published, in response to a request from the G20, its awaited consultation on the regulatory, supervisory and oversight challenges raised by “global stablecoins” (GSCs). Given the FSB’s remit, the focus of the consultation is on the impact of GSC arrangements on international financial stability, together with market integrity and consumer protection. It expressly does not address matters ranging from monetary policy, monetary sovereignty and currency substitution to data privacy, competition or taxation.
Overview: what are global stablecoins and why do they raise financial stability concerns for the FSB?
Nature of the instrument and arrangement
The FSB defines stablecoins as “a crypto-asset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets”.(The stabilisation mechanism of a stablecoin could alternatively be algorithm-based, attempting to maintain a stable value via protocols that provide for the increase or decrease of the supply of stablecoins in response to changes in demand.) A GSC is a stablecoin “with a potential reach and adoption across multiple jurisdictions and the potential to achieve substantial volume”.
The focus of the FSB is on a stablecoin arrangement as a whole, which is described as “an arrangement that combines a range of functions (and related specific activities) to provide an instrument that purports to be used [as] a means of payment and/or store of value”. This is particularly with respect to privately-issued GSCs primarily used for retail purposes and that may be widely used as a means of payment and/or store of value. The FSB notes that the matters it raises may also be relevant to other types of stablecoin or crypto-asset arrangements.
Illustration of functions and activities within a stablecoin arrangement
Where a GSC has achieved systemic importance, GSC arrangements could affect financial stability in a number of ways. For example, any fluctuations in value could affect spending decisions and economic activity. If widely used for payments, any operational disruption could significantly impact economic activity and financial system functioning; and exposures of financial institutions might increase in scale and change in nature – particularly if they perform multiple roles in a GSC arrangement (e.g., as resellers, wallet providers, managers or custodians/trustees of reserve assets). Large-scale redemptions of GSCs could mimic the impact of bank runs.
Given the potential impact on financial stability, the FSB is concerned about how GSC arrangements are designed and performed, and whether they can withstand shocks. It notes that:
“… depending on the facts and circumstances, the decentralised nature of GSC arrangements could pose governance challenges; stabilisation mechanisms and redemption arrangements could pose market, liquidity and credit risks; and, the infrastructure and technology used for recording transactions, and accessing, transferring and exchanging coins could pose operational and cyber- security risks“.
Currently, regulators tend to apply existing regulation to the activities of, and entities involved in, GSC arrangements. This is in line with the “same business, same risks, same rules” principle, and indeed, if GSCs take hold, then existing regulation may adapt to accommodate them. (Across the 51 jurisdictions that responded to the FSB’s survey, the “most common approach [to regulatory classification] is to identify the activity performed by a stablecoin arrangement and the participants involved, and apply the relevant existing regulation for that activity or entity according to the “same business, same risks, same rules” principle”.)
As they stand, however, existing regulatory regimes are not sufficient to capture GSC arrangements in a holistic way and would not address all risks associated with them. To illustrate, the functions and activities that are most likely in scope of current regulation include issuance and redemption of stablecoins, managing reserve assets, providing custody/trust services for reserve assets, exchanging and trading, and storing the private keys for wallets. Governance and control over the whole stablecoin arrangement, operation of the infrastructure of a stablecoin arrangement and the validation of transactions tend to fall outside the scope of existing regulation, however.
Addressing concerns raised
There are two main obstacles that can be identified within the gaps and challenges identified by the FSB:
- First, sector-specific regulation does not map neatly onto GSCs. GSCs which bundle attributes may cut across sectoral regulations, resulting in a patchwork.
- Second, the cross-border nature of GSC arrangements gives rise to the potential for regulatory arbitrage between regimes.
The FSB proposes 10 high-level recommendations (see box below) to promote consistent and effective regulation, supervision and oversight. The intention is that the recommendations support responsible innovation (by being technology neutral) and allow domestic flexibility in implementation, whilst mitigating the risks arising from GSCs that are used as a means of payment and/or store of value. Whilst the recommendations are addressed to national authorities, substantively they split between obligations on authorities and requirements applicable to GSC arrangements.
|Authorities: facilitating effective regulation and oversight||Private GSCs: achieving appropriate structure, design and regulatory compliance|
|Powers and tools
Recommendation 1: Authorities should have and utilise the necessary powers and tools, and adequate resources, to comprehensively regulate, supervise, and oversee a GSC arrangement and its multi-functional activities, and enforce relevant laws and regulations effectively.
|Comprehensive governance framework
Recommendation 4: Authorities should ensure that GSC arrangements have in place a comprehensive governance framework with a clear allocation of accountability for the functions and activities within the GSC arrangement.
|Functional and proportionate approach
Recommendation 2: Authorities should apply regulatory requirements to GSC arrangements on a functional basis and proportionate to their risks.
|Effective risk management frameworks
Recommendation 5: Authorities should ensure that GSC arrangements have effective risk management frameworks in place especially with regard to reserve management, operational resiliency, cyber security safeguards and AML/CFT measures, as well as “fit and proper” requirements.
|Comprehensive cross-border and cross-sector regulation and co-operation
Recommendation 3: Authorities should ensure that there is comprehensive regulation, supervision and oversight of the GSC arrangement across borders and sectors. Authorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication and consultation in order to support each other in fulfilling their respective mandates and to facilitate comprehensive regulation, supervision, and oversight of a GSC arrangement across borders and sectors.
|Robust data systems
Recommendation 6: Authorities should ensure that GSC arrangements have in place robust systems for safeguarding, collecting, storing and managing data.
|Ensuring compliance: before operations commence and on an ongoing basis
Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary.
|Recovery and resolution plans
Recommendation 7: Authorities should ensure that GSC arrangements have appropriate recovery and resolution plans.
|Transparency, particularly of stabilisation mechanism
Recommendation 8: Authorities should ensure that GSC arrangements provide to users and relevant stakeholders comprehensive and transparent information necessary to understand the functioning of the GSC arrangement, including with respect to its stabilisation mechanism.
Recommendation 9: Authorities should ensure that GSC arrangements provide legal clarity to users on the nature and enforceability of any redemption rights and the process for redemption, where applicable.
|Design-inherent ability to adapt to new regulatory requirements
Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary.
Important challenge for national regulatory authorities: developing and implementing appropriate cross-border cooperation mechanisms
An important challenge will be to give national authorities the ability to supervise and oversee a stablecoin arrangement holistically, rather than in a piecemeal framework based on its component functions and activities. This is likely to require legislative change, followed by a fundamental change in regulatory approach. Authorities will need to consider their own regulatory frameworks and how the arrangement interacts across jurisdictions. Arrangements for information-sharing and co-operation will be needed. Arrangements akin to those in place for Global Systemically Important Financial Institutions (G-SIFIs) may be an appropriate model. Traditional cross- jurisdictional supervisory approaches will generally not work when applied to GSC arrangements, for two reasons.
First, stablecoin arrangements may be a loose network of unrelated entities only held together by common policies, standards and agreements about respective roles. This would present challenges for identifying the “home” jurisdiction. Secondly, functions of stablecoin arrangements are a hybrid of traditional financial groups and financial market infrastructures (FMIs).
While there are existing examples of internationally-agreed standards that apply in a cross-border context, e.g., the CPMI/IOSCO Principles for Financial Market Infrastructures, the challenge will be to move from a patchwork approach to a model where all the various aspects can be dealt with together to ensure that from the outset – and on an ongoing basis – a GSC arrangement can function appropriately in the economy. The FSB envisages cooperation arrangements in different forms, including supervisory colleges, fora or networks. In terms of structure, the FSB refers to general bilateral and multilateral memoranda of understanding covering cooperation and information sharing, and crisis management and resolution, which are complemented by single focus mechanisms (e.g., on cyber security).
It appears that a holistic approach model would be a prerequisite for an authority being able to satisfy FSB’s recommendation 10. It will be interesting to see how an authority can satisfy itself that all requirements in its jurisdiction in relation to a whole GSC arrangement are met, particularly for example if resellers, custodians and wallet providers are located in its jurisdiction but the governance and stability mechanisms are located in other jurisdictions; and if an authority is not so satisfied, how it could enforce a prohibition on operation in its jurisdiction.
GSC arrangements to be subject to substantial and wide ranging regulatory obligations
Prior to mid-2019, the prospect of a detailed regulatory regime being developed for stablecoins might have been met with a degree of surprise and scepticism.
Governance framework and permissible degree of decentralisation
Given the interconnectedness, GSC arrangements will need to have in place governance structures and accountabilities covering the whole arrangement – activities, functions and participants. The FSB expects such governance structures and accountabilities would:
- have one or more governance bodies or equivalent mechanism facilitating appropriate oversight, governance and safeguards. It could be challenging to satisfy these requirements if fully permissionless ledgers are used;
- be based on a sound legal basis;
- be clear and transparent, and disclosed to users and other stakeholders;
- show allocation of accountabilities among different entities in different jurisdictions; and
- show limits on accountability and legal liability on a per jurisdiction basis.
Similar to the rules on traditional outsourcing, where a GSC arrangement relies upon a third party, the GSC governance body must demonstrate that this reliance does not impede its ability to meet regulatory requirements and expectations. However, it is unclear what would be caught here given the separate entities with loose connections that may form part of a GSC arrangement.
Risk management frameworks
Similarly, all functions and activities of GSC arrangements must be subject to appropriate risk management. A GSC arrangement will need appropriate policies, procedures and processes, covering at least the following risks: operational; AML/CFT; cyber; market risks; and those idiosyncratic risks presented by permissionless or anonymous networks. These risk management arrangements will need to be evidenced prior to commencing operations (in line with recommendation 10).
Under the heading of ‘risk management’, four further categories of requirements are set out:
- Testing: continuous risk assessments, contingency preparedness and continuity planning.
- Assurance of settlement finality: evidence of how the technology model and rules for transferring coins achieve settlement finality.
- Financial requirements:
- Strict rules on management of reserve assets, covering:
- duration, credit quality, liquidity and concentration of reserve assets;
- increase or decrease in reserve assets corresponding to issuance and destruction of GSC (asset-linked stabilisation mechanisms); and
- increases and decreases in reserve assets being managed to avoid impacts on the broader market.
- Adequate capital and liquidity buffers.
- Strict rules on management of reserve assets, covering:
- Fit and proper: individuals involved in the management and control of the GSC arrangement, and those exercising significant power or discharging significant responsibilities in relation to GSC activities, must satisfy “fit and proper” standards.
Robust data systems
Data management systems within GSC arrangements will need to satisfy certain requirements, including:
- recording and safeguarding relevant data and information in a discoverable format;
- complying with all applicable data privacy requirements;
- safeguarding the integrity and security of on-chain and off-chain data; and
- data being accessible to authorities in a complete and timely manner.
Recovery and resolution plans
GSC arrangements will need to have in place plans to support an orderly wind-down or resolution, which should include continuity or recovery of any critical functions and activities within the GSC arrangement. The implementation of these plans will need further consideration, taking into account the entities within a GSC arrangement and their geographical distribution.
A lack of transparency has been a cause of failure in stablecoins to date, particularly where it leads to a lack of confidence. This recommendation relies on transparency to bolster confidence and mitigate failure risk. There is an extensive list of aspects of a GSC arrangement to be disclosed, including:
- governance structure;
- allocation of roles and responsibilities assigned to operators or service providers;
- design of the stabilisation mechanism and how it maintains the stablecoin’s value;
- operation of the stabilisation mechanism;
- investment mandate for the reserve assets;
- custody arrangement and applicable segregation of reserve assets;
- dispute resolution mechanisms or procedures for seeking redress or lodging complaints;
- mechanisms in place to protect users in event of modification of GSC arrangement which could have a material impact;
- amount of GSC in circulation (subject also to independent audit); and
- value and composition of assets in the reserve backing the GSC (subject also to independent audit).
This recommendation concerns not only legal clarity, but also transparency, in relation to redemption rights. Redemption rights may not feature in all GSC arrangements. To the extent they do, they will have to comply with the following requirements:
- Cost of redemption
- Predictable and transparent rates of exchange.
- Nature and enforceability of redemption rights.
- Any claims users and intermediaries may have on underlying reserve assets.
- Any claims users and intermediaries may have against the issuer or guarantors.
- How claims may be treated in insolvency or resolution.
- Process for redemption and enforcement of claims.
- Recovery avenues for user who loses access to his/her wallet and private key due to cyber-attack/other operational incident.
- GSC widely used for payment purposes:
- Prudential standards comparable to those applicable to financial institutions performing the same economic functions and posing similar risks to be followed.
- Redeemable at par into fiat (where authority considers it appropriate).
Adaptability of design to accommodate new regulatory requirements
This last recommendation effectively requires GSC arrangements to:
Prior to launch:
- Proactively engage with relevant authorities, and meet all applicable regulatory, supervisory and oversight requirements in all jurisdictions of operation; and
- obtain any necessary licenses or registrations.
On a continuing basis:
- Be designed in such a way so as to be able to maintain that level of compliance, even where regulatory requirements change.
This article has also been published by the International Financial Law Review (IFLR).
The payments sector is one of the fastest growing sectors within the financial services industry. It is underpinned by consumers’ widespread move away from physical cash and towards electronic payments. Whether consumers are using payment cards or apps, the result has been a continual increase in the volumes of payments being processed electronically. This has created an enormous opportunity for payments businesses such as FIS and Fiserv (in the US) and Nexi and Klarna (in the EU) to establish themselves as key players in the payment chain, with the potential to become systemically important.
These businesses participate in a well-developed and very active area of the payments sector. So, what comes next?
The use of distributed ledger technology (DLT), and the associated use of cryptocurrencies and other cryptoassets, has long been discussed as a potential means for making global payment systems more efficient and more secure. For many years, payment processing has relied on centralised channels to transfer money, by established participants such as card issuers, clearing banks, and merchant acquiring banks and card schemes. By contrast, DLT involves a decentralised, shared ledger, with no need for central intermediation. It is considered immutable.
The question is, to what extent will cryptoassets become more widely used in the payments sector, including their potential use by central banks. Stablecoins, a relatively recent and topical sub-class of cryptoassets, may play a key role here. It will be interesting to see what types of stablecoins emerge and how they fit into the broader UK regulatory framework applicable to cryptoassets. Another important issue derives from two key aspects of stablecoins that are designed to facilitate payments: (i) in relation to the asset itself – concerns raised by private stablecoins, and whether a central bank digital currency could be an alternative; and (ii) in relation to the technology underlying it – its possible utility as a private payment system and question marks over whether it can co-exist with or link into public payment systems.
Stablecoins: how are they categorised and why does it matter?
“Bitcoin, the first and still the most popular cryptocurrency, began life as a techno-anarchist project to create an online version of cash, a way for people to transact without the possibility of interference from malicious governments or banks.” (The Economist, 30 August 2018)
Sadly for the original creators of cryptocurrencies – and despite their anarchistic intentions, cryptocurrencies and other types of cryptoassets cannot be exempt from the application of law and regulation just because they are a technological construct. The tone for the UK regulatory approach was set in the UK Cryptoassets Taskforce report, where the government stated its ambition for the UK to be the world’s most innovative economy and to maintain its position as one of the leading financial centres globally, to be achieved in part by “allowing innovators in the financial sector that play by the rules to thrive”. The message is clear: innovation is encouraged, but only where it complies with high standards of regulation.
The genesis of stablecoins, a relatively recent sub-category of cryptoassets, was an attempt to address the high price volatility exhibited by many cryptoassets so far. Stablecoins are, in short, cryptoassets that are backed by other assets, including fiat, commodities or other cryptocurrencies (a fuller definition is contained in the Financial Stability Board’s (FSB) ‘Regulatory issues of stablecoins’, 18 October 2019).
There are many types of stablecoin, each with different structures, functions and uses. Despite the word ‘coin’, a stablecoin could constitute a financial derivative, a unit in a collective investment scheme (fund), a debt security, e-money, or another type of specified (regulated) investment. They could potentially fall within any of three broad categories of cryptoassets as described by the UK Financial Conduct Authority (FCA), the categories having been revised in July 2019 following an earlier consultation.The diagram in Figure 1 compares the prior and current UK FCA categories of cryptoassets.
The position could change. During 2020 UK HM Treasury is expected to consult on expanding the regulatory perimeter. The EU Commission is also consulting on an “EU framework for markets in crypto-assets”.
It was the prospect of a stablecoin achieving, in a very short timescale, widespread adoption for transactions currently processed by retail and wholesale payment systems, particularly if integrated into existing online platforms or social media, that brought stablecoins into the sharp focus of national and international regulatory bodies. In a Bank of England speech (Responding to leaps in payments: from unbundling to stablecoins), Christina Segal-Knowles noted that: “In India, Google Tez reported having 50 million users 10 months after its launch in September 2017. In China, Alipay and WeChat Pay by some measures handled more than $37 trillion in mobile payments in 2018”.
The UK and other regulators consider that an appropriate regulatory framework needs to be adopted for stablecoins prior to their launch.
Global stablecoins as a payment asset
Key drivers for the creation of stablecoins as an alternative payment asset include improving
cross-border payments, to increase speed and reduce costs; assisting with financial inclusion
and providing payment tools for people who are underbanked or underserved by financial
services; and the growing preference in society for peer to peer interactions.
However, there are significant challenges and risks arising from use of stablecoins. These include difficulties with legal certainty, sound governance, AML/CFT compliance, operational resilience (including cyber security), consumer/investor and data protection and tax compliance. If stablecoins reach a global scale, they could pose challenges and risks to monetary policy, financial stability, the international monetary system and fair competition.
Here are a selection of key policy points identified by the G7 Working Group on Stablecoins, highlighting why regulators are so concerned about global stablecoins:
- Competition: global stablecoin arrangements could achieve market dominance due to their strong existing networks and the large fixed costs that a potential competitor would need to implement large-scale operations, and the exponential benefit of access to data.
- Stability mechanism: the mechanism used to stabilise the value of a global stablecoin must address market, credit and liquidity risk. If these are not adequately addressed, it could trigger a run, where users would all attempt to redeem their global stablecoins at reference value. Other triggers for a run could include a loss of confidence resulting from a lack of transparency about reserve holdings or if the reporting lacks credibility.
- Credit risk: global stablecoins whose reference assets include bank deposits may be exposed to the credit risk and liquidity risk of the underlying bank.
- Increased cost of funding for banks: if users hold global stablecoins permanently in deposit-like accounts, retail deposits at banks may decline, increasing bank dependence on more costly and volatile sources of funding.
- Change in nature of deposit: in countries whose currencies are part of the stablecoin reserve, some deposits drained from the banking system when retail users buy global stablecoins may be repaid to banks by way of larger wholesale deposits from stablecoin issuers. If banks were to counter this by offering products denominated in global stablecoins, they could be subject to new forms of foreign exchange risk and operational dependencies.
- Exacerbation of bank runs: easy availability of global stablecoins may exacerbate bank runs in times when confidence in one or more banks erodes.
- Shortage of high-quality liquid assets (HQLA): purchases of safe assets for a stablecoin reserve could cause a shortage of HQLA in some markets, potentially affecting financial stability.
- Reduced impact of monetary policy: this could happen in several ways. If, for example, there were multiple currencies in the reserve basket, the return on global stablecoin holdings could be a weighted average of the interest rates on the reserve currencies, attenuating the link between domestic monetary policy and interest rates on global stablecoin deposits. This would be particularly true where the domestic currency is not included in the basket of reserve assets.
The FSB is due to submit a consultative report on stablecoins to the G20 Finance Ministers and Central Bank Governors in April 2020, with a final report in July 2020.
Central bank digital currencies: alternative, interoperable or additional solutions?
Central bank digital currencies (CBDCs) are new variants of central bank money that differ from physical cash or central bank reserve/settlement accounts. There are two potential types of CBDCs: (i) a “wholesale” or “token-based” CBDC – restricted-access digital token for wholesale settlements (for example, interbank payments or securities settlement); and (ii) a general-purpose variant available to the public and based on tokens or accounts, allowing for a variety of ways of distribution.
So how would a CBDC act as an alternative to global stablecoins? A general purpose CBDC would essentially give effect to a disintermediated currency of which the central bank, rather than a private entity, would keep control. The view of the UK central bank, which first raised the possibility of CBDCs in 2015, seems to be evolving. Back in 2018, in his ‘The Future of Money’ speech (March 2 2018), Bank of England Governor Mark Carney identified that a general-purpose CBDC could mean a much greater role for central banks in the financial system. He noted that central banks could find themselves disintermediating commercial banks in normal times and running the risk of destabilising flights to quality in times of stress.
An independent report commissioned by the Bank of England on the Future of Finance noted that there was no compelling case for CBDCs and that the focus should be on improving current systems to allow for private sector innovation. However, in January 2020 the Bank of England announced that it would be participating in a central bank group with six other banks to assess potential use cases on CBDCs.
Payments systems and the transfer technology underlying stablecoins
In his ‘The Future of Money’ speech in 2018, Carney noted the potential for underlying technologies to transform the efficiency, reliability and flexibility of payments by increasing the efficiency of managing data; improving resilience by eliminating central points of failure, as multiple parties share replicated data and functionality; enhancing transparency (and auditability) through the creation of instant, permanent and immutable records of transactions; and expanding the use of straight-through processes, including with smart contracts that on receipt of new information automatically update and if appropriate, pay.
An European Central Bank (ECB) Occasional Paper (‘In search for stability in crypto-assets: are stablecoins the solution?’) notes that: “A platform for the recording of stablecoins and other assets using DLT and smart contracts may either benefit interoperability and competition among different DLT-based infrastructures and issuers – if its governance aims at harmonising the business and technological standards adopted by different operators and issuers competing in the market –, or lead to increased fragmentation if multiple initiatives emerge that compete for the market.”
The Bank of England confirmed in July 2018 that its renewed real-time gross settlement (RTGS) service would support DLT settlement models following a successful proof of concept.
Cryptoassets are a daily reality
The prevailing market views seems to be that in the short to medium term, DLT will augment rather than replace RTGS. Interoperability remains a key challenge, as do the technological and energy requirements of a successful and permanent DLT-based payments system.
Nevertheless, it no longer seems fanciful to talk of cryptoassets forming a daily part of the mainstream payments system. They are no longer only the preserve of speculators, or of payors seeking anonymity. The number of transactions in cryptoassets continues to grow rapidly, and regulators are focused on managing their increasing role in day-to-day financial services. It will be fascinating to see how central banks and regulators continue to respond to the growth of cryptoassets, and where this sector will go next.
In another article entitled, ‘Fintech market enters a new stage of maturity‘, we review macro-developments in Europe.
The European Securities and Markets Authority (“ESMA”) has recently published final technical advice on the effects of product intervention measures under the Markets in Financial Instruments Regulation (“MiFIR”). ESMA makes recommendations in relation to the product intervention framework under MiFIR, including proposing extending the framework to alternative investment fund managers (“AIFMs“) and UCITS management companies. In addition, ESMA has said that it will be monitoring the markets in financial instruments linked to crypto assets as it is aware that some national competent authorities (“NCAs”) are consulting on potential product intervention measures concerning these products. If necessary, ESMA will consider exercising its intervention powers in this area.
When MiFIR was introduced in 2018, ESMA was given the power to temporarily prohibit or restrict the marketing, distribution or sale of certain financial instruments, financial instruments with certain specified features or a type of financial activity or practice. ESMA has since used this product intervention power in relation to binary options and contracts for difference (“CFDs“) due to detriment caused to retail investors. ESMA has been asked to report to the European Commission on, amongst other MiFID II/MiFIR topics, its experience of temporary intervention powers, including areas in which legislative changes might be appropriate in relation to the product intervention framework.
For more information on regulators’ product intervention powers across various jurisdictions, please see our global guide on Product Intervention Powers and Design and Distribution Obligations in Financial Services, available here.
ESMA’s technical advice
The main elements of ESMA’s technical advice are as follows:
- Level playing field between MiFID firms and AIFMs/UCITS management companies: ESMA and NCAs currently cannot exercise MiFIR product intervention powers in relation to AIFMs and UCITS management companies despite these firms being able to carry out certain MiFID services/activities. ESMA recommends that the European Commission addresses the risk of arbitrage between MiFID firms and these fund management companies, and advises that NCAs and ESMA should have the powers to apply restrictions/prohibition directly to AIFMs and UCITS management companies.
- Extending time validity of ESMA’s temporary product intervention powers: ESMA’s product intervention measures currently only last for a short-term period (3 months – although this period will be increased to 6 months from 1 January 2022) and reviews for extension is resource intensive and burdensome for both ESMA and the NCAs. Additionally, ESMA notes that there are divergences in product intervention measures taken by different NCAs, particularly where permanent national measures diverge from temporary ESMA ones. ESMA recommends consolidation of temporary measures into permanent ones by the European Commission, or alternatively extending ESMA’s powers to allow the introduction of temporary product intervention measures for 18 months.
- Interaction of national product intervention measures: Article 42(1) MiFIR permits NCAs to take product interventions measures “in or from” their Member State, which ESMA suggests means that an NCA has the possibility to take measures that only apply in that Member State (and not from), and vice versa. Confusion also arises where Member States take overlapping product intervention measures. ESMA advises the Commission to clarify the application of product intervention measures to firms acting on a cross boarder basis and how those measures will be supervised and enforced.
- ESMA opinion on proposed national product intervention measures: NCAs are required under Article 42(3) MiFIR to notify ESMA of proposed national product intervention measures, at least one month before the measure is intended to take effect, in order for ESMA to issue an opinion on the measure (Article 43(3) MiFIR). In ESMA’s view, this requirement is burdensome. ESMA advises the European Commission that NCAs should be exempt from seeking an opinion where their national measures are exactly the same as ESMA’s temporary measures, and that ESMA should have the option (not an obligation) to give an opinion in these circumstances.
- Further clarification on Article 40(3) MiFIR: ESMA considers the wording in Article 40(3) MiFIR (“Where … competent authorities have taken a measure under Article 42, ESMA may take any … measures … without issuing the opinion provided for in Article 43”) to be unclear, and is of the view that the situation described is unlikely to occur in practice. ESMA asks the European Commission for further clarification of Article 40(3) MiFIR.
Future use of product intervention measures
ESMA is aware that some NCAs are consulting on potential product intervention measures concerning certain financial instruments linked to crypto assets. ESMA will continue to monitor markets and will exercise its coordination role in relation to measures proposed by NCAs. ESMA will consider taking product intervention measures if issues become apparent which cause significant concerns around investor protection or a threat to the orderly functioning and integrity of markets.
Next steps and Brexit
The European Commission will now present a report to the European Parliament and the Council on product intervention, and a decision will be taken on whether to adopt any of the measures set out by ESMA in this final report. If so, we may see an expansion of the scope of product intervention powers in the future.
Now that the UK has formally left the EU, the UK’s FCA is no longer a member of ESMA’s Board of Supervisors nor can it participate in any of ESMA’s other governance bodies. However, until the end of the transitional period on 31 December 2020, EU law (including MIFIR) will continue to apply to the UK as if it were a Member State, which means that ESMA will have product intervention powers over financial instruments and firms in the UK. Therefore any extension of these powers prior to the end of 2020 could have an effect in the UK. From 2020 onwards, it remains to be seen whether the UK will follow the EU’s approach in relation to product intervention.