Important for the Community to review: ESMA MiCAR Consultation on criteria for the qualification of crypto-assets as financial instruments
The European Securities and Markets Authority (ESMA) has published a consultation paper proposing a comprehensive framework for classifying crypto-assets as financial instruments at the end of January 2024. This framework aims to provide clear and consistent guidance on how to regulate the crypto-asset market, ensuring that investors are protected and that markets are fair and orderly.
ESMA encourages stakeholders, including crypto-asset issuers, service providers, financial institutions, and investors, to provide feedback on the proposed framework by April 29, 2024. This feedback will be instrumental in shaping the final guidelines on the classification of crypto-assets as financial instruments. We as a community should contribute.
At the heart of the ESMA's proposal lies a technology-neutral approach, recognizing that the underlying technology used to represent or distribute crypto-assets should not determine their regulatory classification. This approach aligns with the principles of "same activities, same risks, same rules" and "technology neutrality" enshrined in the Markets in Crypto-Assets (MiCA) Regulation.
ESMA proposes (very much shortened and over-simplified) following concepts or guidelines:
(1)?? General - The technological format of crypto-assets should not be considered a determining factor by stakeholders when assessing the qualification as financial instruments. Following this, the process of tokenisation of financial instruments60 should not affect the nature of such assets.?
(2)?? Classification as transferable securities - Stakeholders should classify crypto-assets as transferable securities if they confer to their holders similar or equivalent rights to those granted by shares, bonds, other forms of non-equity securities or other negotiable securities as defined by MiFID II. Crypto-assets should fulfil cumulatively the following three criteria: (i) not being an instrument of payment; (ii) being “classes of securities”; and (iii) being negotiable on the capital market.
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(3)?? Classification as money-market instruments - To be classified as a money market instrument as defined in Article 4(1), point (17), of MiFID II, crypto-assets should be a class of instruments typically traded within the money market, with the exception of payment instruments.
(4)?? Classification as units in collective investment undertakings – The project attached to the crypto-asset should involve the pooling of capital from a number of investors for the purpose of investing this capital in accordance with a defined investment policy and with a view to generating a pooled return for the benefit of those investors. It should be noted that, to qualify as a collective investment undertaking, it does not matter whether participants contribute fiat currency, cash equivalent, or crypto-assets to the pool. It should also be considered whether unitholders or shareholders– as a collective group –have a day-to-day discretion or control over operational matters relating to the daily management of the assets included in the pool. Where this is the case, the crypto-asset will likely not qualify as collective investment undertaking.
(5)?? Classification as derivative contracts - Regarding the conditions and criteria for crypto-assets to be qualified as derivative contracts, stakeholders should as part of their assessment consider whether: (i) the rights of the crypto-asset holders are contingent upon a contract based on a future commitment, creating a time-lag between the conclusion and execution of such contract; and (ii) the crypto-asset's value is derived from that of an underlying asset.
(6)?? Classification as emission allowances - Stakeholders should consider that for a crypto-asset to be classified as an emission allowance, it should represent a right to emit a certain quantity of greenhouse gases and be recognised for compliance with the EU Emissions Trading Scheme. The crypto-asset's capability to be exchanged, managed and used like conventional emission allowances within existing carbon trading frameworks should also be assessed. Crypto-assets that represent a verifiable emission allowance (or a set number of allowances) and that are tradeable should fall under MiFID II's remit.
(7)?? Classification as crypto-assets - Stakeholders should take into account whether the crypto-asset is a digital representation of value or rights, capable of being transferred and stored using DLT, including whether these value or rights represent a right vis-à-vis the issuer, aligning with the definition of 'crypto-asset' within the meaning of MiCA. The nature of the crypto-asset’s electronic transfer and storage should be taken into account considering the use of DLT or similar technologies (e.g. a database using a consensus mechanism for ledger state agreement, transaction record maintenance, shared, managed and synchronized among a group of distributed participants).
?(8)?? Crypto-assets which are unique and not fungible with other crypto-assets (NFTs) - Stakeholders should consider that to be unique, NFTs should be considered distinct and irreplaceable where their characteristics and/or the rights they provide are not identical to the other crypto-assets issued by the same (or any other) issuer. An “interdependent value test” should be conducted in order to classify a crypto-asset as unique and non-fungible considering: (i) if the value of the crypto-asset primarily stems from the unique characteristics of each individual asset and the utility/benefits it offers to its holder; (ii) the extent to which the interconnection of various types of crypto-assets influences the value of one another in such a way that the NFT has no value of its own that would be de-correlated from the other NFTs in the series; as well as (iii) the unique characteristics that distinguish these crypto-assets from others.
(9)?? Hybrid crypto-assets - Stakeholders should adopt a hierarchical approach in the classification of hybrid crypto-assets. The initial step should be a comprehensive evaluation to ascertain if the crypto-asset meets the criteria of a financial instrument. If the hybrid token displays features of a financial instrument, this characteristic should take precedence in its classification. This assessment should be conducted before considering alternative classifications, such as utility tokens. I should be prioritized to assess crypto-asset's inherent attributes over the labels provided by issuers, especially for hybrid tokens whose functions or attributes might evolve during their life-cycle, to determine whether they seamlessly combine investment-driven functions (e.g. returns or capital appreciation), with utility-centric purposes (e.g. granting exclusive access to a service or digital platform).