06 Mar MiCA – Offering and Admission to Trading of Asset-referenced and E-money Tokens
1. Setting the Scene
According to the MiCA Article 3 definitions, asset-referenced and e-money tokens are crypto assets primarily intended as means of exchange that purport to maintain a stable value by reference to other forms of capital. However, while asset-referenced tokens may refer to baskets of goods, including fiat currencies, securities, commodities and even other crypto assets, e-money tokens may refer only to a single fiat currency. E-money tokens bear a lot of resemblance to e-money under the Electronic Money Directive 2 (EMD2) and after MiCA enters into force, the two types of asset classes will be subject to analogous requirements. Whether an electronic representation of value falls under the scope of MiCA or EMD2 would depend on whether it relies on distributed ledger technology (DLT) for storage and transfer purposes. The offering and admission to trading of asset-referenced and e-money tokens is based on the same provisions applicable to other crypto assets. However, there are some key supplementary conditions, concerning issuers’ licensing, reserve assets and own capital requirements, which complicate the procedure. According to a 2019 G7 Working Group report called ‘Investigating the impact of global stablecoins’, assets of this category have a great potential of becoming a viable alternative to fiat currencies and the traditional banking sector. This is reflected in the MiCA Regulation, which demonstrates a particularly careful approach towards asset-referenced and e-money tokens.
When it comes to the public offering and admission to trading of asset-referenced and e-money tokens, whitepapers are mandatory. No exemptions apply regardless of the size, value or target of the offering. In addition to the information that must be disclosed in relation to crypto-assets other than stablecoins, asset-referenced and e-money token issuers must also include data regarding their asset reserves, such as the custody arrangements and investment policies related to them, as well as a description of the composition and professional qualifications of the issuer’s management body. Issuers of asset-referenced tokens have to provide their coin purchasers with a permanent redemption right. The issuer has the possibility to redeem either by paying an amount of funds other than e-money equivalent to the market value of the assets referenced by the token, or by delivering the assets referenced by the token. The issuer should provide sufficiently detailed and easily understandable information to disclose the different forms of redemption available. E-money token issuers must also be ready to redeem holders completely at any moment. Holders of e-money-tokens should always be granted with a redemption right at par value with funds denominated in the official currency that the e-money-token is referencing. The whitepaper should explicitly indicate that holders of e-money-tokens are provided with a claim in the form of a redemption right. Liquidity fees can be imposed on the redemption.
Besides having to register as legal entities, issuers of asset-referenced and e-money tokens must also obtain authorization from their designated NCAs. Exceptions are allowed only if issuers are already licensed as credit institutions, their offering is made solely to qualified (professional) investors, or the total annual value of their tokens does not exceed EUR 5 million. The licensing process for asset-referenced tokens includes assessment of the issuer’s own capital, draft whitepaper, business model soundness, token features, and security protocols. It also involves checking issuers’ conformity with other key MiCA requirements, such as the prohibition of granting interest to token holders or the obligation to appoint credit institutions as reserve assets custodians. NCAs will have the final say in the matter and could issue a refusal on grounds that issuers appear likely to fail to meet MiCA’s requirements or that their management body or business model pose a threat to the legitimate interests of clients, financial stability, and monetary policy. With regards to issuers of e-money tokens, they will have to be authorized as credit or e-money institutions. It suffices to say that if such entities stick solely to the issuance and distribution of stablecoins, they need to follow the same procedure for authorization as already described above. However, if they wish to engage in other activities related to the business of e-money institutions, such as the provision of payment services, additional capital requirements will apply.
4. Reserve Assets and Own Capital Requirements
Issuers of asset-referenced and e-money tokens will be obliged to create and maintain asset reserves in order to guarantee the stable value of their cryptocurrency. These reserves will be subject to prudential governance requirements, ensuring that they are invested only in highly liquid financial instruments with minimum market and credit risk. This will be verified through mandatory independent audits conducted every 6 months at the expense of the issuer. MiCA further imposes a set of rules regarding the custody of reserve assets, which will need to be separated from the issuer’s own funds, will not be available for securitization purposes, and will have to be entrusted to a credit institution. Lastly, NCAs will demand that issuers enter into and maintain contractual arrangements that guarantee the proceeds of the reserve assets are paid out to token holders in case the issuer ceases operations, becomes subject to a wind-down, or loses its authorization.
In addition to asset reserves, issuers of asset-referenced and e-money tokens will need to comply with own capital provisions which stipulate that they should have in place funds equal to or higher than either € 350,000 or 2% of the average amount of their reserve assets. This capital pool must consist of Common Equity Tier 1 items or in other words the most reliable and liquid forms of capital, such as common stock and subordinated loans. Essentially, all measures related to reserve assets and own capital funds aim to mitigate the potential economic harm that token holders may suffer should their asset-referenced or e-money tokens cease trading.
5. Significant asset-referenced and e-money tokens
At the point of authorization, the NCA reviewing the application will make a determination as to whether the crypto offering should be considered significant. If this is the case, issuer supervision will be carried out by the European Banking Authority (EBA) under a heightened set of standards. According to MiCA, the factors that suggest significance are as follows:
- Customer base exceeding 10 million people;
- Total value of issued tokens of more than € 5 billion;
- Execution of more than 2,500,000 transactions per day;
- Daily transactions value exceeding € 500 million.
Offerings that meet three or more of these thresholds will be classified as significant. To reflect the increased responsibility owed to customers, issuers of significant tokens will have to implement internal remuneration policies that promote effective risk management, ensure that their stablecoins are accessible to different crypto-service providers (CASPs) on a fair, reasonable and non-discriminatory basis, establish liquidity management policies in relation to their product, and comply with a higher own capital requirement threshold set at 3% of the amount of reserve assets.
6. Expected effects
As is the case with all types of crypto-assets that MiCA sets out to regulate, MiCA will radically improve transparency and investors protection with regard to asset-referenced and e-money tokens, although at an increased cost for issuers. Measures requiring the continuous disclosure of information, such as the monthly publication of data regarding the number of tokens in circulation as well as the mandatory commissioning of independent reserve asset audits, will serve to reassure investors of the true value of their assets, discrediting ungrounded public speculations. Yet, auditing services, for example, could prove to be quite expensive given the small number of firms that currently specialize in reviewing such assets. Similarly, provisions stating that all profits and losses resulting from price fluctuations of the reserve assets must be borne by the issuers as well as the additional own capital requirements, will serve as a guarantee for investors that their crypto assets would not lose value even during times of financial instability. However, compliance with those requirements may create a barrier to entry for small and medium-sized entities, which will need to source more initial funding and expend additional resources to ensure they are properly managing their underlying capital, especially in the current financial climate with negative interest rates.
Another point to consider is the reserve assets custody provisions that require funds received in exchange of tokens to be stored by third party credit institutions. While such arrangements will contribute to increased levels of security, they may be at odds with some of the current crypto projects in circulation. For instance, DAI is a stablecoin pegged to the US dollar, which can be obtained by users when they deposit collateral on the Ethereum network. Smart contracts then track a predetermined collateral to token value ratio threshold, falling under which triggers automatic liquidation of the position, destroying the tokens and paying out the deposit. Obviously this setup is inconsistent with the proposition that reserve assets should be stored only with credit institutions. Thus, MiCA’s implementation may necessitate that some existing stablecoin crypto projects change their underlying propositions accordingly or exit the EU market.
And finally, the prohibition of granting interest to holders of asset-referenced and e-money tokens warrants a discussion. It is a clause that may undermine the ability of issuers to attract capital. However, according to the Commission Impact Assessment the prohibition is necessary to limit the risks of “shadow banking”, which is a term that refers to financial activities, such as lending, taking place among non-banking institutions. The purpose is to counter the practice of collecting money from crypto investors in exchange for a fee and then using it to grant loans to the wider public outside the scope of regulatory frameworks.
Series of blogs ‘MiCA’
The draft Markets in Crypto-Assets (MiCA) Regulation was released by the European Commission in September 2020. As with most markets-focused regulations, one of MiCA’s priorities is to limit the potential risks to the consumer. But the EC’s proposal also aims to address certain issues that it sees as hindering the EU crypto-asset sector.
Watsonlaw will publish a series of blogs about MiCA over the coming weeks.
The following topics are covered:
MiCA – Introduction to the Markets in Crypto-Assets Regulation
MiCA – Reasons and Objectives
MiCA – Choice of Legislative Instrument and Scope
MiCA – Offering of Crypto-Assets and Admission to Trading
MiCA – Offering and Admission to Trading of Asset-referenced and E-money Tokens
MiCA – Regulation of Crypto-asset Service Providers
MiCA – Market Abuse Prevention under MiCA
If you have any questions about the MiCA, please contact new tech expert Willem-Jan Smits or Camiel Vermeulen. Our cryptoteam has extensive knowledge of the crypto- asset sector and are ready to help you.