Tuesday, 15 January 2019

ESMA recommends tailored regulation of crypto-assets to secure investor protection

Fulfilling its obligation from the FinTech Action Plan (on which we reported here), last week the European Securities and Markets Authority (ESMA) published a recommendation for EU law and policy-makers for closing the regulatory gap on crypto-assets.

Crypto-assets are a type of private asset that depends primarily on cryptography and Distributed Ledger Technology. There are a wide variety of crypto-asset, their number is currently estimated to be around 2000. They range from  crypto or virtual currencies like Bitcoin, to so-called digital tokens issued through Initial Coin Offerings (IPOs) that allow businesses to raise capital for their projects, by issuing digital tokens in exchange e.g. for crypto-currencies. Consumers thus may use these assets as investment or as a means of payment, or both if the asset has hybrid features.

Crypto-assets are relatively new and the market is evolving, and poses challenges for regulators and market participants. In cooperation with National Supervisory Authorities, ESMA revealed that the current regulatory framework including MiFID with the rules on investor protection is either difficult to apply to these assets (and how the regulatory framework is applied may be vary between between Member States) or that it cannot be applied at all.

From a consumer protection perspective, these are risky instruments where protection is especially needed. Consumers are likely to have insufficient understanding of the risks involved in the transaction, especially the value of the investment, for example, how the price of the asset is going to change and how likely it is that the underlying project for which the investment is made in case of IPOs is likely to be successful. And then there is also the problem of the reliability of trading platforms. While some of these risks are pertinent to other consumer transactions, they are exacerbated here due to the nature of the products (as being highly abstract, diverse and subject to fast innovation), and to the regulatory gap. The additional practical problem is that consumers may not easily distinguish between those assets that are within the rules are those that are outside the scope of the regulatory framework.

To overcome the current regulatory gap and to ensure a consistent approach, ESMA calls for a special regulatory regime tailored for crypto-assets, that would ensure adequate information disclosure and enable consumers to make informed decisions. While information rules would certainly be helpful, we must urge EU law and policy makers to also consider more intrusive forms of regulation such as product regulation should this prove necessary to provide effective protection for consumers. At least, national legislators/regulators should be empowered to impose limits on product design e.g. price cap. Is opting for more intrusive regulation (or at least a balanced approach between information and product regulation) a preferred regulatory route compared to a mixture of more relaxed information rules with an option of banning products from the market when things get out of control (on which see here)? What do you think?

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