The demands of building a comprehensive regulatory structure are multiplied when we consider the EU. There are advanced fintech nations among the European Union’s 27 member countries, those with strong foundations when it comes to cryptocurrency and blockchain. And there are also those countries lagging far behind the curve.
That makes regulating cryptoassets at a supra-national level extremely challenging to negotiate.
And it’s one reason why the EU Parliament desires to make new rules at the highest level, instead of co-opting piecemeal advances within each state.
Any threat to the existing banking system — that potentially loosens the grip of central banks and their ability to control markets and the flow of money — is viewed first with suspicion before begrudging respect and eventual adoption.
The EU is known for its intense desire for encylopedic regulation of financial services. That manifests itself in the form of long and complex policy research documents – like this one by the European Parliament Research Service from April 2020 – which lays out the structure of the cryptoasset market.
The document notes two notable developments since the last major cross-border research study in 2018. They are: “The massive growth of the number of so-called private “tokens” issued on existing platforms in order to raise funds, and the emergence of so-called “stablecoins” and central bank digital currencies (CBDCs).”
The study recommends several points.
- That the EU broaden the definition of cryptocurrency and expand the list of crypto entities subject to regulations.
- That 5AMLD is outdated when compared to higher international standards proposed by the likes of the Financial Action Task Force (FATF)
- That cryptocurrency miners should be more closely scrutinized
- That coin developers and non-custodial wallet providers should not be subject to AML procedures
- That there should be a clearer definition between regulated products and unregulated cryptoassets “that do not qualify as MiFID II financial instruments, nor EMD2 electronic money and hence escape all EU financial regulation”.
Of chief importance to the EU at present are the emergence of fast-moving fintech trends of so-called global stablecoins, like Facebook’s Libra, and the issuance of tokens to represent a form of private, non-governmental currency.
The transparency and immutability of blockchain-based money is of particular interest to the EU. As such the bloc has a keen focus on Central Bank Digital Currencies, digital fiat programmes like those being developed in China “It is too early to tell whether CBDCs will become game changers for payments,” it says. However, “an interesting line of thought that links CBDCs with compliance with laws, is that replacing anonymous, untraceable cash with a public, traceable CBDC, could theoretically mark the end of many money laundering and criminal activities.”
Financial institutions are not currently prohibited from gaining exposure to cryptoassets under current regulations. “As part of a conservative prudential treatment, for now, the best way forward to deal with the uncertainty is probably to deduct them from a financial institution’s own funds”, the report says.
The roadmap for cross-border EU cryptoasset regulation is now well underway. The financial department of the trade and monetary union began a feedback and public consultation period on 19 December 2019, closing on 19 March 2020. This framework seeks an exhaustive response to the emergence of cryptoassets like Bitcoin, and to deal with the effect these technologies will have on the way all financial assets are issued, exchanged, shared and accessed in the future.
The EU has scheduled the initiative to be adopted in the third quarter of 2020.
The EU has a vast swath of financial services legislation, the most prominent being AMLD and MiFID II.
MiFID II was rolled out on 3 January 2018. It seeks to increase transparency of costs relating to financial transactions and improved record-keeping, and covers virtually every asset in the EU financial services industry.
The major piece of legislation relevant to cryptoassets is the EU’s Anti-Money Laundering Directive (AMLD).
On 5 July 2016 the European Commission put forward a proposal to alter the fourth iteration of this law (AMLD4) to bring crypto custodian wallet providers and digital asset platforms with the scope of AMLD4.
This meant they would have to fulfill due diligence requirements and have in place procedures to detect, prevent and report potential money laundering and terrorist activity.
Know-your-customer (KYC) and anti-money laundering (AML) rules are at the heart of the AMLD.
These specify, in brief, that financial service entities should be able to track and trace the identity of their customers. This requirement rubs up against the semi-anonymous nature of cryptocurrencies and has caused a lot of soul-searching in the crypto business community.
In May 2018, the EU adopted the fifth version of this law, (rather unimaginatively) called the Fifth Anti-Money Laundering Directive (AMLD5). It puts forward a strict financial framework that requires cryptoexchanges and custodians to register with regulators and demonstrate how they comply with KYC and AML laws.
This does bring with it the issue of regulatory arbitrage. Crypto companies have closed down, citing the financial burden of meeting these more stringent requirements. For example, UK crypto payments firm Bottle Pay closed in December 2019 saying it was not willing to meet KYC requirements, and that to do so would “alter the current user experience so radically and so negatively”. Dutch Bitcoin savings company Bittr shut its doors in April 2020 for the same reason. Trading platform Deribit announced it would move its operations from the Netherlands to a more lax regulatory environment in Panama ahead of 5AMLD, while the second-largest non-custodial exchange by market share, KyberSwap, switched from Malta to the British Virgin Islands.
The European Banking Authority has published reports on the regulatory approach to cryptoassets. But the tone of their arguments has shifted significantly from 2014 to today, switching away from blanket warnings on the dangers of investing in virtual currencies as “highly risky and unregulated products unsuitable as investment, savings, or retirement planning products”.
The EBA tends to defer to the more forward thinking countries, like German, which in a 29 November directive gave its financial institutions the legal right to custody and sell cryptocurrencies.
Financial Market: The wider picture
The European Securities and Markets Authority is the EU market regulator. Its stated aims are to assess risks to investors, markets and financial stability, as well as completing a single rulebook for EU financial markets and directly supervising credit rating agencies. Its chairman since 1 April 2011 is Steven Maijoor.
The Union does not at present have an EU-wide sandbox, preferring instead to support country-level fintech innovation hubs formed by the likes of the Bank of Greece. This may change in future. The case is now being made for a kind of “guided sandbox” at supra-national level, to avoid the issue of firms who have successfully tested innovations in one member state needing to start afresh in other EU countries, even where similar legal requirements apply.
By Maxim Bederov