ESMA’s Advice on ICOs and Crypto-Assets: an endorsement of Malta’s legal framework?

On 9 January 2019, the European Securities and Markets Authority (“ESMA”) published its advice to regulators across the EU Member States in relation to initial coin offerings (“ICOs”) and crypto-assets in general. 

It is our view that the advice can be construed as an endorsement of Malta’s legal framework on distributed ledger technology and crypto-assets. Below are some of the key points, including a brief explanation on how Malta’s framework corresponds to such: 

1.    The advice encourages the EU Member States to regulate ICOs and crypto-assets in general and identifies investor protection, money laundering, and market integrity as key industry risks. 

o    At the heart of Malta’s legal framework are onerous obligations imposed upon issuers of crypto-assets, and industry service providers, to prevent money laundering by classifying such players as “subject persons”, in the process, imposing upon them “know your client” duties to ascertain the identity of their clients, investors, and counterparties, and the provenance of wealth and any funds transferred; 

o    Issuers and industry service providers are also obliged to protect their investors. In this regard, Malta’s framework has reproduced most of the safeguards set out in MiFID and the Prospectus Directive, including accurate investor disclosure, segregation of assets, client categorization, and prevention of conflicts of interest. The same applies with respect to market integrity, with the vast provisions set out in the Market Abuse Regulation also being applied in respect of issuers and industry service providers.

2.    The advice encourages the Member States to implement mechanisms for the determination of the legal status of crypto-assets, with a view to ascertaining whether the ‘traditional’ financial services rules and regulations are likely to apply. 

o    The Malta Financial Services Authority went to great lengths to develop what is now known as the “Financial Instrument Test” (“FI Test”). The FI Test takes the form of an elaborate questionnaire, and provides certainty as to whether a crypto-asset is: (i) a financial instrument (a term which comprises transferable securities, money market instruments, units in collective investment schemes, financial derivatives, and emission allowances); (ii) electronic money (as defined in the Electronic Money Directive); (iii) a virtual token (commonly referred to as the pure utility token); or (iv) a virtual financial asset (an umbrella term for all tokens that do not qualify under any of the previous categories);

o    In terms of Maltese law, if a crypto-asset is categorized as a financial instrument, issuers and related service providers are required to observe the respective ‘traditional’ financial services rules and regulations, including, in particular, MiFID, MiFIR, and the Prospectus Directive. If, on the other hand, a crypto-asset is categorized as electronic money, issuers must comply with the respective transpositions of the Electronic Money Directive; 

o    If a crypto-asset is categorized as a “virtual token”, an issuer or a service provider remains unregulated;

o    Finally, if a crypto-asset is categorized as a virtual financial asset, the new ad hoc regulatory regime set out in the Virtual Financial Assets Act and ancillary rules and regulations apply (the “VFA Framework”); 

o    The FI Test can be accessed through this link:  https://www.mfsa.com.mt/fintech/virtual-financial-assets/guidance/financial-instrument-test/.

3.    ESMA’s advice also outlines challenges related to inconsistent regulation of crypto-assets across EU Member States. Of particular note was ESMA’s suggestion that regulators should take a “technology-neutral approach to ensure similar activities and assets are subject to the same or very similar standards regardless of their form”. 

o    Taking a ‘technology-neutral approach’ may imply that the EU Member States should also be discouraged from creating unnecessary hurdles which may preclude passporting;

o    Although Malta has succeeded in providing legal certainty in so far as local laws are concerned, uncertainty still exists in relation to whether crypto-assets, categorized as financial instruments or electronic money, as well as services related therewith, will be allowed to exercise the European right of passporting across the Single Market, thus impinging on the comprehensiveness of Malta’s legal framework;

o    In this regard, ESMA observed that gaps in the existing regulatory framework for financial instruments, relating specifically to the underlying technology and to the definition of the term, need to be addressed for progress to be made towards the harmonization of regulation and supervision of crypto-assets.