Chris Brummer is a law professor at Georgetown University Law Center
Much ado has been made of the challenges the United States faces when it comes to regulating cryptocurrencies: the split authority of the SEC and CFTC, the ad hoc application of legal tests (most notably, the Howey test) to determine whether or not new financial products fall within the regulatory perimeter of agency rules and regulations, and the limited human capital and funding necessary to vigorously understand and supervise new, technologically-driven markets.
But it could be worse. Indeed, whatever the challenges of a split US regulatory architecture, the European Union faces the problem of potentially having no regulator at all.
At the national level, approaches are splintered. France recently introduced new legislation that would allow the Authorité des Marchés Financiers (AMF), to approve issuers of ICOs and require them to submit detailed information about their offerings to the AMF. Switzerland (not formally a member of the EU, but still subject to EU rules) has long adopted a light-touch approach to cryptocurrency regulation in order to attract transactions. Germany’s BaFin, like the AMF, has begun to push for a stronger approach to cryptocurrency regulation, and leaders have called for EU-wide coordination, but to little practical effect.
There are EU rules that theoretically could facilitate a common regional approach, but what they mean is far from certain. Part of the problem resides in the fact that the primary piece of legislation, the Markets in Financial Instruments Directive (MIFID), regulates “financial interests,” but the definition is itself of extremely limited help. The term “financial interests” itself is divided into eleven classes, of which only one seems especially applicable, that of a “transferable security.”
Article 4.1 of MiFID contains the definition of transferable securities. This definition covers those classes of securities which are negotiable on the capital market (except instruments of payment), such as:
- Shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares.
- Bonds or other forms of securitised debt, including depositary receipts in respect of such securities.
- Any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures.
Mifid thus indicates that “transferable securities” are “securities” negotiable on capital markets. Well then, what’s a security? Answer: there is no answer. Unlike the US, there is no (however ad hoc it may be) EU version of the Howey test. Instead, civil law predilections tend to define these kinds of things ex ante, creating a presumption in many quarters that cryptocurrencies lie outside the scope of Mifid, at least as it’s been written thus far, unless national authorities interpret Mifid in such a way that it does.
This leaves key agencies like ESMA in the unenviable position of having to question whether or not they even have the power to issue warnings on cryptocurrencies and risks posed to investors, much less engage in rulemaking. Instead, the onus is on the Commission (and to a much lesser extent, ECB) to consider whether or not a redrafting of Mifid is necessary, or a fully fledged new regulatory apparatus for cryptocurrencies.
Again, this diverges considerably from the discussions in the United States. In the US, there is a sense that although the SEC and CFTC may in some instances only be able to regulate cryptocurrencies indirectly (through financial intermediaries), or through their antifraud and anti manipulation capabilities, they have tools to do so if they so choose.
The lack of a clear EU framework leaves the member states in charge of regulating cryptocurrencies and exchanges in their own backyard, an inherently difficult position given the transnational nature of crypto products and fund-raises—and legacy approaches to financial regulation. For instance, the German Federal Financial Supervisory Authority (BaFin) has concluded that Bitcoins are financial instruments, reflecting a predating binding decision on units of account relating to the German Banking Act. Its approach is not, however, at all reflective of the MiFID II’s framework, which nowhere suggests that units of account constitute financial instruments. Germany’s more stringent approach is thus country specific, casting a broader net than in other jurisdictions, almost entirely on the basis of previous rulemaking.
And then there’s Malta, which in July passed a series bills ushering into law what some describe as the first blockchain/cryptocurrency regulatory framework. Under the new legislation, which came into effect earlier this month, the Malta Monetary Financial Services Authority (MSFA) is tasked with determining whether an ICO or cryptocurrency should be deemed a security or other financial instrument by administering a “Financial Instruments Test.” If it determines that the product in question is indeed a financial instrument, that product would be subject to MiFID and all its accompanying rules. However, even if the MSFA does not deem a transaction to be a financial instrument, it does not mean that another jurisdiction (outside the EU) will not find otherwise—or more importantly, that another country (inside the EU) will not impose indirect rules (relating say, to secondary trading, custody or more) that can impact the development of a unified regional approach and market.
Notice, by the way, that these are all merely the “front-end” regulatory problems. But that’s not all: just as important as actually issuing rules, every member will have to have their own enforcement regime. And to my knowledge—and not surprisingly—there has been no enforcement action taken anywhere in Continental Europe thus far.
This again contrasts considerably with the United States which, along with issuing warnings and a joint op-ed last year by the CFTC and SEC Chairmen, has engaged in record enforcement actions against cryptocurrencies, and is looking to take its supervision abroad. Indeed, if a leadership vacuum persists on the issue in Europe, I would not be surprised to see the G20, FSB and IOSCO approaches largely emulating the direction taken in the United States, however disjointed, especially if the rout in cryptocurrency prices continues.