Crypto View - January 2024

After a bit of a break for December, we're back with a bang with this month's edition of Crypto View. Clearly, the big news over the past two months has been the approval (then unapproval, then re(?)approval) of a series of Bitcoin ETFs in the United States. We take a look at this, as well as what this means in some other jurisdictions. Related to that, my colleagues have published an update on Crypto ETNs which we discuss as well. Elsewhere, the UK Financial Promotion Regime keeps giving, with the delayed introduction to certain "frictions" coming into effect earlier this month. We also take a look at developments in the world of CBDCs and fiat backed stablecoins, as well as an innovative tokenised securitisation in Italy. As usual, we'll finish with some updates on MiCA, which I'm sure you noticed, is getting closer and closer...

Bitcoin ETFs

As you will have no doubt seen, the SEC managed to jump its own gun and put out confirmation on Twitter (now X) that it had approved Bitcoin ETFs, before Gary Gensler, the Chair of the SEC, swiftly posted that this was not, in fact, the case and that the SEC's account had been hacked. However, it was only a day later that the SEC did approve the listing of Bitcoin ETFs. All a bit odd, but then nothing is straightforward in this industry. What is also odd is the vastly different statements that were published by Gensler, and Commissioner Hester M. Pierce.  The former was characteristically enthusiastic about the industry: "Though we're merit neutral, I'd note that the underlying assets in the metals ETPs have consumer and industrial uses, while in contrast bitcoin is primarily a speculative, volatile asset that's also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing. While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin." While Commissioner Pierce opened both barrels at the SEC - "We squandered a decade of opportunities to do our job." It's good to see the regulator is aligned at the top.

It seems a very long way off that we might see something similar in the UK. In terms of UK investors being able to invest into a US Bitcoin ETF, it would be considered a third country Alternative Investment Fund (AIF), and so to be marketed in the UK would need to be registered under the National Private Placement Regime (NPPR). While there are some US ETFs that have been registered under this regime, there would still be a restriction on marketing such funds to retail.  

Generally, retail investors are limited to UCITS funds, and the approach is similar in both the UK and EU. UCITS can only invest in certain eligible assets, which are, broadly, transferable securities, Units in certain collective investment schemes (not ones that invest in cryptoassets), approved money market instruments, derivatives and forward transactions (with a UCITS eligible investment as their underlying), or deposits. Cryptoassets are certainly not permitted.

Though one way that retail investors in Europe are able to gain exposure to cryptoassets through exchange traded products is through Exchange Traded Notes (ETNs)...

Crypto ETNs

Crypto ETNs are debt instruments linked to one or more specified cryptoassets - the linkage means that the value of crypto ETNs will rise and fall in-line with the underlying cryptoassets, subject to the deduction of fees and expenses. You may be aware that the FCA introduced a ban on the marketing and sale of such products for retail customers that applies to authorised firms in the UK, however the structure is more common in Europe to allow such customers to invest in these exchange traded products.

In case you missed it, my colleague Oliver Ward published a briefing on these products in December that you can see here.

FCA Causing Friction

It's perhaps a good sign that this month the UK's financial promotion regime has moved down the billing. You may remember that the FCA gave cryptoasset firms a bit of a breather with implementing all the changes that were supposed to come in on 08 October last year - this meant that firms were not required to implement the 24-hour cooling off period (where firms don't let their customers trade until 24 hours has elapsed from initial sign up), customer categorisation or appropriateness assessments until this month - 08 January 2024. By way of reminder, the "third friction", is that customers of cryptoasset firms must be categorised into one of four categories in order to be able to "view a direct offer financial promotion", or trade in cryptoassets:

• Certified as a 'high net worth investor' (an investor that earns more than £100,000 or has net assets of more than £250,000);
• Certified as a 'sophisticated investor' (an investor that has been certified by an authorised person as sophisticated);
• Certified as a 'restricted investor' (an investor that confirms that they have not, in the last 12 months, nor will in the forthcoming 12 months, invest more than 10% of their net assets into restricted mass market investments), or
• None of the above

If a customer selects "none of the above" they won't be able to continue to purchase cryptoassets. Interestingly, the Financial Promotion Order was updated yesterday (31 January) to increase the thresholds for high-net worth investors, from an income of at least £100,000 to an income of at least £170,000, or net assets of at least £250,000 to net assets of at least £430,000. These don't seem to have been tracked through to the COBS rules yet, but we expect them to at some point.

The "fourth friction" is that the cryptoasset must be assessed as being appropriate before a cryptoasset company can allow its customers to trade. There are guidelines published by the FCA as to how these should be carried out. For example, firms are discouraged from having binary yes/no answers, and customers should have different questions if they retake. Further, firms must not let a customer retake within 24 hours of failing for a second time.

We are aware that the FCA is beginning to look at firms' implementation of these frictions, and we would be happy to discuss if you have any questions on this. Please do get in touch.

An Innovative Tokenised Securitisation

My colleagues in Italy advised on an innovative tokenised securitisation for Zenith Service S.p.A., a first of its kind in the Italian market. When compared to a traditional transaction, the novel arrangement involved the sale of portfolios of trade receivables - groups of unpaid amounts owed to the business - that have been accumulated by Zenith.

Under the deal, the trade receivables have been sold by Zenith as a financial asset to 2023 Blockchain Vision S.r.l - a special entity set up under Italian law - which will issue it as partly-paid asset backed securities (ABS), with a maximum value of €50 million. The securitisation was carried out in "proof of concept," using blockchain technology through the public platform "Algorand". Through the use of smart contracts - executed on the blockchain - the portfolios, associated payments and issuance of tokens replicating the ABSs, will be digitised.

If you would like more information on this, you can read about the deal here, but also please do get in touch with my colleagues Simone Lucatello, Ugo Malvagna, Marcello Rivoir and Veronica Ciardo.

Bank of England and HM Treasury Respond to CBDC Consultation

I hesitated to include the Bank of England's latest publication on CBDCs - I mean, it's not really '*crypto'  *is it...? There is no tokenisation, no blockchain - it's a ledger. It's basically e-money? (There's a great write up in Payments View to be fair).

However, the fact that the Consultation Paper received over 50,000 responses suggests I'm wrong not to be excited about this - and indeed, the very future of money is an important discussion. I do agree with the Bank and HM Treasury that a digital pound would likely be needed in the future, and their conclusion that further preparatory work is justified seems sensible. The fact that it isn't as innovative as it might otherwise have been looks to be deliberate, as Oli Irons discussed in that Payments View - governments and regulators around the world have already demonstrated that they aren't prepared to allow large scale private initiatives such as Libra to take off so this initial stage should be seen as more of a defensive move to establish a UK CBDC ahead of commercial alternatives.

We'll see what happens next, as we enter the design phase.

This month in MiCA

It seems ESMA did not have a slow start to 2024, publishing two consultation papers on 29 January covering the qualification of cryptoassets as financial instruments and guidelines on reverse solicitation. Comments on these are requested by 29 April 2024 and ESMA intends to publish the final reports by end of 2024.

The first of these consultations aims to provide high level considerations to help with deciding whether a cryptoasset should be categorised as a financial instrument under MiFID II (by way of reminder, MiCA does not apply to cryptoassets that qualify as financial instruments). ESMA emphasises the importance of substance over form throughout, and advises a technology neutral approach so that equivalent activities and assets are subject to similar standards; accordingly tokenised financial instruments are still financial instruments - this is very much in line with the approach the market has been taking to date. The consultation also proposed guidance on how to establish if cryptoassets will fall outside of MiCA's scope (e.g. NFTs), the key characteristics being uniqueness and non-fungibility. An 'interdependent value test' can be used to assess this considering (1) if the cryptoasset's value primarily stems from its unique characteristics, (2) the extent to which interconnection of types of crypto-asset influence the value of one another and (3) the unique characteristics that distinguish it. For instance, an NFT in a large collection where each NFT represents the same image with minor modifications would not be exempt from MiCA because of its comparability to other cryptoassets, rendering them interchangeable.

The second consultation is much shorter, and indeed, much more interesting. It aims to provide more guidance on the conditions of the reverse solicitation exemption. This will be of importance to the many firms based outside of the EU that rely on the provision of services at the client's own exclusive initiative to avoid extra-territorial application of EU financial regulatory requirements - but it will also have potentially wider impact on the broader financial services industry, showing the direction of travel that European regulators are taking with regard to reverse enquiry.

The guidelines proposed by the consultation advise that the concepts of solicitation, means of solicitation and person soliciting should be construed in the widest possible way, while what is meant by the 'exclusive initiative of the client' should be construed as narrowly as possible. Interestingly, it also seeks to reframe the reverse solicitation exemption, saying that while it is often referred to as an exemption, it is, in fact, a prohibition - a prohibition on third-country firms soliciting clients established or situated in the EU. The MiCA draft guidelines follow largely, but not in all regards, the established practice under the MiFID II framework (as found in the "ESMA Q&A").

The "Means of Solicitation" now includes explicit examples that seek to broaden the scope of the exemption as found in the ESMA Q&A - it includes any other form of physical or electronic means, including social media platforms, mobile applications, as well as promotions, advertisements and offers of a general nature and addressed to the public (with a broad and large reach) such as, for instance, brand advertisements by way of sponsorship deals. An example given states that a website in an official language of the EU (and which is not customary in the sphere of international finance) should be a strong indication that a third-country firm is soliciting EU clients, whereas geo-blocking to prohibit website access by EU clients would be a strong indication that the firm is not soliciting clients via the website (other examples of a third-country firm's presence in the EU were EU country extensions on web addresses or local telephone numbers).

Similarly the "Person Soliciting" has been broadened from the ESMA Q&A, now also including people acting explicitly or implicitly  on behalf of the third-country firm. It states that indications of "acting on behalf of the third country firm" may include, for example, the direction of the audience to the third-country firm's website, the provision of the means of access to the services offered by the third-country firm, the offering of promotional deals or the displaying of a third-country firm's logo. This goes far further than "acting on behalf" as found in the MiFID II framework, and could include, for example, independent ranking websites that include links to different firms' websites.

The guidelines also go further to explain what is meant by the 'exclusive initiative of the client'. Here, time is of the essence. Firms may not offer the client further services, even of the same type, unless they are offered in the context of the original transaction (so marketing of crypto services at the time the client reaches out to the firm for the same type of services is permitted, but marketing those services to the client a month later would not be). What is meant by "same type" is also discussed, and is to be granular enough to ensure that reverse solicitation is not used as a way of circumventing a national regime of a member state. It isn't just the case of the categories being Cryptoassets, Asset-referenced Tokens, E-Money Tokens etc. ESMA provides examples of pairs of cryptoassets which should not be considered as belonging to the same type for the purposes of reverse solicitation:

• utility tokens, asset-referenced tokens or electronic money tokens;
• crypto-assets not stored or transferred using the same technology;
• electronic money tokens not referencing the same official currency;
• asset-referenced tokens based mostly on FIAT currencies and asset-referenced tokens having significant crypto-currency ponderations;
• liquid and illiquid crypto-assets;
• crypto-assets other than asset-reference tokens and electronic money tokens with a non-identifiable-offeror and crypto-assets other than asset-reference tokens and electronic money tokens with an identifiable offeror.

As mentioned, ESMA has requested feedback by 29 April 2024 and we would definitely recommend responding to this.