Syed Rahman considers the argument
The European Union's (EU’s) finance watchdog has told national regulators authorising crypto firms to consider each one to be high risk.
The European Securities and Markets Authority (ESMA) has made it clear to regulators that there are no low-risk crypto-asset service providers (CASPs). Regulators have been told they cannot make only brief checks into providers under the Markets in Crypto-Assets Regulation (MicA) as providers are a high risk; particularly in relation to money laundering and terrorist financing.
In a briefing to regulators, ESMA stated: "CASPs often deal directly with retail investors and have a limited track record when it comes to regulatory compliance and supervision. They should thus be regarded as constituting a higher risk than entities operating in more mature sectors."
The watchdog added that CASPs are exposed to money laundering and terrorist financing risks because they can transfer assets instantly around the world, take on customers in numerous jurisdictions and offer services with a degree of anonymity. It said that CASPs with more than a million active users per year in the EU or a balance sheet of €3 billion need extra scrutiny – although this should not stop regulators subjecting smaller CASPs to extra scrutiny when it is appropriate.
Structures
ESMA said that national watchdogs need to understand CASP group structures, which can be complex, involve numerous entities and be covered by different legal frameworks. It emphasised the risks associated with cross-border activity, which is made possible because of the passporting regime that allows CASPs regulated in one member state to operate in another.
ESMA said any national regulator authorising a CASP should coordinate with regulators in other EU countries where it operates, to ensure concerns about its ability to meet standards are identified. It added that trading platforms and custody providers that offer services to other CASPs need extra scrutiny, as do CASPs seeking authorisation for many services, those businesses combining digital asset issuer and CASP activities, and CASPs that assign key functions (such as compliance) to separate companies.
According to ESMA, the regulatory history of a CASP and its key staff members should help determine the level of scrutiny necessary. National regulators should consult information exchange systems relating to individuals' fit and proper status, which are run by ESMA, the European Banking Authority and the European Insurance and Occupational Pensions Authority.
Assessment
ESMA’s approach may strike some as alarmist but its assessment is a fair one. Whilst newly-incorporated CASPs should not be overly criticised for their limited track record when it comes to regulatory compliance and supervision - as this takes time to build - ESMA is right to highlight the risks that stem from a lack of a compliance framework.
The business model of CASPs exposes investors to more risks and, as such, stronger oversight is needed, from a regulatory perspective and from within CASPs themselves. The lack of market maturity and the growing concern about the volatility and risks of cryptocurrencies adds to the uncertainty, which leads to ESMA’s concern.
Whether ESMA is being too alarmist is a matter of perspective. Its assessment reflects the heightened scrutiny the crypto industry as a whole is facing - especially in Europe, where regulators often prefer a more cautious, measured approach. Some may argue that many players within the cryptoasset industry are trustworthy, and that ESMA’s assessment places an undue burden on a relatively new industry. They could also point to the fact that the US is now increasingly embracing the crypto industry, and that Europe (as it did with the tech industry) may fail to entice current and future leading players in the sector.
A cautious approach is, in general terms, the correct path to take, as the risks to investors are simply too big to overlook or underestimate. ESMA will, however, have to be careful to ensure that the EU does not suffer as the US warms to the crypto industry.
