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On the 31st of July, 2024, the European Securities and Markets Authority (ESMA) released an opinion concerning the application and enforcement of the Markets in Crypto-Assets (MiCA) regulation within the European Union. The main goal is to a unified approach to regulating crypto-assets and the entities involved in their trading, issuance, and brokerage. With the advent of MiCA, ESMA aims to increase investor protection, market integrity, and financial stability across the EU’s crypto-asset ecosystem.

The MiCA regulation, published in June 2023, provides the legal framework for crypto-asset issuers and service providers. It emphasizes transparency, disclosure, authorization, and supervision of crypto-assets, including asset-reference and e-money tokens. By regulating these areas, MiCA seeks to address risks associated with crypto-assets and enhance consumer protection.

The Role of Trading Platforms

Trading platforms play a role in the crypto-asset ecosystem, particularly Multifunction Crypto-asset Intermediaries (MCIs), which offer a wide range of services centered around trading platforms. The collapse of FTX highlighted the potential market disruptions caused by large MCIs, emphasizing the need for stringent regulatory oversight. Article 76 of MiCA sets forth extensive requirements for trading platforms, including operational resilience, transparency, fair access, and efficient execution of orders. Enhancing the identification, assessment, and mitigation of potential risks, ensuring that critical functions remain operational during unforeseen events and protecting the platform and its users from cyber threats and data breaches.

Best Execution

Under MiCA, crypto-asset service providers are required to achieve best execution for their clients. This means taking all necessary steps to ensure that orders are executed to provide the best possible result, considering factors such as price, costs, speed, and likelihood of execution. Service providers must actively evaluate available execution venues and make informed decisions to benefit their clients.

In the ESMA’s opinion, it is emphasized that brokers should not rely solely on a single execution venue, especially if doing so compromises the quality of execution for certain crypto-assets. Instead, they should continuously assess and compare execution venues to ensure they deliver the best outcomes for their clients. This approach promotes competition and transparency, leading to potential better services and pricing for investors.

Conflicts of Interest

MiCA mandates that crypto-asset service providers identify, manage, and disclose any conflicts of interest that may arise between themselves and their clients. This is particularly important for Multifunction Crypto-asset Intermediaries that offer a broad range of services and may face internal pressures to prioritize certain activities over others.

ESMA highlights the risk of conflicts when brokerage activities are combined with other services, such as trading platforms within the same group. Firms must establish robust policies and procedures to manage these conflicts, ensuring that their interests do not unduly influence the execution of client orders. Simply disclosing conflicts is not enough; they must be actively managed and mitigated to protect clients’ interests.

Obligation to Act Honestly, Fairly, and Professionally

MiCA imposes a clear obligation on service providers to act honestly, fairly, and professionally in the best interests of their clients which means that all interactions between service providers and their clients, requiring firms to prioritize client needs above everything else. This includes providing accurate information, delivering on promises, and maintaining high ethical standards in all dealings with clients. ESMA stresses that this obligation extends to assessing the quality and level of protection offered by non-EU trading platforms where client orders may be executed.

Custody and Administration of Crypto-Assets

A key aspect of MiCA is the requirement for proper custody and administration of crypto-assets on behalf of clients. Service providers must ensure that any entities involved in these activities are authorized under MiCA to provide such services. This is crucial to safeguarding client assets and maintaining trust in the crypto market.

In the ESMA’s opinion, it is highlighed that crypto-asset service providers must not allow unauthorized third-country entities to hold or administer client assets. Any custody arrangements must comply with MiCA’s stringent standards, ensuring that client assets are protected against loss, theft, or mismanagement. This includes maintaining clear records, implementing robust security measures, and regularly auditing custody practices.

Challenges with Third-Country Firms

ESMA highlights a significant challenge with third-country firms seeking to operate in the EU without adhering to MiCA regulations, which is represent today a serious risk on the efficacy of MiCA application on EU citizens. These firms often engage in a practice known as regulatory arbitrage, which involves exploiting differences between jurisdictions to minimize regulatory burden.
In order to avoid any potential loopholes or regulatory discrepancies, ESMA mandates that trading platforms operating outside the EU, yet serving EU clients, adhere to the stringent standards set forth by the MiCA regulation.

Third-country firms often tout their disintermediated business models as a key selling point. These models enable firms to offer a wide array of crypto-asset services directly to consumers, bypassing traditional financial intermediaries. While this approach can increase efficiency and reduce costs, it also poses significant risks. Without a centralized point of oversight, these firms can obscure critical operations from regulators, making it challenging to ensure compliance with investor protection and market integrity standards.

The ability of third-country firms to operate in the EU without being subject to MiCA’s robust regulatory framework poses a direct threat to market integrity. These firms may not be bound by the same transparency and disclosure obligations as their EU counterparts, leading to asymmetries in information that can distort market dynamics. Such disparities can erode trust among investors and stakeholders, potentially resulting in decreased participation and liquidity in the EU crypto-asset markets.

Investor protection is a one of the main aspect of MiCA, aimed at safeguarding EU citizens from the inherent risks associated with crypto-assets. Third-country firms may expose investors to higher levels of risk, particularly if these firms operate under jurisdictions with lax regulatory standards. The absence of stringent requirements around capital adequacy, operational resilience, and consumer disclosure can leave investors vulnerable to fraud, market manipulation, and financial losses.

ESMA’s opinion on broker models under MiCA highlights the importance of robust regulatory standards for crypto-asset service providers. By focusing on best execution, managing conflicts of interest, increasing professional obligations, and ensuring secure custody of assets, ESMA aims to enhance investor protection and market integrity.

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The views and opinions expressed in this article are my own and do not reflect the official policy, position, or opinions of any financial institution, or other organization.
The content of this article is based on personal research of the author and understanding of AML (Anti-Money Laundering) and compliance topics.