ESMA clarifies which crypto-assets might qualify as financial instruments in the EU

At a glance

On 29 January 2024, the European Securities and Markets Authority (ESMA) put up for consultation the long awaited guidelines under Markets in Crypto-assets (MiCA) regulation on the classification of crypto-assets as financial instruments.

Although it might not be obvious if a particular digital asset or a token should be considered a financial instrument or a crypto-asset, correct classification is crucial as regulatory treatment is not the same. Financial instruments fall within the scope of the Markets in Financial Instruments Directive (MiFID II), while MiCA applies to most of the crypto-assets that are not already covered by existing EU legislation and in particular by MiFID II.

These ESMA guidelines therefore aim to help the market make this distinction and to clarify which crypto-assets should be considered as financial instruments and therefore should be subject to the MiFID II framework (and vice versa).

How to assess the legal nature of a digital asset?

Overarching principles

• Case-by-case assessment: In order to properly assess the qualification of a digital asset, one should consider the specific features, design and rights attached to it.
• Technology neutrality: The technological structure of an asset is irrelevant for the purpose of this assessment. If an asset is issued by means of a Distributed Ledger Technology (DLT) such as blockchain, this does not make it a crypto-asset by default. Tokenised financial instruments (in a MiFID II sense, with the only difference being that these are issued on a digital ledger) continue to be considered as financial instruments for all regulatory purposes.
• Substance over form: Classification of a digital asset should be guided by its actual features rather than sole reliance on the label given by the issuer or offeror.
• Hierarchical approach: If a digital asset displays features of a financial instrument, this characteristic should take precedence in its classification. Hence, questioning if it is a financial instrument should be prioritized. Only when a digital asset does not meet this criteria should alternative classifications be considered, such as is it a crypto-asset (e.g., a utility token).

Bearing that in mind, crypto-assets should be designated as financial instruments if they align with MiFID II's definition of financial instruments. Each type of financial instruments, as provided in the Annex I Section C of MiFID II (transferable securities, money-market instruments, units of collective investment undertakings, derivatives and emission allowances), should be excluded before coming to a conclusion that a token is indeed a crypto-asset.

Refining per type of financial instrument

The following criteria should be taken into account for the purpose of assessment if a digital asset is a:

1. Transferable security:

• It confers to their holders similar rights¹ to those attached to securities (e.g., dividend rights, voting rights on the issuer's decision-making process, right over a portion of company’s assets or rights to liquidation proceeds);
• It is not being used as an instrument of payment;
• It is transferable/tradable on capital markets², which should be interpreted more broadly (e.g., is the asset capable of being transferred or traded on trading venues?); and
• It is interchangeable/fungible in a sense that it’s capable to express the same characteristics per unit.

2. Money-market instrument:

• It has a predefined, short maturity period as required in Money Market Funds Regulation (MMFR);
• It exhibits stable value and minimal volatility; and
• It aligns returns with short-term interest rates.

For example, some platforms offer short-term savings accounts for crypto-assets which aim to maintain a stable value (e.g., crypto-assets pegged to stable assets like Euros or the US dollar). If these savings arrangements had maturity and provided returns to users, they might be seen as analogous to traditional money-market instruments.

3. Unit in a collective investment undertaking:

• If a crypto project involves the pooling of capital from a number of investors;
• With a view to investing in accordance with a defined investment policy for the benefit of those investors; and
• Investors do not have control over daily management of the assets included in the pool (rather this is controlled by third parties or code/algorithms/smart contracts).

If these conditions are satisfied, the crypto-asset itself will qualify as a unit in a fund, while the issuer of the crypto-asset will qualify as a collective investment undertaking.

4. Derivative:

Distinction should be made between derivative contracts that have an underlaying that is a crypto asset, a basket of crypto-assets or an index on crypto-assets. These should be qualified as financial instruments.

However, a crypto-asset itself may qualify as derivative financial instrument (regardless of what is underlying) if the following conditions are satisfied:

• "Digital representation" of a contract³ meaning that there is some sort of an agreement between involved parties, detailing the terms, maturity (if any), price and other conditions of the contract;
• An underlying reference⁴, which determines its value (this could be an asset, an index, a commodity);
• Its value fluctuates based on changes in this reference assets; and
• It typically involves financial settlement⁵, where the parties exchange cash payments based on the difference between the contract price and the market value of the underlying reference.

Moreover, we see the emergence of types of securities that primarily serve an investment function (securitized derivatives). By investing in such securities, the investor participates in the performance of an underlying asset (e.g., commodities, transferable securities, crypto-assets) without having a direct investment in that asset itself. Hence, there is no “owner-like” direct claim to the underlying asset. These include but are not limited to, investment certificates such as Exchange-Traded Commodities (ETCs), participation certificates and tracker certificates. This is especially important in the realm of crypto-assets, where direct ownership right might be complex or undesirable for investors. Therefore, crypto-assets comparable to these types of securitized instruments should be treated as transferable securities as per the MiFID II framework.

If not a MiFID financial instrument, is MiCA the only other option?

Not necessarily. As previously mentioned, MiCA will apply to most crypto-assets not considered as financial instruments and as such being captured by MiFID II.

However, there are several exemptions from this rule. For example, MiCA does not apply to digital assets non-transferable to other holders, and to those which are only accepted by the issuer.

Furthermore, unique and not fungible crypto-assets (NFTs) also do not fall within MiCA’s perimeter and remain unregulated for the moment.That said, an “interdependent value test” should be conducted based on the criteria provided in the ESMA guidelines in order to ascertain that a particular crypto-asset is a true NFT.

The deciding criteria is that the value of NFTs primarily stems from the unique characteristics of each individual asset and the utility/benefits it offers to its holder. For this reason, NFTs that are issued "in a large series or collection" may be considered fungible and thereby covered by MiCA.

Another important criterion for a crypto-asset to qualify as an NFT is that it has a value on its own that is decorrelated from the other NFTs in the series. For this reason, fractionalized NFTs may be qualified as crypto-assets within the meaning of MiCA, especially if fractional parts, when considered separately, are not deemed unique and non-fungible. This interconnectedness should become a key factor when these crypto-assets influence each other’s value, thereby challenging their perceived “uniqueness.”Finally, MiCA’s approach toward pure decentralized finance (De-Fi) based crypto-assets (such as Bitcoin) is unique. Such crypto-assets are not subject to MiCA’s issuer regime (as there is no identifiable issuer); however, Crypto-Asset Service Providers (CASPs) providing services in respect of DeFi crypto-assets will be captured by MiCA.

ESMA guidelines will impact all financial firms, beyond those active in crypto space

As a result of changes in the legislative framework, notably introduced by MiCA6, the crypto sector will begin to blend with traditional finance. It is expected that crypto firms, investors in this asset class, and CASPs will increasingly engage with financial institutions, especially banks.

For this reason, financial institutions should stand ready to be challenged by regulators to prove understanding of their products and clients. If requested, this will include the justification of a classification of a particular digital asset or services provided in relation to such assets as either a financial instrument, or a crypto-asset – all based on the above criteria stemming from the ESMA guidelines.

With this in mind, MiCA should not be perceived as a compliance pain – rather, it is an opportunity. Forward thinking financial institutions may want to construct a business model to enter this space and offer certain crypto-related services. In this context, MiCA is an important step forward, as it significantly reduces regulatory uncertainty.

How can Deloitte help?

Deloitte’s specialists and dedicated services can help you clarify the opportunity and impact of MiCA, Luxembourg Blockchain Laws, and their regulatory and compliance requirements. We can also foster the way forward in your digital journey by supporting you in critical areas like defining your strategic digital assets value chain, new services, and operating models efficiency - combining our regulatory and IT expertise.

Our Regulatory Watch team closely follows digital finance developments and helps you stay ahead of the regulatory curve.

¹Financial rights that are unrelated to company profits or liquidation surpluses might exclude financial instrument classification. A difference between voting rights on the company's decision-making process and other voting rights on a project (without participating in the company's decision-making processes) should be also made. In other words, rights should replicate the rights attached to securities in order to classify a crypto asset as a financial instrument.

²Crypto-assets tradability on online trading platforms for crypto-assets may serve as an indicator but does not necessarily coincide with the notion of “capital market”.

³Illustratively, a crypto-asset that represents an agreement for a future Bitcoin purchase at a set price would likely be classified as a future. Similarly, a crypto-asset giving one party a right to buy or sell a specific crypto-assets at a predetermined price within a stipulated timeframe might be seen as an option.

⁴To ascertain that the crypto asset has an underlying reference point, one should take into account the list of Annex I Section C, points (4)-(10) of MiFID II as well as related provisions in the Commission Delegated Regulation 2017/565.

⁵Interestingly, ESMA is still unsure how to treat crypto-assets that are not settled in cash but other crypto-assets such as stablecoins or E-Money tokens.

6MiCA will start to apply 30 December 2024