Officials in the European Union (EU) say their landmark new legislation, the Markets in Crypto Assets Regulation (MiCA), would have prevented FTX-style collapses – but there’s also a major loophole that could allow offshore companies to continue to operate within the bloc.
Even when the Markets in Crypto Assets legislation goes into force in the coming years, companies like FTX, based in the Bahamas, would still be able to serve EU clients without extra regulation, thanks to a technique known as reverse solicitation.
MiCA requires companies targeting the EU market to register with a local regulator, with checks on their governance and marketing – ensuring that, for example, they don’t mislead potential investors, or misuse client funds, as FTX was alleged to have done before it filed for bankruptcy earlier in November.
But the text – politically approved but not yet formally enacted – contains some pretty wide exemptions that could in reality allow EU citizens to go to a foreign crypto site and buy all the bitcoin they want.
Reverse solicitation exists because, on a practical level, it’s hard for regulators to enforce financial rules on overseas firms, and because they don’t want to block companies from seeking foreign expertise outright. But it can also be abused, such as via standard contract clauses which deem a trade to have taken place at the client’s sole request.
MiCA broadly allows the practice, but, compared to other EU financial service laws, includes stronger powers for supervisors to stop solicitation being abused - including an ad ban for unauthorized products. However, the detailed ground rules need to be set by the European Securities and Markets Authority (ESMA), which has to issue guidelines, and its officials already see this topic as a source of concern.
Reverse solicitation “might be a particularly pronounced problem in this space of crypto assets, and that is something that is of concern for us,” Steffen Kern, head of ESMA’s Risk Analysis and Economics Department, told lawmakers Wednesday.
“Service providers outside the EU play a dominant role in crypto markets and should be expected to do so” even after MiCA is implemented, Kern added.
One answer, favored by the European Commission, which proposed MiCA and is now responsible for monitoring the new law, is to ensure other jurisdictions play ball using the same rulebook.
“Crypto asset markets are global, interconnected and mobile,” Alexandra Jour-Schroeder, a deputy director-general at the commission’s financial-services arm, told lawmakers on Wednesday, She said unilateral clampdowns in places like China have done little to curb citizens’ access to crypto.
“We have to be vigilant that our EU protections are not undermined by jurisdictions that ultimately fail to regulate and supervise their companies,” she said. She added that she wants other countries to adopt crypto rules on the EU model.
In traditional finance, received wisdom is that the problem will largely solve itself. Alhough you might find the odd client from overseas, to really scale up in the EU market you’ll need a proper marketing campaign, which means you need to be based there; a regulatory badge of approval will prove a selling point, the argument goes.
“In financial services there's a flight to quality over time” due precisely to FTX-style scandals, Barney Reynolds, a partner in the financial services practice of London law firm Shearman, told CoinDesk. “Business gravitates to where the most sophisticated regulators and regulations are."
The question is whether that logic applies in a sector where people are as likely to get advice from Reddit or YouTube as from a regulated financier, and where decentralized freedom from government control is part of the attraction. Jour-Schroder might be able to persuade the U.S. and U.K. to regulate crypto, but what about Bahamas, Dubai and Antigua, or those firms that deny they have any headquarters at all?
It’s that kind of question that leaves some lawmakers nonplussed, and concerned that EU registration confers an unfair disadvantage.
“Companies physically present in the EU targeting EU consumers have to adhere to all these principles, rules and regulations,” Dutch lawmaker Michiel Hoogeveen told CoinDesk after the Wednesday hearing. “There's a disbalance, and a loophole.”
“I don't really think they [the commission] have a concrete answer, and it's something that we have to look into in the future – to find out how to prevent these loopholes from happening,” Hoogeveen said.
CoinDesk is an award-winning media outlet that covers the cryptocurrency industry. Its journalists abide by a strict set of editorial policies. In November 2023, CoinDesk was acquired by the Bullish group, owner of Bullish, a regulated, digital assets exchange. The Bullish group is majority-owned by Block.one; both companies have interests in a variety of blockchain and digital asset businesses and significant holdings of digital assets, including bitcoin. CoinDesk operates as an independent subsidiary with an editorial committee to protect journalistic independence. CoinDesk offers all employees above a certain salary threshold, including journalists, stock options in Bullish Group as part of their compensation.