Barely a year into the EU’s Markets in Crypto Assets (MiCA) regime, designed to deliver a uniform regulatory environment across the 30 nations of the European Economic Area, cracks are beginning to show, and there are signs that EU regulators are looking to ensure they do not widen.
Concerns have already emerged that some member states are handing out licenses in an overly accelerated manner, and now reports are emerging that the European Securities and Markets Authority (ESMA) is preparing to take greater, more centralized control of crypto regulation across countries within its purview.
Details of ESMA’s plans are still few, but MiCA policy watchers know where the clues lie. A likely change, which works technically but could have significant knock-on effects, concerns the sharing of liquidity outside the EU and the use of uniform order books.
From a regulatory perspective, a shared order book obscures who is responsible for matching, disclosures, risk management and best execution. From a trader’s perspective, pooling buy and sell orders across a wider population creates greater liquidity, easier transactions and more accurate pricing.
ESMA would not comment on shared order books specifically, but said in an email that the position stated in a Q&A earlier this year (which states that MiCA does not allow a crypto trading firm to aggregate its order book with any non-EU, non-MiCA regulated trading platforms) “is part of the efforts that ESMA has made, and continues to make, to ensure a level playing field for MiCA in the application of MiCA.”
“Shared order books are something that’s been possible for a long time, and it creates a lot of liquidity,” Nikolai de Koning, financial services attorney at Norton Rose, said in an interview. “But ever since the question and answer from ESMA, regulators have been asking applicants and firms how they separate order books. So firms have had to demonstrate how they separate those order books, and this includes some of the biggest exchanges. Some of the platforms created separate order books – so non-EU and EU – that they could really run separately.”
Pressing for clarity
Part of the push for more centralized supervision comes from the EU countries’ supervisory authorities themselves, so-called national competent authorities. France’s financial watchdog, the AMF, Austria’s FMA and Italy’s Consob asked ESMA to take tighter controls on MiCA in a co-authored letter in September. The AMF was specific about local order books in an email to CoinDesk:
“The reference to maintaining effective controls within the EU is intended to capture, among other things, the need for trading and execution activities – including through local order books – to be effectively located and monitored in the Union,” the AMF said.
“From our perspective, it is important that this interpretation is made explicit at level 1 of the MiCA framework. Embedding this clarification directly in the legal text would ensure greater legal certainty and more effective supervision by avoiding ambiguities about what constitutes genuine EU-based substance of and control over crypto trading infrastructure,” the regulator said.
What would be the effect of this? Historically, crypto-trading firms have shared liquidity with non-EU platforms, so any change will be highly relevant to most crypto-trading platforms and ultimately also to prop firms that trade crypto and a lot of other parties in the market, de Koning said.
The devil will be in the details when it comes to what is acceptable to EU regulators, who are still refining their approach. There are platforms that share liquidity but operationally maintain separate books: There is some routing between the books, but the real matching happens at each venue separately, de Koning said. In such cases, there is not a complete ledger, but there are still some advantages of liquidity sharing.
Widening of spreads
Not only is it operationally and legally difficult to change a shared order book, it will also have an impact on the EU markets, according to de Koning.
“This will further concentrate pricing inside the EU and have an impact on order flows and on liquidity in general. The bigger the pool, the better liquidity for the platforms and for users in the end. My view is that forcing EU-only pools is likely to fragment liquidity and widen spreads initially; markets adjust normally, but the adjustment will not be immediate,” he said.
For some crypto companies, the necessary tweaks may not be too challenging. But for a large exchange that draws on liquidity outside the bloc, there can be major operational changes.
US-listed Coinbase (COIN) could be one such company. Coinbase is authorized in Luxembourg as a broker. As such, ESMA’s “Broker Model Opinion” is more relevant. It says EU member state regulators should ensure that any crypto firm making an application “does not aim to obtain a ‘legal cover’ in the Union for third-country companies seeking to solicit customers or potential customers in the Union through a MiCA-authorized entity (typically belonging to the same group) while still providing services from outside the Union.”
‘In the right place’
Tom Duff Gordon, VP of international policy at Coinbase, said the statement from ESMA “landed more or less in the right place” and the situation does not require immediate revision. He also said it was “surprising” to see the joint proposal from AMF, FMA and Consob calling for areas such as order routing to be revisited as MiCA is barely a year old.
“At one point it was unclear whether or not there were two valid parts or whether the liquidity should be onshore. We have consistently argued that both models are legally viable. We currently operate a broker for our US exchange where we can provide the best execution for European clients and deep liquidity,” said Duff Gordon in an interview with CoinDesk.
“We honestly feel that by acting as a broker in the way that we are, we can deliver the best results for our clients,” said Duff Gordon. “I think as long as you can do that, and as long as the European operations have enough substance – which ours absolutely does – and as long as the local entity has control over where the execution happens, then a bit like international finance with MiFID, there’s total validity in having both sort of brokerage models and local platform models.”
Coinbase’s regulator, Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF) said in an email: “In relation to MiCA, the CSSF acts in full respect of EU rules and works closely with the other national competent authorities and the relevant European authorities with a view to supervisory convergence.”
Dea Markova, director of policy at crypto-tech firm Fireblocks, said it is unclear whether being part of a large and heavily regulated group – as Coinbase is – will reduce risk in the eyes of European regulators at the ESMA level.
“I think regulators are concerned that a broker in Austria, for example, might want to draw liquidity from an American or a South Korean exchange and usually have to pre-fund that exchange with some of its clients’ assets,” Markova said in an interview. “So if something happens to that exchange, those client assets will be lost.”
The debate for regulators is now where to draw the line, Markova added.
“If you think about it logically, eventually everyone will get their liquidity outside the EU. There is not enough liquidity, so it’s just a matter of how many steps they go through to get there,” she said.
