Barely a year into the European Union’s Markets in Crypto Assets (MiCA) regime, formulated to provide a unified regulatory environment across the 30-nation European Economic Area, the cracks are starting to show and there are signs that EU regulators are seeking to ensure they don’t get bigger.
Concerns have already surfaced that some member states are handing out licenses too quickly, and reports are now emerging that the European Securities and Markets Authority (ESMA) is preparing to take greater, more centralized control of crypto regulation in countries under its jurisdiction.
For now, there are few details about ESMA’s plans, but MiCA policy observers know where the clues lie. One likely change, which appears technical but could have significant repercussions, concerns the sharing of liquidity outside the EU and the use of unified order books.
From a regulatory perspective, a shared order book makes it unclear who is responsible for matching, disclosures, risk management and best execution. From a traders’ perspective, pooling buy and sell orders across a larger population creates greater liquidity, easier trading, and more accurate pricing.
ESMA declined to comment specifically on shared order books, but said in an email that the position expressed in a Q&A session earlier this year (which states that MiCA does not allow a crypto trading firm to pool its order book with non-EU trading platforms not regulated by MiCA) “is part of the efforts that ESMA has made and continues to make to ensure a level playing field in the application of MiCA in the EU”.
“Sharing order books is something that has been possible for a long time and it creates a lot of liquidity,” Nikolai de Koning, a financial services lawyer at Norton Rose, said in an interview. “But since the ESMA Q&A, 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 that includes some of the biggest exchanges. Some platforms have created separate order books – so outside EU and EU – that they could actually operate separately.”
Push for clarity
Some of the pressure for more centralized oversight comes from regulators in EU countries themselves, called national competent authorities. The French Financial Authority, the AMF, the Austrian FMA and the Italian Consob asked ESMA to strengthen supervision of MiCA in a letter co-authored in September. The AMF was specific about local order books in an email to CoinDesk:
“The reference to maintaining effective supervision within the EU is intended to reflect, among other things, the need for trading and execution activities – including through local order books – to be effectively located and supervised within the Union,” the AMF said.
“In our view, it is important that this interpretation is made explicit at level 1 of the MiCA framework. Integrating this clarification directly into the legislative text would ensure greater legal certainty and more effective supervision by avoiding ambiguities on what constitutes genuine European substance and control over cryptocurrency trading infrastructure,” the regulator said.
What would be the impact? Historically, crypto trading companies have shared their liquidity with non-EU platforms, so any changes will be very relevant to most crypto trading platforms, and, ultimately, also to support companies trading in crypto and many other parties in the market, de Koning said.
The devil is in the details when it comes to determining what is acceptable to European regulators, who are still refining their approach. There are platforms that share liquidity, but operationally maintain separate accounts: There is some routing between accounts, but the actual matching happens separately at each site, de Koning said. In such cases, there is no fully unified portfolio, but there are still some benefits to sharing liquidity.
Widening of spreads
According to de Koning, not only is it operationally and legally onerous to change a shared order book, but it will also have an impact on EU markets.
“This will further concentrate price formation within the EU and impact order flow and liquidity in general. The larger the pool, the better liquidity will be for platforms and for users. My view is that forcing EU-only pools is likely to fragment liquidity and widen spreads initially; markets generally adapt, but the adjustment will not be instantaneous,” he said.
For some crypto companies, the necessary adjustments may not be too difficult. But for a large exchange tapping liquidity from outside the bloc, there could be major operational changes.
US-listed Coinbase (COIN) could be one of these companies. Coinbase is licensed in Luxembourg as a broker. As such, ESMA’s “Broker Model Opinion” is more relevant. That said, EU member state regulators should ensure that any crypto company applying “does not seek to obtain “legal cover” in the Union for third-country companies seeking to solicit customers or potential customers in the Union through a MiCA-authorized entity (usually belonging to the same group), while providing services outside the Union.
‘In the right place’
Tom Duff Gordon, vice president of international policy at Coinbase, said the advice provided by ESMA “landed more or less in the right place” and that the situation does not require immediate review. He also said it was “surprising” to see the joint proposal from the AMF, FMA and Consob calling for a review of areas such as order routing, when MiCA is barely a year old.
“At one point, it was unclear whether or not there were two valid parties, or whether the liquidity needed to be local. We have always maintained that both models are legally viable. We currently operate a broker for our US exchange where we can provide best execution to European customers and significant liquidity,” Duff Gordon said in an interview with CoinDesk.
“We honestly believe that by acting as a broker as we do, we can provide the best results for our clients,” Duff Gordon said. “I think as long as you can do that, and as long as the European operations have enough substance – which ours absolutely do – and as long as the local entity controls the place of execution, then a bit like international finance with MiFID, it’s totally valid to have both broker models and local platform models.”
Coinbase’s regulator, the Commission de Surveillance du Secteur Financier (CSSF) of Luxembourg, said in an email: “In the context of MiCA, the CSSF acts in full compliance with EU regulations and works in close cooperation with other competent national authorities and competent European authorities for the purposes of supervisory convergence. »
Dea Markova, director of policy at crypto technology company Fireblocks, said it was unclear whether being part of a large, heavily regulated group – like Coinbase – would mitigate risks in the eyes of European regulators at the ESMA level.
“I think regulators are concerned that a broker in Austria, for example, wants to source liquidity from a U.S. or South Korean exchange and usually has to pre-fund that exchange with the assets of some of its clients,” Markova said in an interview. “So if something happens to this exchange, then customer assets will be lost.”
The debate for regulators now is where to set the limit, Markova added.
“If you think about it logically, everyone ends up getting their liquidity from outside the EU. There’s not enough liquidity, so the question is just how many steps do they take to get there,” she said.
