America’s Answer To MiCA Heads To Congress

July 31, 2023
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The US House Financial Services Committee has marked up a new piece of legislation that could offer America’s answer to Europe’s Markets in Crypto-Assets (MiCA) Regulation.

The US House Financial Services Committee has marked up a new piece of legislation that could offer America’s answer to Europe’s Markets in Crypto-Assets (MiCA) Regulation.

The Financial Innovation and Technology for the 21st Century Act, passed by the Committee last week, aims to provide a “comprehensive framework” for a federal digital asset market structure.

Also known as the FIT Act, the bill lays out a clear rulebook for the issuance, custody and trading of digital assets.

Committee chair Patrick McHenry (R-NC) said the legislation is long overdue, given that other major jurisdictions have already passed or are about to pass similar legislation.

“As other jurisdictions like the UK, the EU, Singapore and Australia move forward with clear regulatory frameworks for digital assets, the United States is at risk of falling behind,” he said.

Securities vs commodities

In Section 204, the bill introduces a new mechanism by which digital assets can become recognised as “digital commodities” rather than securities.

This will be achieved through an amendment to the Securities Exchange Act 1934, whereby token issuers will be invited to “certify” that their token is sufficiently “decentralised” to be a commodity.

If the digital asset meets the criteria, then it leaves the remit of the Securities and Exchange Commission (SEC) and enters that of the Commodity Futures Trading Commission (CFTC).

Through this amendment, McHenry said the bill recognises a “key issue” that was clarified in the SEC v Ripple case earlier this month, as covered by VIXIO.

“Digital assets that are not inherently securities may be offered as part of an investment contract, but that does not make them securities,” he said.

Alongside decentralisation requirements, Section 204 also lays out “functionality” criteria that, if fulfilled, would also allow a digital asset to be recognised as a commodity.

A clear rulebook or a loophole heaven?

McHenry and others backing the bill believe that these new standards will bring an end to “regulation by enforcement”, whereby the SEC has been accused of arbitrarily applying securities laws to digital assets.

However, legal observers who have followed the evolution of the bill have warned that, if passed in its current form, it will “eviscerate” existing securities laws.

Hilary Allen, professor of financial regulation at American University Washington College of Law, said the rules outlining which digital assets can port to commodities oversight are unclear, unnecessarily complex and will quickly become outdated.

“The definition of ‘decentralisation’ is so complicated that it is likely to contain multiple loopholes to exploit,” she said.

“Section 204 also creates lots of procedural presumptions in favour of those asserting their networks are decentralised and therefore outside of SEC jurisdiction, making it more challenging for the SEC to protect investors from harm.”

Moreover, Allen noted that as “literally anyone” may to petition the SEC at any time, it “virtually guarantees” that the SEC will be “inundated” with certification filings.

And since the SEC is required to respond to all such petitions within 30 days, it is unlikely that SEC staff will have the time or resources to give due diligence to every application.

Cannibalising the traditional securities market

But an even greater danger flagged by Allen is that the bill opens the door to traditional securities issuers to try and take advantage of the softer oversight they can receive under the CFTC.

“One problem we identified with the draft bill is that it wouldn’t just give the crypto industry an accommodative regulatory regime, it would create opportunities for other kinds of securities to migrate into the same light touch regime,” she said.

“This problem arises because most financial assets are already in digital form, and the draft legislation said it would apply to any fungible digital asset whose ownership is recorded on a blockchain.”

“Despite blockchain’s limitations,” she continued, “I’m sure that many issuers of existing securities would be willing to put their assets on a blockchain if it meant they could avoid SEC regulation but still have their securities traded on a public exchange.”

In an article co-authored with Lee Reiners, lecturing fellow at Duke Financial Economics Center, and Mark Hays, senior policy analyst at Americans for Financial Reform, Allen expanded on this theme.

They wrote that the bill would essentially create an “unfunded mandate” for the CFTC — an agency that is already thought to be understaffed and underfunded compared to the SEC.

“Transforming the CFTC into an agency that prioritises the type of regulatory approach that understands and prioritises retail investors would require changing the mission and mandate of the agency, and the underlying statutes that guide it,” they said.

Making sure FTX 'never happens again'

Though falling short of Allen and co’s expectations, the bill does include investor protections that have bipartisan support both on the Committee and in Congress.

For example, commingling of company and customer assets is prohibited under the bill, as is the lending out of customer assets without their consent.

“The worst practices of FTX are banned in this bill,” said McHenry. “It is better in the worst case than what we have currently, which is no consumer protection.

“At its core, this bill ensures everyday investors are not left with less protection than institutional investors.”

However, again Allen has pointed out that these protections are perhaps not as “robust” as McHenry suggests.

Section 406, for example, prohibits commingling but allows consumers to waive this protection if stated in writing.

“Cue the contracts of adhesion with waivers built in,” said Allen. “Want to use the exchange? Then you’ll need to let us use your funds.”

Allen also pointed out that Section 406 doesn’t require structural separation of digital asset broker-dealers, exchanges and clearing agencies.

“Instead, digital asset broker-dealers get to come up with their own ‘conflict of interest systems and procedures’,” she said.

In the SEC’s lawsuits against Coinbase and Binance, both are alleged to be operating an unregistered securities exchange, brokerage and clearing agency — three market functions that should be offered separately under securities laws.

In the view of Allen, Reiners and Hays, the bill would allow the same “conflicted business models” to continue, rather than be curtailed.

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