Welcome to the third part of our exploration of the Markets in Crypto-assets (MiCA) regulations pertaining to asset-referenced tokens. Our journey has delved into the importance of organizational structure, risk management processes, financial requirements, and much more. You might find reading Part One and Part Two beneficial if you're just joining us.
In today's discourse, we will unravel the intricacies of the reserve of assets requirement, a cornerstone provision critical in promoting asset-referenced tokens' stability. It's a complex topic that's crucial to understanding the intricate web of compliance and accountability that the MiCA legislation weaves.
Reserve of Assets Obligation for Issuers of Asset-Referenced Tokens under MiCA
Article 36 of MiCA lays out the essential requirements related to the obligation of asset-referenced token issuers to maintain a reserve of assets. It details how these reserves should be structured and managed, including the specific composition, segregation, valuation, and audit requirements.
Reserve of Assets: Issuers of asset-referenced tokens must always establish and maintain a reserve of assets. This reserve should be managed in a way that (a) covers the risks associated with the assets referenced by the tokens; addresses liquidity risks linked to the permanent rights of token holders' redemption.
Legal Segregation: In the best interest of the token holders, the reserve of assets must be legally separate from the issuer's estate and the reserves of other asset-referenced tokens.
Operational Segregation: The reserve of assets must also be operationally segregated from the issuer's estate and the reserves of other tokens.
Regulatory Technical Standards: The European Banking Authority (EBA), in cooperation with the European Securities and Markets Authority (ESMA) and the European Central Bank (ECB), is tasked with developing regulatory technical standards to specify liquidity requirements further. These will include (a) guidelines for daily and weekly liquidity; (b) techniques for liquidity management; (c) minimum deposit amounts in each official currency.
Multiple Tokens and Issuers: Issuers that offer multiple asset-referenced tokens must operate separate reserves for each token. Similarly, different issuers offering the same token should maintain only one reserve.
Effective Management: The issuer's management body must ensure the effective and prudent management of the reserve, matching the issuance and redemption of tokens with a corresponding increase or decrease in the reserve.
Valuation: The reserve's aggregate value should be determined using market prices and at least equal the total value of claims against the issuer from circulating tokens.
Stabilization Mechanism Policy: Issuers must have a clear policy outlining the stabilization mechanism of their tokens. This policy should cover several elements, including the assets referenced, risks, issuance and redemption procedures, investment policy, and more.
Audits: An independent audit of the reserve of assets is required every six months. Audit results must be reported to the competent authority and made public, except in specific circumstances that may require a delay in publication.
Valuation Methodology: Valuation at market prices should be conducted using the mark-to-market method when possible. When not possible, or if the market data isn't of good quality, a more conservative mark-to-model method is recommended.
Custody of reserve assets
Article 37 of the MiCA regulation deals with the custody of reserve assets by issuers of asset-referenced tokens. In layman's terms, this provision regulates how the companies that issue tokens representing some underlying value must manage and protect the assets that back up these tokens. This is to ensure that the value of the tokens remains stable and the interests of the token holders are safeguarded.
1. Custody Policies
Companies that issue asset-referenced tokens must have policies to ensure that they always maintain control of the reserve assets backing the tokens. This includes ensuring the assets are not encumbered or used as financial collateral.
These companies must be able to access the reserve assets quickly to meet any redemption requests from the token holders.
Companies must avoid situations where custody of the reserve assets is concentrated with one custodian or where the reserve assets are concentrated in one area.
2. Multiple Tokens and Issuers
If a company issues more than one type of asset-referenced token, it must have a separate custody policy for each reserve of assets.
Multiple companies can maintain a single custody policy if they issue the same asset-referenced token.
3. Holding Reserve Assets
Depending on the nature of the reserve assets, reserve assets must be held in custody by specific types of institutions, including crypto-asset service providers, credit institutions, or investment firms.
This custody should be established five working days after the date of issuance of the asset-referenced token.
4. Due Diligence in the Selection of Custodians
Companies must exercise due diligence when selecting and reviewing the custodians of their reserve assets.
Custodians must be different from the issuer and should have the necessary expertise and reputation to act respectively.
Companies must ensure that the reserve assets held in custody are protected against claims of the custodians' creditors.
5. Selection and Review of Custodians
Custody policies should outline the criteria for selecting custodians and the process for reviewing these appointments.
Companies should regularly review their custodian appointments, considering their exposure to the custodians and monitoring their financial conditions.
6. Custody Manner
Custodians must follow specific rules when holding assets in custody, depending on the type of the reserve asset.
All reserve assets should be identifiable as belonging to each reserve of assets.
7. Contractual Arrangements
The appointment of custodians should be evidenced by a contractual arrangement, which regulates the flow of information necessary for them to perform their functions.
8. Honesty and Fairness
Custodians should act honestly, fairly, professionally, independently, and in the interest of the issuers and the holders of asset-referenced tokens.
9. Conflict of Interest
Custodians should not engage in activities that could create conflicts of interest unless they have properly separated their custody tasks from their potentially conflicting tasks and the potential conflicts of interest have been properly identified, monitored, managed, and disclosed.
10. Loss of Assets
In case of a loss of a financial instrument or a crypto-asset held in custody, the custodian that lost the asset must compensate the issuer without undue delay unless the loss occurred due to an external event beyond their control.
Investment of reserve assets by the issuers of asset-referenced tokens
Investment Parameters: Issuers who wish to invest a portion of their reserve assets can do so, but certain stipulations bind them. Investments must be limited to highly liquid financial instruments, meaning they can be quickly and easily converted to cash without significant loss in value. These instruments must also demonstrate minimal market, credit, and concentration risks.
Undertakings for Collective Investment in Transferable Securities (UCITS): Assets invested in UCITS are presumed to possess minimal market, credit, and concentration risks. This is only valid if the UCITS invests solely in assets specified by the European Banking Authority (EBA) and the issuer has taken steps to minimize concentration risk.
Custody of Invested Assets: All financial instruments in which the reserve assets are invested must be held in custody.
Profit, Loss, and Risk: Any gains or losses resulting from the investment of the reserve assets are solely the responsibility of the issuer of the asset-referenced token. This includes fluctuations in the value of the financial instruments and any counterparty or operational risks.
Regulatory Technical Standards: In cooperation with the European Securities and Markets Authority (ESMA) and the European Central Bank (ECB), the EBA will create technical regulatory standards detailing the highly liquid financial instruments bearing minimal risks.
These standards will consider the different types of assets that an asset-referenced token can reference and the correlation between those assets and the highly liquid financial instruments the issuers might invest in.
Constraints will be imposed on the concentration to prevent the issuer from investing or holding in custody more than a certain percentage of reserve assets in any one entity or group.
Redemption rights of holders of asset-referenced tokens
Permanent Right of Redemption: Holders of asset-referenced tokens have a continuous right to redemption against the token issuers. This right also extends towards the reserve assets if the issuers are unable to fulfill their obligations. Issuers must develop, sustain, and enforce precise policies and procedures about this right of redemption.
Redemption Process: When a token holder requests redemption, the issuer must either repay an amount equivalent to the market value of the referenced assets or deliver the assets themselves. This amount will be paid in funds other than electronic money. Issuers need to establish a policy detailing:
The specific conditions, such as thresholds, periods, and timeframes, for exercising the right of redemption.
The mechanisms and procedures to guarantee token redemption, even under stressed market circumstances, as well as during the implementation of a recovery plan or an orderly redemption.
The valuation principles of the tokens and reserve assets upon redemption.
The settlement terms for the redemption.
The steps issuers take to manage fluctuations in the reserve assets to prevent any negative market impacts.
Suppose issuers accept payment in funds other than electronic money, denominated in an official currency when selling a token. In that case, they must always offer an option to redeem the token in the same official currency.
It is crucial to note that the redemption of asset-referenced tokens should not be subject to any fees except as provided in Article 46 of MiCA (recovery plans regulation).
Granting interest in relation to asset-referenced tokens
No Interest on Tokens: Issuers of asset-referenced tokens are expressly prohibited from granting any form of interest in connection with these tokens.
Crypto-Asset Service Providers: The restriction also applies to crypto-asset service providers. When providing services related to asset-referenced tokens, these providers are also forbidden from granting interest.
Definition of Interest: The term 'interest' is broadly defined here. Any compensation, benefit, or financial advantage related to the length of time a holder retains asset-referenced tokens is treated as interest. This includes net compensation, discounts, or similar financial benefits with the same impact as interest. Whether it's received directly from the issuer or third parties, and whether it's directly associated with the token or from the remuneration or pricing of other products - if it benefits the token holder in a way equivalent to receiving interest, it's treated as such. * * * That wraps up the third part of our detailed analysis of MiCA's provisions for asset-referenced tokens. Next time, we'll continue our journey through MiCA's comprehensive regulatory framework, shedding light on more legal intricacies and provisions. Stay tuned for the upcoming parts, where we continue to simplify and demystify the MiCA for you.
DISCLAIMER: The information provided is not legal, tax, or accounting advice and should not be used as such. It is for discussion purposes only. Seek guidance from your legal counsel and advisors on any matters. The views presented are those of the author and not any other individual or organization. The information provided is for general educational purposes only and is not investment advice. The author of this material makes no guarantees or warranties about the accuracy or completeness of the information. A professional should review any action based on the information discussed. The author is not liable for any loss from acting on the information discussed.
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