Market Data requirements for banks, investment firms and crypto-assets service providers (CASPs) in the light of MiCAR

On 9 June 2023, the European Union adopted the Markets in Crypto-Assets Regulation (MiCAR). The Regulation provides a comprehensive regulatory framework for issuers of crypto-assets based on distributed ledger technology (DLT), as well as market operators, custodians and intermediaries providing services to support trading in those assets.

MiCAR delivers consistent requirements for the authorization of crypto-asset service providers (CASPs) and crypto-asset issuers (CAIs). With a minimum Market Abuse Regime (MAR), conduct rules, and own-funds standards, MiCAR is intended to deliver greater protection for investors and contribute to market stability while leaving room and flexibility for (product) innovation.

The Regulation was published in the Official Journal of the European Union on 9 June 2023. It entered into force on 29 June 2023 and becomes fully effective on 30 December 2024; however, issuers of stablecoins will become subject to certain provisions on 30 June 2024.  Level 2 legislation – delegated acts and technical standards – needed to refine the regulatory perimeter. The European Securities and Markets Authority (ESMA) has been empowered to develop these technical standards and guidelines specifying certain provisions and has already published three consultation packages in July 2023, October 2023 and in January 2024.

MiCAR is derived from other European legislation, including MiFID, CRR/IFR, MAR, UCITS, and the AIFMD. It is intended to be a parallel regime to MiFID, while recognizing that firms with existing authorizations ought to be able to rely upon them. MiCAR does not completely excuse firms from its requirements (e.g., for approvals, disclosures, and notification), but there are concessions which allow banks to issue stablecoins within their existing authorizations. Similarly, banks and investment firms can extend their existing permissions to include crypto-assets.

Having said that, MiFID II and MiCAR play a complementary role in regulating the crypto-asset market. MiFID II, the Markets in Financial Instruments Directive, provides a general framework for regulating financial markets, including crypto-asset markets. It establishes investor protection rules, market conduct standards, and reporting requirements. MiCAR, the Markets in Crypto-Assets Regulation, specifically addresses the unique characteristics of crypto-asset markets and provides additional regulatory safeguards.

In its latest consultation ESMA end of January 2024 aimed at precising the interaction between MiCAR und MiFID. The different approaches to the national transposition of MiFID across Member States mean that there is no commonly-adopted application of the definition of ‘financial instrument’ under MiFID in the EU. Whilst this issue has been noted as a concern since the implementation of MiFID/MiFID II, practical consequences may emerge with Regulation (EU) 2023/1114 (MiCA) regarding the classification of crypto-assets as financial instruments.

For the digital assets, that qualify as “crypto-assets” under MiCAR, the regulation does not apply the full EU market abuse regime; but it does borrow from it in TITLE VI PREVENTION AND PROHIBITION OF MARKET ABUSE INVOLVING CRYPTO-ASSETS. Insider dealing, improper disclosure of inside information, and market manipulation are prohibited, e.g. Article 86 Scope of the rules on market abuse, Article 89 Prohibition of insider dealing, Article 91 Prohibition of market manipulation, Article 92 Prevention and detection of market abuse. This requires an ample range of reliable and compliant market data, that is available near term, if not real time, to validate ongoing compliance.

In order to comply with these rules market participants – both banks, investment firms and CASPs - need to adopt a comprehensive approach that encompasses data sourcing, quality assurance, compliance procedures, and risk management strategies. By effectively managing their crypto-asset market data, market participants can ensure compliance with MiFID II and MiCAR while providing their clients with a secure and reliable trading environment. It is important to note that for cypto-assets it is very common to exchange one crypto-asset against another crypto-asset (as opposed to simply buying a financial instrument in exchange for fiat currency), which means that market data on multiple crypto-asset pairs is required for any given point in time (as opposed to one price of a financial asset in fiat currency and potentially fiat exchange rates). As these crypto asset pairs tend to be traded on multiple market places, the market prices for these pairs are relevant as opposed to a “simple” exchange rate, that is centrally fixed.

For financial institutions active in crypto-assets the challenge is, that the data can not necessarily be procured through their traditional market data redistributors.

For crypto-asset service providers the on-top challenge is to build the relevant infrastructure, policies and procedures from scratch, when MiCAR comes into force.

To highlight the scope of regulation and need for market data, please find a short description of the key areas relevant in MiCAR in the subsequent text.

In accordance with Article 92 - Prevention and detection of market abuse – “Any person professionally arranging or executing transactions in crypto-assets shall have in place effective arrangements, systems and procedures to prevent and detect market abuse. That person shall be subject to the rules of notification of the Member State where it is registered or has its head office or, in the case of a branch, the Member State where the branch is situated, and shall without delay report to the competent authority of that Member State any reasonable suspicion regarding an order or transaction, including any cancellation or modification thereof, and other aspects of the functioning of the distributed ledger technology such as the consensus mechanism, where there might exist circumstances indicating that market abuse has been committed, is being committed or is likely to be committed.”

A special burden of compliance is put on crypto-asset service provider operating a trading platform for crypto-assets. Here Article 62 - Application for authorisation as a crypto-asset service provider - inter alia mandates, that “a description of the operating rules of the trading platform and of the procedure and system to detect market abuse“ needs to be provided. They need to be able to “prevent or detect market abuse” and “their abuse for the purposes of money laundering or terrorist financing”. “Crypto-asset service providers operating a trading platform for crypto-assets shall inform their competent authority when they identify cases of market abuse or attempted market abuse occurring on or through their trading systems.”

In addition, for all CASPs, best execution and thereby market conformity checks are expected: “When a crypto-asset service provider executing orders for crypto-assets on behalf of clients is the client’s counterparty, there might be similarities with the services of exchanging crypto-assets for funds or other crypto-assets. However, in exchanging crypto-assets for funds or other crypto-assets, the price for such exchanges is freely determined by the crypto-asset service provider as a currency exchange. Yet in the execution of orders for crypto-assets on behalf of clients, the crypto-asset service provider should always ensure that it obtains the best possible result for its client, including when it acts as the client’s counterparty, in line with its best execution policy.”

Also, Article 60 - Provision of crypto-asset services by certain financial entities - mandates, that all CASPs require, inter alia:

• „a description of the operating rules of the trading platform and of the procedures and system to detect market abuse, where it is intended to operate a trading platform for crypto-assets;
• a description of the non-discriminatory commercial policy governing the relationship with clients as well as a description of the methodology for determining the price of the crypto-assets they propose to exchange for funds or other crypto-assets, where it is intended to exchange crypto-assets for funds or other crypto-assets;
• a description of the execution policy, where it is intended to execute orders for crypto-assets on behalf of clients;“

It is important to note, that for digital assets that qualify as “financial instruments” or “hybrids” the full MiFID scope applies.

Therefore, it is paramount for all stakeholders in the market for digital assets to already today address the question which data needs to be sourced to be implement compliant processes, procedures and reporting for digital assets that are either “crypto assets” or “financial assets” or as “hybrids” fall at different points during the lifecycle of the digital asset into one or the other category.

For regulated entities, already today licensed by the relevant National Competent Authority (NCA) and active in “classic” financial instruments, it might be useful to point out the key areas of overlap and interaction between MiFID II and MiCAR:

• Market Abuse Regulation: Both MiFID II and MiCAR prohibit market abuse, including insider trading, market manipulation, and manipulation of benchmarks. They establish similar reporting requirements for suspicious market activities.
• Market Conformity Check (MCC) / Best Execution: Both directives mandate that firms conduct MCCs to assess the quality of execution services for clients. Both directives aim to protect retail investors by establishing requirements for due diligence, suitability, and best execution. While MiFID II focuses on financial instruments, MiCAR specifically addresses the unique challenges of crypto-assets.
• Insider Dealing Prohibition: Both directives aim to prohibit insider dealing and require issuers, offerors and persons seeking admission to trading inform the public as soon as possible of inside information.
• Anti-Money Laundering (AML) and Know Your Client (KYC): Both directives mandate that firms implement AML and KYC procedures to prevent money laundering and terrorist financing. MiCAR places particular emphasis on the risks associated with crypto-asset transactions.
• Supervision and Enforcement: Both directives establish supervisory bodies responsible for enforcing compliance with the regulations. MiFID II falls under the purview of national regulators, while MiCAR implementation (for now) is overseen by the European Securities and Markets Authority (ESMA) until the National Competent Authorities (NCAs)are nominated. In parallel to the drafting of technical standards, ESMA is working with the national competent authorities on a convergent approach to authorisations of crypto-asset service providers (CASPs) during the transitional phase.

In summary, Market Participants face several challenges in acquiring and utilizing crypto-asset market data in compliance with MiFID II – i.e. financial institutions - and MiCAR – financial institutions as well as crypto-asset service providers - regulations. These challenges can be broadly categorized into four areas:

Market Abuse Regulation:

• Identifying and preventing market abuse: Crypto-assets are highly volatile and susceptible to manipulation, making it crucial for banks to employ robust market abuse detection systems. This requires access to comprehensive and reliable market data, including data from Decentralized Exchanges (DEXs) and Centralized Exchanges (CEXs) as well as potentially liquidity providers. A broad coverage is required, as transaction volumes tend to move between DEXs and CEXs, depending on market conditions.
• Timely reporting of suspicious activities: Market Participants are obligated to report any suspicious market abuse activities to the relevant authorities within strict timeframes. This necessitates real-time or at least same day monitoring of market data and seamless integration with reporting systems.

Market Conformity Check (MCC):

• Ensuring data quality and consistency: MCCs require market participants to assess the quality and consistency of their market data sources. In the crypto-asset market, where data sources can be fragmented and liquidity pools tend to shift, banks need to implement rigorous data quality controls to maintain compliance.
• Reconciling data discrepancies: Discrepancies in market data can lead to inaccurate MCC reports. Market participants need to establish robust data reconciliation procedures to identify and resolve discrepancies promptly.
• Best Execution: MiCAR clarifies, that while execution of crypto asset orders might be more complex, as it might encompass services of exchanging crypto-assets for funds or other crypto-assets, “the execution of orders for crypto-assets on behalf of clients, the crypto-asset service provider should always ensure that it obtains the best possible result for its client, including when it acts as the client’s counterparty, in line with its best execution policy”.

Compliance:

• Adhering to regulatory requirements: Market Participants must comply with the specific data and reporting requirements outlined in MiFID II and MiCAR for crypto-asset markets. This includes ensuring that data is sourced from authorized providers, meets data quality standards, and is used for legitimate purposes.
• Documenting data usage and processes: Market Participants need to maintain comprehensive documentation of their data usage practices and compliance processes. This documentation should be readily accessible to regulators for audit purposes.

Valuation:

• Accurately reporting client transactions: Market Participants providing crypto-asset trading services to clients, necessitating accurate reporting of client transactions. This requires market participants to ensure that their market data is linked to client accounts and can be used to generate accurate reports for e.g. tax or compliance purposes. In addition all Market participants require reliable „settlement“ and „valuation“ prices for their positions and P&Ls.
• Valuation of assets: MiCAR Article 36: Valuation of Reserve Assets - The valuation at market prices shall be made by using mark-to-market. “When using mark-to-market valuation the reserve asset shall be valued at the more prudent side of the bid and offer unless the reserve asset can be closed out at mid-market. Only market data of good quality shall be used, and such data shall be assessed based on all of the following factors.the number and quality of the counterparties;the volume and turnover in the market of the reserve asset;the size of the reserve of assets.”
•  Complying with Know Your Client (KYC) and Anti-Money Laundering (AML) regulations: Banks must comply with KYC and AML regulations when handling client data, including crypto-asset transactions. This includes verifying client identity, assessing transaction risk, and reporting suspicious activities.

Our Team of Experts: BLOCKSIZE , Michael Wellenbeck , Christian Labetzsch , Michael Wutzke , Dr. Axel U. J. Lode , Burak Özgelen , Johann Focke