Regulation of E-Money and E-Money Tokens under MiCAR

Digital money - Current and Future Regulation of E-Money and E-Money Tokens under ZAG and MiCAR.

The bankruptcy of the crypto exchange FTX affects millions of customers who fear for their money. According to newspaper reports, FTX owes the 50 largest creditors more than 3 billion euros. At the same time, significant opinions, e.g. the Bank of England, are calling for tighter regulation of crypto assets to protect investors. Investor protection seems particularly important when it comes to digital money. After all, these electronic assets are not only acquired as an investment, where realistically every chance of return comes with a risk of loss but are also intended to serve as payment instruments with stable value. That's why it's worth looking at the current regulation for digital money in Germany and in the EU, and at the changes the Markets in Crypto Assets Regulations (MiCAR) will bring.

I. Regulation of E-Money under Current Law

According to the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz - ZAG) implementing the EU E-Money Directive 2009/110/EC, digital money is regulated if it is electronic money as defined in Sec. 1 (2) s. 3 ZAG. Accordingly, the following criteria characterize e-money: (1) It is an electronically stored monetary value as represented by a claim on the issuer. (2) It can be acquired against payment of a monetary amount. (3) Its purpose is making payment transactions, i.e., primarily to transmit sums of money to others. (4) Third parties, i.e., not just the issuer, accept these assets as payment.

What becomes clear when looking at this definition but may be surprising given the attention that crypto currencies have received in recent years: Bitcoin, Ethereum and the likes are generally not e-money. It is true that these tokens are used, among other thing, for payment purposes and are accepted as means of payment. However, the well-known crypto currencies, especially Bitcoin and Ethereum, do not provide a claim against an issuer (or any other debtor). A typical and widespread example of e-money, on the other hand, can be found at PayPal: With a PayPal payment one does – technically - not transfer currency, but rather PayPal users acquire e-money, which PayPal transmits to the recipients, and which can be exchanged back into currency by the recipients.

To protect users of e-money, German law, in implementation of the EU E-Money Directive 2009/110/EC, provides for comprehensive regulation of the e-money business. The most important point is that the acquirer or recipient of e-money can exchange it back into the legal currency at any time without incurring losses.

For this, Sec. 33 (1) ZAG obliges the issuer to issue electronic money only at the par value of the amount of currency accepted and to redeem it for legal tender at any time at par value. Put simply, anyone who acquires e-money for one euro is entitled to have the e-money exchanged back into one euro at any time, without any loss due to premiums or discounts.

Secondly, it must be ensured that the issuer can fulfill this redemption obligation for the electronic money issued, i.e., that that the issuer remains solvent. The pertinent regulation is partly modeled on banking supervision law: Pursuant to Sec. 11 (1) s. 1 ZAG, only those entities may issue electronic money that have a license from the German Federal Financial Supervisory Authority (BaFin) to do so, namely, in addition to the CRR credit institutions, which are supervised anyway, primarily the electronic money institutions. Pursuant to Sect. 15 (1) ZAG, a license as an electronic money institution requires, in particular, adequate capital. In addition, the reliability and professional suitability of the managers (Sec. 12 No. 5 ZAG) and a proper business organization in accordance with Section 27 ZAG are required, among other things. Finally, specific to the e-money business is the provision in Sec. 17, 18 ZAG, which requires issuers to safeguard the funds received, either by investing them separately and in an insolvency-proof manner in a trust account or in other liquid, low-risk assets, or by insuring them with an insurance company or credit institution.

II. Future regulation of E-Money Tokens

With MiCAR, the EU legislator reacts to the developments in recent years and seeks to regulate transactions with crypto assets, at least for many forms of these crypto assets, in order to protect consumers.

This is not alien to German law. Since the beginning of 2020, crypto assets have been classified as financial instruments within the meaning of Sec. 1 (11) s. 1 no. 10, s. 4 of the German Banking Act (KWG), and both the acquisition and sale of such crypto assets and their safekeeping for customers are financial services requiring a license. However, business with e-money has so far remained exempt from this because, according to Section 1 (11) s. 5 no. 1 KWG, e-money as defined by the ZAG is explicitly not a crypto asset as defined by the KWG; thus, only the rules of the ZAG so far apply to e-money.

In contrast, MiCAR explicitly includes e-money tokens in the regulation of crypto assets. According to the draft version of MiCAR, as it stands as the result of the trilogue, crypto-assets that purport to maintain a stable in value by referencing to the value of one official currency are covered by the regulation as e-money tokens (Art. 3 para. 1 no. 4 MICAR). In this respect, e-money tokens are similar to e-money, which, as a monetary value, can only be issued at the par value of an official currency and must be redeemed at par value by the issuer. Consequently, Article 43 (1a) MICAR stipulates that e-money tokens are deemed to be e-money within the meaning of the EU Electronic Money Directive 2009/110/EC and are covered by this regulation unless MiCAR provides for special rules. E-money tokens are thus subject to two regulatory regimes, as a form of e-money to the E-Money Directive 2009/110/EC and as crypto assets to MiCAR; an exception to the rule that MiCAR should in principle conclusively provide the regulatory framework for crypto assets.

If every e-money token is therefore also e-money, the same does not apply vice versa: not every e-money is also an e-money token. MiCAR only covers crypto-assets, and this also applies to digital money: it is only an e-money token if it is a crypto-asset (Art. 3(1) no. 4 MiCAR). Crypto-assets are only those digital representations of a value or a right that can be transmitted and stored electronically using distributed ledger technology (DLT) or similar technology (Art. 3 (1) no. 2 MiCAR). The characteristic feature of e-money tokens is thus the use of DLT, of which the blockchain is probably the best-known example.

Thus, for the sake of simplicity, the following principle will apply to the demarcation and interaction of regulations in the future: All e-money tokens are also e-money and, unless MiCAR provides otherwise, will be regulated as e-money. Conversely, not every e-money is at the same time an e-money token regulated by MiCAR, but only if it is a crypto-asset, i.e., if the e-money is transferred and stored using DLT.

For e-money tokens, MiCAR provides for several particular rules compared to the regulation of e-money under the EU E-Money Directive 2009/110/EC and the ZAG. In terms of content, the regulations correspond in large parts to the already familiar regulation of e-money. Thus, Art. 44 MICAR also requires that e-money in the form of e-money tokens may only be issued at par value and that the holders of the e-money tokens must have a claim against the issuer for redemption at par value at any time. To ensure this, Art. 43(1)(a) MiCAR stipulates that, as with other e-money, in addition to CRR credit institutions only e-money institutions may issue e-money tokens. This means that issuers of e-money tokens will be regulated and supervised in the same way as all other issuers of e-money. Finally, the obligation to safeguard the money received, which is already provided for other e-money, is also found in Art. 49 MiCAR with a reference to the corresponding regulations in the E-Money Directive 2009/110/EC and modifications to the extent that only the investment in a trust account or in other liquid, low-risk assets is permissible and at least 30% of the funds must be held in a trust account.

MiCAR provides for a special feature for e-money tokens insofar that in future issuers of e-money tokens will have to publish a so-called white paper prior to the public offering (Art. 46 MiCAR). White papers are established in practice as the typical offering document for crypto assets of all kinds, and MiCAR will, on the one hand, make the publication of a white paper with specified content mandatory for many crypto assets and, on the other hand, introduce liability for the accuracy of the information - a form of prospectus liability is thus introduced for e-money tokens.

According to Art. 46 MiCAR, the white paper for e-money tokens must, in particular, contain comprehensive information on the design of the e-money tokens (e.g., on the issuer, the associated rights and obligations, the underlying technology and the environmental impact of the consensus mechanism, etc.) as well as risk warnings in particular on the lack of deposit protection. The draft white paper must be submitted to the competent supervisory authority in advance but does not require approval.

As is otherwise customary for securities and asset investment prospectuses, and as provided for in MiCAR on other white papers, Art. 47 MiCAR introduces liability for incomplete, unfair, or ambiguous information, as well as for misleading information in the white paper. Holders of e-money tokens may claim damages for losses suffered because of such infringement, provided they prove that such infringement had an impact on their decision to acquire or dispose of the e-money tokens.

This form of prospectus liability is designed particularly sharply by MiCAR because, on the one hand, no time limit applies. According to Art. 46 (10) MiCAR, this corresponds to an obligation for the issuer of e-money tokens to continuously update the white paper in the event of relevant changes and new facts. On the other hand, not only the issuer itself is liable for the correctness and completeness of the white paper, but according to Art. 47 (1) MiCAR also the members of its management bodies personally; a form of external liability in principle not previously provided for in capital markets laws. Corresponding to this external personal liability is the duty of the management body under Art. 46 (4) MiCAR to confirm in the white paper that it complies with all legal requirements, that the information contained therein is correct to the best of their knowledge and that there is no significant omission.

III. Summary

Thus, the rules for digital money envisioned by MiCAR can be summarized thus:

• E-money tokens define a new class of digital money
• E-money tokens are characterized by two features: They purport to maintain a stable value by referencing to the value of one official currency, and they use distributed ledger (or similar) technology.
• For crypto currencies such as bitcoin, which are a means of payment but do not reference to the value of an official currency, it remains that they are neither e-money nor e-money tokens.
• E-money tokens are e-money within the meaning of the EU E-Money Directive 2009/110/EC and the ZAG, and the current regulation of e-money also covers, in principle, e-money tokens.
• As has been the case with e-money, holders of e-money tokens must have a claim against the issuer for redemption at par value.
• In addition, however, special rules apply to e-money tokens, in particular the obligation to publish a prospectus in the form of a white paper prior to the offer and to update this prospectus on an ongoing basis.
• Not only the issuers of e-money tokens but also their management bodies are personally liable for the ongoing accuracy and completeness of the white paper.