Podcasts

Stephen Wink:

Hello and welcome to LathamTECH Podcast, where we survey the latest trends emerging from the world of tech and explore their impacts on your company – both the opportunities and the risks. I'm Stephen Wink, Co-Chair of Latham's Fintech and Digital Assets Group, and I'm joined today by my colleague Stuart Davis, who advises tech companies on regulatory aspects of cutting edge fintech initiatives. Welcome, Stuart.

Stuart Davis:

Thanks for having me on the podcast, Steve.

Stephen Wink:

In this episode, we're going to discuss the shifting fintech regulatory landscape in the US, the EU, and the UK, and what that means for tech companies moving forward. So, Stu, let's start with, you know, what are companies on your side of the Atlantic thinking about now? What are their biggest concerns?

Stuart Davis:

I think there's probably two things, Steve. The first is what's going to happen in the US. So what we've seen is a quite restrictive approach from the US historically. We now have a new administration. I know you'll probably want to talk a little about this in more detail, but from our side of the pond, we're thinking, is this going to change the perception of digital assets, this less restrictive approach with the new administration? That's the first thing.

The second thing is new regulation. So we have seen the first fully comprehensive crypto assets regulatory regime be released in the EU with the MiCA regime. And that covers everything from issuance of crypto assets, stablecoins. It covers crypto asset service providers and how they're going to be regulated, prudential regulation, everything, market abuse. What that does is very significant for digital assets because it takes what was an unregulated asset and therefore a risky asset for institutional investors, and it legitimizes it. It means that players can come in where they couldn't before. They can now get a license. They have compliance standards, and they can effectively issue these assets in a compliant manner. So institutional investor’s not going to look at this sector and it starts to look more like regulated securities. So new regulation is going to change the game.

The UK isn't quite there yet. We have currently a restrictive regime which says you need to be regulated in a TradFi sense in order to market these assets into the UK, but it's currently looking at and consulting on a similarly wholesale regulatory regime for the UK market as well. And if you think the UK and the EU, taken together, consists of population about 450 million people, you know, the EU is the largest trading bloc in the world. It's a really significant thing and I think it could potentially inform the regulatory approach in the US as well.

Stephen Wink:

And in the US we're seeing this sea change as you reference, where we went from a very restrictive regime, you know, where, you know, regulation by enforcement, lots of enforcement actions being prosecuted, you know, against all kinds of players in the industry. And now, just a few months later, we've already had many of those cases getting close to all of them being dropped by the SEC. So clearly the enforcement environment has changed dramatically.

What hasn't really changed is the law. You know, we still have the same laws on the books. We have court cases based on those SEC enforcement cases that still are standing on the books, and are precedent – the precedent that plaintiffs lawyers have used as well. So that's still there. And we also have, you know, the SEC commission saying here are some areas that we'd like some feedback on. And lots of folks in the industry are responding to those questions and providing that feedback. And they've already started to provide further guidance to the industry as well. Like, we recently had a statement on meme coins clarifying that meme coins are not securities, which actually made a ton of sense, was a very sort of common sensical approach. But it was extremely refreshing to see this kind of actual statement from the SEC, and very helpful to the environment overall.

Stuart Davis:

And let's talk about that. So we're in a position now where we can see that there is a change in the approach from the government and from regulators as well in terms of pulling back enforcement action. But we haven't yet seen legislation. What companies do in this interim state when they want to try and launch in the US or expand their businesses in the US? What are some of the pitfalls and how would you advise clients?

Stephen Wink:

Well, it is a little hard because as you said, that nothing has really been changed substantively. Certainly the risk level overall has decreased. And so clients are obviously much more willing to take on some of that risk, but we still think it's prudent to, you know, to use, utilize many of the same procedures that we've used in the past to ensure that you have a valid securities law exemption, for example, for transactions in the US, at least until there's a, you know, a better, you know, sense of what the actual approach should be.

So, Stu, what does MiCA mean for fintech companies?

Stuart Davis:

It means a few things, and it really depends on what type of business you are. So MiCA is focused on the crypto assets market. It excludes securities: so tokenized securities, tokenized bonds, etc., they're outside of scope. They're regulated by a traditional securities regulation called MiFID. What MiCA means for issuers is that unless you're issuing a stablecoin, you need to produce a white paper, which is a mini version of prospectus. It follows a very fine format and content requirements, and it's intended to be a disclosure document that purchasers of crypto assets can look at and understand what they are buying, what they're investing in, understand the risks, understand the issuer itself.

That disclosure document needs to be sent to one regulator. Once that a regulator has the disclosure document, the asset is able to be marketed throughout the EU. If you're a stablecoin issuer, on the other hand, and a stablecoin issuer means an issuer of a stablecoin that's backed by fiat or what's called an asset reference token, which is a stablecoin backed by a commodity or another asset. If you're one of those, you need to get a license. So you need either be an e-money issuer or you need to be an asset reference token issuer. And that involves a whole host of compliance requirements, prudential requirements, safeguarding requirements.

The other aspect of MiCA is the crypto asset service provider regime. So this covers exchanges, broker dealers and other forms of intermediaries in the market. If you're one of those and you're offering services to EU users or your customers, then you need to again get a license and comply with a bunch of compliance requirements that are similar to the kinds of requirements that apply to traditional securities businesses.

The final thing that MiCA does is it implements a market abuse regime that's very similar to the TradFi market abusive scheme for securities. So it involves concepts like inside information, market manipulation and market disclosures. It's really important to note that it's extraterritorial. So even if you're a US business, if you are trading in a token which is admitted to trading on an EU cryptoasset venue and you have inside information, then it's prohibited to deal off the back of that inside information. And as I said, extraterritorial nature of that means that it could impact, you know, people or businesses anywhere in the world.

Stephen Wink:

You mentioned the white paper as a disclosure document. Now what, you know, when people hear prospectus, when you're comparing it to a prospectus, that sounds like a big, expensive document to produce. What is the sort of the level of that disclosure? Is it, you know, is it something in this startup, you know, can handle or is it, you know, or is there a simplified version of it or is it a very, you know, comprehensive document?

Stuart Davis:

It's a great question. So the good news is it's not as substantive as a traditional prospectus. You know, traditional prospectuses can be three, four hundred pages long, involving hundreds of pages of financials and forward looking statements, etc.. The MiCA White Paper isn’t that. It reflects the idiosyncrasies of the crypto asset market and the smaller nature of issuers. The areas it focuses on, it's a very factual document. It focuses on description of the issuer, a description of the purpose of the token and the nature of the blockchain that the token is on. It focuses on risk factors. So explaining to users the risks of purchasing the token. And there's a part at the end of the of the document that focuses on sustainability disclosures.

Now, that was an area that was kind of hotly contested when MiCA is being debated in the European Parliament. At one point, there was a proposal to ban proof of work consensus mechanisms or tokens that use those from being permitted to be traded in the EU. But they realized that that would effectively ban Bitcoin, which is the largest, most widely traded asset in the crypto asset market. So they pulled back from that and said, well, actually, instead of that, we'll take a disclosure based regime. So there's quite a significant amount of sustainability disclosures. The good news is that there's a bunch of consultants that offer this service. What's the, I guess, what's the upshot? We're seeing these documents, you know, topping out at 50 to 60 pages in terms of length. They're quite factual. And therefore, in my experience, they're a lot easier and more cost effective to produce than prospectuses.

Stephen Wink:

Got it. So it's a little bit more like what the industry has traditionally seen as a white paper, it sounds like, with a few extra bells and whistles.

Stuart Davis:

It's more like what they've seen traditionally as a white paper, but probably removing most of what you would think of as the marketing content. It's a much more factual description of the token and its risks. There is a regime, a separate regime, so I'm glad you mentioned it, which covers marketing. And at a high level summary, what that regime size, under the MiCA, is you can market these tokens outside of the white paper, but the rule is that in marketing them, you can't say anything inconsistent to the white paper. It has to all be consistent. So nothing kind of factually inconsistent. And the other rule is that you need to have a flag to the white paper, the URL to the white paper in that marketing document.

Stephen Wink:

That's a good point.

Stuart Davis:

So I guess, Steve, from my perspective, looking ahead, it seems like the big question in the digital asset space is what's the future of legislation going to look like in the US? Do we have any indications of that yet?

Stephen Wink:

Well, we're starting to see, you know, the stablecoin bills are getting some traction in Congress. And that seems to be, priority one. You know, the President has said he wants something on his desk before the August recess. And I think there's every intention to make that happen by that time. There are three bills currently that have been considered, are being considered. I think really two of those have the most traction currently. And, you know, probably they'll just be one that will go to a vote. So we'll see about, you know, the details of each of those are different. But, you know, I think there's some real promise that we get a stablecoin bill this summer.

So there's also some support for an infrastructure bill, you know, that would that would revise or utilize is a is kind of an initial draft. Some of the prior iteration of these digital asset infrastructure bills like Fin 21 in the House. So there's some momentum building around that. But it's also unclear just how much support that will receive and on a bipartisan basis. So it remains to be seen, it appears to be a bit of a longer road than the stablecoin bills. I mean, that's as far as we can kind of see into the future on the legislative front at this point.

Stuart Davis:

Yeah. And what about the reserve fund? What's happening there with the new administration?

Stephen Wink:

Yeah, this strategic reserve, you know, which was announced to some fanfare. There's still quite a bit of uncertainty about what exactly is happening there. But, you know, there's a number of assets that were mentioned. That's, you know, I think still remains to be seen what exactly happens there. We've also seen a number of states propose similar strategic reserves. So that will be, you know, an interesting development. But overall, not sure how entirely significant that is in the long term. But what I think it's important for is kind of establishing, you know, the value of these assets in the broader, you know, marketplace and in broader American life.

Stuart Davis:

So this is the federal government and the states potentially investing on a proprietary basis in digital assets.

Stephen Wink:

Right. This is, you know, this is kind of the, you know, similar to, you know, the gold in Fort Knox, you know, having this strategic reserve of assets. Well, you know, as I mentioned, we'll see how this develops and unfolds over the course of this year. But it's a fascinating, you know, new idea that, you know, supports, I think, the growth of the industry generally.

Stuart Davis:

And presumably makes the asset more, seen as more legitimate from an institutional investor perspective.

Stephen Wink:

Yeah. What do you think, Stu, companies can do to adapt to, you know, this continually evolving global regulatory landscape? You know, we've got, you know, the uncertainty in the US. We've got the new MiCA regime. We've got the UK regime that's beginning to evolve. Maybe talk a little bit about where do you think the UK fits between MiCA and wherever we end up in the US?

Stuart Davis:

Yeah, that's a really interesting question, Steve. We're seeing this very European regime emerge with MiCA based on core principles of European securities law. The UK, in terms of its current discussion papers and proposals, seems to be leaning towards the EU framework. And that makes sense, right? Because the UK's financial services framework, until Brexit, was entirely aligned with the EU's framework, it was the EU’s framework that was implemented in the UK. But I think a really interesting question for the UK is, is that the right approach? The US is the largest capital market in the world. It's going to be the largest market in terms of digital asset investment. And what we don't know yet is what the US regime is going to look like.

If you're the UK at the moment and you haven't committed to a draft of your regime, would it be better to wait and see? Wait to see what the US regime looks like and maybe, you know, maybe have a regime where you are you're a bridge between the US and Europe. I think what will happen because of the integration of the UK's financial services framework, is that it will continue to lean on the EU path. I'm not sure that is right.

In terms of what fintech’s can do to try and navigate this space. Obviously, having a good legal firm representing you is very important, but what we're seeing is these businesses, they operate on a global basis often. How do you manage to navigate, you know, two hundred, hundreds of different legislative regimes that are emerging? What we always say to clients is focus your marketing efforts, focus your business efforts on the key low hanging fruit jurisdictions and navigate the regulatory regimes there first. Where are the core places where your users are based? Where are you incorporated? Make sure that you're complying with those regimes. And then as you expand, you can deal with chunks of different jurisdictions, we split it up like that. It's very difficult for even the largest companies to have a big bang approach and say, we're just going to comply with the legislation of the world in one go. So make it bite size. And that way, I think, is a reasonable way to achieve it.

Stephen Wink:

That's a great point. And, you know, I think it's true in the US, I think it's true in many jurisdictions around the world. It's, you know, the main concern is where are your customers? Where are your clients, where are those folks located? That probably determines your primary jurisdiction of regulation. And then also where you're operating from, of course. You know, but we also get folks saying, well, hey, if I just offshore, you know, my, you know, my operations, am I out of the out of the woods on this, on the regulation stuff in the US, for example. The answer is no. If you're still, you know, dealing with US persons in some way, then you're likely captured by these.

Stuart Davis:

Yeah. If only it was that simple.

Stephen Wink:

Absolutely. So I think that's a good place to stop. And, Stu, thanks for joining me.

Stuart Davis:

Thanks for having me, Steve.

Stephen Wink:

My pleasure. And thank you for listening to this episode of the LathamTECH Podcast. You can subscribe and watch or listen to the new and archived episodes of Latham's podcast on lw.com, YouTube, Apple Podcasts, Spotify, or wherever you get your podcasts. If you'd like more information on the topics in this podcast, please email us from the notes in the show description. We hope you'll join us again next time.