It is no secret anymore that the MiCA (Markets in Crypto-Assets Regulation) is coming. But why is this important for insolvency practitioners and clients? This update aims to give an answer to this question and to provide an outlook on how the German legislator plans to implement these principles.

The MiCA has recently been published in the Official Gazette of the European Union (“Amtsblatt”) which means it has become effective within 20 days. Basically, the MiCA provides a harmonious regulatory framework for this ever more important market. As we indicated in our R&I Update before it also aims for more insolvency protection in order to prevent cases like the FTX collapse in which customers lost vast amounts of their investment due to a lack of specific insolvency protection.

Context - What happens in insolvencies?

If an entity has to declare insolvency, the insolvency court calls upon the insolvency administrator whose main task is to collect all collectable assets for the insolvency estate. The aim is to maximise the insolvency estate to ensure that all insolvency creditors can be equally satisfied at the end of the insolvency proceedings. Normally, despite the many privileges that the insolvency administrator can take advantage of, the insolvency estate is not sufficient to satisfy all the insolvency creditors. In order to ensure the principle of equal compensation all insolvency creditors receive an insolvency quota with regard to their individual claims. These quotas usually remain below 10% which is why an insolvency often results in large losses for the insolvency creditors. If, however, a creditor has a right for segregation (Aussonderungsrecht) in respect of a particular asset, due to e.g. ownership, he/she may claim this asset from the insolvency administrator without any loss. These insolvency creditors do not have to fear the insolvency of their e.g. service provider and simply need to wait for the insolvency administrator to transfer the asset into their custody once he/she has taken control of the insolvency estate. Whether or not digital assets held by crypto asset service providers, provide for such a right of segregation, however, is subject to discussions among German scholars. The MiCA now provides the first concrete guidance on this issue.

Stipulations by MiCA

Among other aspects the MiCA stipulates in article 63 no. 1 that crypto asset service providers (such as stock exchanges like FTX or so-called neo banks like Nuri) shall

“(…) make adequate arrangements to safeguard the ownership rights of clients, especially in the event of the crypto-asset service provider’s insolvency (…)”.

MiCA then goes on and specifies in article 67 no. 7 that the client’s holdings on the DLT (Distributed Ledger Technology) shall be

 “(…) held on separate addresses from those on which their own crypto-assets are held. (…)”

The reason for this stipulated separation of funds/assets cannot be overstated: The MiCA demands that crypto asset service providers make sure all their clients may take advantage of the right of segregation. This is due to the fact that the prevailing opinion confirms a right of segregation of any asset if, held by a custodian, it remains identifiable and separate. As long as these principles are complied with most German scholars will recognize a right of segregation.

The fact that MiCA now requires the compliance with these principles is an important step towards legal certainty for practitioners, the supervisory authorities such as the BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht – Federal Financial Supervisory Authority) and investors/clients.

Implementation by German legislator – German Future Finance Act

The German legislator has reacted and introduced a draft of the so-called Future Finance Act (Zukunftsfinanzierungsgesetz - ZuFinG). Among other things this Future Finance Act makes changes and amendments to the already existing German Banking Act (Kreditwesengesetz – KWG). With these amendments it also implements exactly the same obligations for crypto asset service providers that are already laid down in MiCA. Instead of amending the German Insolvency Code or the Code of Civil Procedure, it decided to implement these rules through the regulatory framework which makes perfect sense from a regulatory perspective.

It is worth noting that the German counterpart is more specific in formulating these duties. For example, it clarifies that these assignments of assets to clients apply not only to segregated wallets but also to the very common omnibus wallets.

It is also important to note that the Future Finance Act makes an exception to the application of the right of segregation. It states (translated):

(…) This does not apply if the customer has given consent to disposals of the value for the account of the institution or third parties. (…)

This means that the right for segregation could be waived by way of consent for other purposes. Colleagues such as Haneke (in: Neue Zeitschrift für Insolvenz- und Sanierungsrecht (NZI) 2023, p. 529) believe that the purpose of this exception could be to allow crypto asset service providers to access client funds for their service fees.

Comment

MiCA and potentially the updated German Banking Act are an important milestone in providing overdue clarity and certainty regarding digital assets in insolvency. However, whether this latter exception could also invite crypto asset service providers to circumvent the German legislator’s intention for more security remains to be seen. It is certainly something to be paid attention to in the future.