The promotion, placement, and trading of atypical financial products in EU create new regulatory challenges. There is not a European definition of financial product and with the term atypical financial products the reference is to investments products that do not qualify as ‘financial instruments’, securities or PRIIPS and do not fall within the scope of the EU rules on public offerings and investment services currently in force (MiFID II ), or another EU financial regulation (such as PSD2 , EMD , Solvency II ). Financial intermediation is carried out through investments services that are specifically identified by MiFID II with provisions outdated due to market and technological developments. The exclusive objects of investment services are ‘financial instruments’ as defined by MiFID II. The category of ‘financial instruments’ by the MiFID II definition is a closed category, unlike the Italian ‘financial products’ or ‘investment contract’ in the U.S. system.
MiCAR addresses the main challenges related to crypto-assets and the centralized provision of crypto-asset services, but still leaves open issues regarding decentralization. The crypto-assets regulated exhibit also different causal paradigms, which are essentially related to the enjoyment of goods or services (utility tokens) and the payment function (ARTs and EMTs). The potential negotiability of MiCAR crypto-assets gives them a financial character, transforming an originally and typically non-financial phenomenon into an essentially financial one. However, remain issues related to MICAR conflicts with existing financial regulations, as in principle MiCAR has a residual application and it does not apply where other EU financial regulation applies. On 29 January 2024, ESMA published a consultation paper on the draft Guidelines on the conditions and criteria for the qualification of crypto-assets as financial instruments. The Guidelines aims to assist in determining which legal regime will apply to crypto-assets and provides clarification on certain features of NFTs and utility token. Unregulated crypto-assets (atypical financial technological products) can be dangerous particularly for retail investors together with the fact that there is a high aggressive and misleading advertising in connection with these assets. These advertisements focus on the advantages and do not provide information about the risk or not in a clear way. The current economic situation makes innovative and sometimes unregulated retail investment products more enticing turned to crypto-assets. In EU financial regulation, crypto-assets can now be distinguished into (i) crypto-assets falling within the category of MiFID financial instruments, and (ii) crypto-assets falling within the category of MiCAR instruments. However, remain crypto-assets that fall outside EU financial regulation and ESAs competencies and powers.
Supervisory authorities have been established with the aim of guaranteed fairness and transparency of information, through the regulation of inter-private relations, realising one of the necessary conditions to favour the ‘disintermediated supply of wealth’ and the revitalisation of the stock exchange. Notwithstanding the recent developments towards a further European harmonisation, the capital and financial markets supervision is predominately executed by the Member States and its National Competent Authorities (NCAs). The European supervisory authorities (ESAs) have no powers regarding financial products that are not regulated at EU level. ESAs have several powers, but mainly the power to analytical detail the general primary standards contained in the law. ESMA can also prohibit or restrict certain financial products that threaten the orderly functioning of the markets or the financial stability for a period of three months (product intervention power). However, only national law of Member States applies to the public offer of atypical financial products and only the NCAs can therefore have powers and competencies about atypical financial products.
Digital financial innovation involves crypto-assets characterised by low costs grater speeds and easiness. Regulatory needs emerge from the numerous frauds on the market. It is therefore very important to govern innovation. Indeed, protection beyond competition increases trust, widens exchange, and increases collective welfare.
Technology has introduced atypical financial products that have similar characteristics to products already known to the market. Traditional works of art for example have been joined by creations made using Non-Fungible Tokens (NFTs). NFTs are one of the applications of Decentralized Finance (DeFi). NFTs can be used in many ways. They constitute a new paradigm in property rights management and can be used into financial sector. These products aren’t any of the traditional financial products falling under the definition of EU financial instrument or other definitions in EU financial regulation, including MiCAR. The challenges raised by atypical financial technological products, but specifically NFTs and hybrid tokens are numerous.
Increasingly complex financial products pose a threat to financial stability. Micro – and macro – prudential policies, despite the frictions that may arise between them, overall complement each other, and the two policy domains play an equally important role in ensuring financial stability. It is important that macro-prudential actions be taken in a timely manner, i. e. already during booms. Regulation and supervision ensure reduction of the impact of financial crises and spill over effects. The general investors approach to crypto appears from the outset to be characterised by an unawareness and nonchalance, which is greater in the case of crypto-art and memecoin than in the case of ICOs of utility tokens ecosystem and could generate a ‘speculative bubble’. Financial stability according to the authorities is currently not affected by atypical technological financial products, but interlinkages to traditional finance must be supervised, especially with reference to DeFi.
Indeed, at the moment market fairness and integrity related to crypto-assets deserve more attention. A first ESMA notice on crypto-assets dates to 2019. The warning informs consumers on the lack of recourse or protection available to them, as crypto-assets and related products and services generally did not fall under the protection of the existing EU financial services rules prior to MiCAR. Again in 2022 EU financial sector regulators warned consumers about the risks of crypto-assets. In 2023, EU adopted MiCAR that is the first comprehensive legislation in the crypto-asset sector and fills a regulatory gap highlighted in 2019 by ESAs. Crypto-assets sector today is different from the one for which MiCAR was drafted and brings with it significant regulatory challenges. It is therefore necessary to address the remaining challenges and seek the best solutions with reference to the objectives of the rule maker, such as: legal certainty, protection of financial stability, market, and investor integrity. Technological innovation has created and/or developed new variants of crypto-assets that need to be systematically framed, such as hybrid tokens and NFTs. Decentralized entities (i. e., fully decentralized) are, therefore, excluded from the scope of MiCAR. The market following the trend of rule makers to regulate centralized services is increasingly focusing on the development of decentralised and/or decentrally delivered services. In essence, MiCAR regulates most of the crypto-assets sector but there are exceptions like Decentralized Autonomous Organizations (DAOs), DeFi, NFTs and other novelties may arise in the future.
DLT allows the creation, on the one hand of atypical financial products (i. e., cryptocurrency), NFT that are created and/or held in a decentralized manner, and on the other DAOs that manage and/or provide services, as well as can create products in a decentralized manner. Regulatory issues today are related to financial NFTs; DeFi trading protocols and services provided in a decentralized way (via DAO) that are not covered by EU Regulation. Criminal behaviour and financial misconduct are unfortunately widespread in this sector and can be considered among the causes of the Crypto Winter of 2022-2023. The Crypto Winter 2022-23 was preceded by a series of events where outsiders could exploit a system’s deficiency and divert assets. All in all, these events undermined trust in the crypto industry, triggered asset valuation deterioration and prompted various regulators to move crypto-assets up their agenda. The regulation to be introduced should therefore be functional to market efficiency and transparency (creating a semi-strong form of information-efficient markets). Very relevant are the issues related to client, depositor, and investor protection. These increase considerably for the less informed and overly enthusiastic market participants. The asymmetry between the sellers of atypical financial products and the buyers are relevant. False information together with the investment recommendation on social media increase the needs of investors protection. Until the implementation of MiCAR crypto-assets and related service providers remained mostly unregulated. Crypto exchanges largely operate outside of national legal frameworks and are often based in countries with lighter regulatory requirements. The increase of retail participation in EU financial markets with the digitalisation of the investment process, the use of digital finance and the use of social media for posting investment recommendation by ‘influencer’ promising consumer fast and hight returns increase the need for robust retail investor protection more than ever. Participation of small investors is often stimulated by misleading advertising messages that do not clearly explain the risks inherent in these products.
The complexity and highly innovative features of crypto products create problems for the regulator who needs a deep knowledge of the instruments and related technology to regulate and classify them. Supervisory law is the legal foundation for financial services supplied by investment firms. In a Statement of May 25, 2023, ESMA highlights the risk arising from the provision of unregulated products and/or services by investment firms and that gives rise to both investor protection and prudential risks. MiFID II provides for a specifically tailored regime of obligations when investment firms provide investment services, which is limited to regulated services and does not cover atypical financial products. Investment firms should be particularly vigilant about additional risks relating to products and/or services outside the scope of financial regulation. The issue is that, where investment firms or banks engage in providing both regulated and unregulated products and/or services, there is a significant risk that investors may misunderstand the protections they are afforded when investing in those unregulated products and/or services. Supervisory authorities are responsible for ensuring and promoting the integrity, transparency, efficiency and functioning of the capital market, as well as for ensuring the protection of investors. The EU retail rulebook is supervised and enforced by NCAs, using the supervisory powers and enforcement tools specified under the relevant legislation. ESMA monitors complaints data which can inform its supervisory convergence priorities. ESMA has materially thickened the retail rulebook through detailed and often heavily proceduralised soft law (i. e., Guidelines, Q&A). In fact, ESMA has emerged as having an ambitious approach to direct intervention in the retail markets using its MiFID II product intervention power in 2018.
In financial regulation, the classification of instruments determines which body of law will apply, and which supervisory powers an NCA or ESA may exercise. The approach of the authorities when faced with new investment products is to verify the classification of such instruments for supervisory purposes and to determine the applicable law.
In Italy supervisory powers over the provision of investment services, even if carried out by banks, are divided between the National Commission for Companies and Stock Exchange (Consob) and the Bank of Italy. Indeed, Italian law alongside the definition of ‘financial instrument’ (as transposed considering the MiFID II directive) there is the definition of ‘financial product’ unlike in other European countries. Financial products category is an open-ended and which includes but is not limited to financial instruments. The legally atechnical term ‘other form of investment of a financial nature’ is apt to embrace any transaction carried out with the use of capital that entails the assumption of a risk related to the expectation of a profit. For a transaction to be of a financial nature, according to Consob , it must have the following essential elements: i) investment of capital; ii) the expectation of a profit and iii) associated risk. According to the Italian Supreme Court, to qualify the investment as an ‘investment of a financial nature’ are decisive the practical intent of the parties and the overall purposes of the exchange. The definition of ‘financial product’ in the Italian legal system therefore includes all the atypical and unnamed forms of investment gradually created by the market and represents the legislative response to the creativity of the market, the multiplicity of instruments offered to the public and the need for investor protection. The Italian discipline of ‘financial products’ is composed by: (i) the discipline of public offerings (Art. 1 (1) (t) (v) Legislative decree no. 58/1998 (Consolidated Law on Finance, hereinafter TUF); and (ii) the disciplines of “off-site offerings” (i. e., offerta fuori sede Art. 30 TUF) and the promotion and “means of distance communication” (i. e., le tecniche di comunicazione a distanza Art. 32 TUF). The activity of offering to the public - unlike the provision of investment services - is not a reserved activity but requires the drafting and publication of a prospectus, subject to authorization by Consob, containing information on the offeror and the characteristics of the financial product offered. Indeed, depending on the manner through which the offer of financial products is put in place, it may detect the case in relation to unfair commercial practices or other violations of the Consumer Code. The mere fact that a bank intervenes in the intermediation of atypical products such as works of art does not make the rules on investment services applicable. The investment firms when offering to customers atypical financial products like through its banking channels not seem to have to comply with the behavioural provisions and adopt the specific organizational safeguards provided by the TUF and the Regulations on the implementation of Legislative Decree No. 58 of February 24, 1998. In addition, activities related to atypical financial products can only be carried out by banks as a ‘related or instrumental activity’. The investment firms’ position can mislead investors about the level of protection provided. Consob represents the need for offerors to always make investors fully aware of the regulations applicable to financial products and services, particularly if they are banking operators. In 2018, the Bank of Italy reminded banks that even when they intend to provide services that are not banking and financial in nature, they must pay full attention to the cognitive needs of customers. Bank of Italy states that in the absence of complete risk control, it is necessary for banks to refrain from or discontinue this type of activity. Powers of the NCAs in Italy in the event of a crypto-assets has the characteristics of a financial product include the inhibition, i. e. blacking out the site. There are numerous Consob press releases regarding the measures by which it ordered internet connectivity service providers, through the powers arising from the “Decreto Crescita” (converted in Law No. 58 of June 28, 2019) to inhibit access from Italy to websites through which financial services are offered without due authorization and ordered the removal of initiatives of anyone in the Italian territory, that through telematic or telecommunication networks offers financial products to the public in defect of the prescribed prospectus and/or disseminates advertisements related to offers to the public of financial products. Indeed, the Italian approach is like U.S. concept of ‘investment contract’. The leading case on the definition of an ‘investment contract’ is the U.S. Supreme Court case, SEC v. W.J. Howey Co. Under the Howey test, an investment contract is “a contract, transaction or scheme whereby a person invests his money in a common enterprise”.
In France, the Sapin II law has introduced a change in the French system: no offer on atypical investments can be directly marketed on without prior allocation by the Autorité des Marches Financiers (AMF) of a registration number. These proposals are subject to the ex-ante control by the AMF and cannot be advertised or directly marketed without prior allocation by the AMF of a registration number on the information document for investors. Miscellaneous asset offers are atypical financial products proposing the acquisition of rights to an asset by stressing the potential for direct or indirect financial returns or having a similar economic effect. Periodically the AMF warns the public against companies proposing atypical investments without being authorised to do so and reminds investors that to keep attention on the advertising materials, the company or intermediary trying to sell a product, specialized knowledge.
German federal financial supervisory authority (BaFin) examined the risks associated with NFT and analyses the matter from a supervisory perspective. The Authority categorises NFTs and find out what relevance it has for the financial market. BaFin have argued that probably the most prominent categories of NFTs are “collectibles” and “digital art”. When conducting supervisory assessments of NFTs, BaFin takes the same approach that it takes for fungible tokens. In cases where NFTs are to be categorised as securities under the EU Prospectus Regulation or as capital investments under the German Capital Investment Act, issuers are generally required to draw up a prospectus.
A generalised approach to atypical financial products (physical and technological) can be the introduction of EU financial regulation on financial products such as that adopted in Italy or in France for miscellaneous assets, with a principle-based regulation. Thinking to Gaius tripartition this would be regulating the res. Instead of prescribing detailed rules, principle-based regulation lay out the broader principles and the outcomes intended. Principle-based regulation could foster the single capital market introducing future-proof EU financial regulation on all investment products. There is the possibility that crypto-assets which, however, fall outside MiCAR and MiFID with investment purposes will grow in the future.
Providing services by atypical financial intermediaries like DAOs involves high risks. In this case the regulation could concern personae and an entity-based approach focused on risks can be effective. Indeed, a possibility is the introduction also through MiCAR II of regulation for NFTs and DAOs through a risk-based regulation. Risk-based regulation enables regulators to use their resources efficiently, focusing their efforts on higher-risk activities.
Investors usually carry out the acquisition and sale of securities with the assistance of banks and other investment firms. Investment firm intermediation reduces the friction to efficient capital allocation which can be generated by information and transaction costs. Retail investors have a special need for protection because they are often unable to assess the quality of the financial product. The provision of specific obligations for investment firms offering atypical products does not seem to need specific hard law regulation and can be overcome by statement and warnings. In this case are sufficient soft law instruments that are becoming widely used and important to supervisors.
Designing appropriate regulation for atypical financial products is not an easy task, regulation of any kind tends to have distorting effects on incentives. Indeed, considerations that see regulation as an obstacle to market development and economic growth are widespread. Excessive regulatory complexity can create barriers to entry for newcomers, limiting or even hindering competition and innovation in the financial system. However, regulation is vital to ensure that retail investors are protected from taking out a dangerous financial service. Seem not appropriate to regulate everything so as not to hinder progress by introducing unnecessary obligations, but to continue to regulate those areas that concretely endanger financial stability or investor protection. European regulatory framework for the financial sector is currently highly composite. Soft law and supervisory convergence appear to be a favored response and information is sufficient when investments firm provides atypical financial products. Indeed, the introduction of EU regulation on all financial products seems excessive at the moment, but the need may emerge in the future. Another protection for consumer is provided by the Directive (EU) 2023/2673 published on 22 November 2023 amending Directive 2011/83/EU as regards financial services contracts concluded at a distance. Digitalisation has amplified certain aspects not fully addressed by this directive, such as how and when to provide information to the consumer. This Directive therefore revises the rules on financial service contracts concluded at a distance between a consumer and a trader. A deadline of 19 December 2025 has been set for Member States to enact national transposition provisions, which will apply from 19 June 2026.
Instead, DeFi has attracted attention from investors and regulators, as the latest and arguably most innovative development in the crypto area. The borderless nature of the technology, the interconnectedness within the crypto-asset ecosystem and the prospect of linkages with the traditional financial ecosystem strengthen the case for a EU and global approach to crypto-asset regulation and particularly to DeFi. Aspects related to DeFi might need a more paternalistic regulation. The introduction of a specific framework for the regulation of DeFi, NFTs and DAOs appears to be the current regulatory challenge at EU level. It must be acknowledged that at EU level there is a strong commitment to regulating these phenomena. In fact, these are topics that will be addressed at the end of this year by the European Commission that by 30 December 2024 shall submit a report to the European Parliament and Council detailing crypto-asset advancements, focusing on the market evolution of NFTs and evaluating the need for their regulatory oversight. n
