EU expresses displeasure over FTX debacle

Yesterday morning there was a debate in the European Parliament about the implosion of FTX and its consequences for Europe. Members of the Committee on Economic and Monetary Affairs (ECON) engaged in discussion with specially invited guests, including Stefan Berger (Rapporteur of MiCA), Alexandra Jour-Schroeder (Deputy Director of FISMA) and Steffen Kern (ESMA’s Head of Risk Analysis and Economics).

The fallen exchange FTX brings about a lot. Sam Bankman-Fried (SBF)’s company was worth $32 billion at its peak and is today bankrupt. SBF turned out to cover the risks of FTX with self-created FTT tokens. When this leaked out, investors sold off these tokens en masse and withdrew their funds from FTX, causing FTX to get deeper and deeper into trouble and eventually implode.

Court papers provide insight into the number of creditors of FTX. That is at least 100,000, but according to estimates it can rise to more than one million. Many Dutch people may also be the victims of the fallen FTX, as well as other Europeans. This is one of the reasons why the debate has been held. The speakers gave their preliminary assessment of the events.

The debate

The debate was moderated by Irene Tinagli, Chair of the ECON Committee. She kicked off with the following four spearheads that shaped the discussion. It is often quite normal for crypto companies to perform various trading activities (such as brokerage, custody, clearing, lending, trading ) themselves. This should not be possible without proper separation between departments with opposing interests. This is in order to properly handle and manage confidential data and to prevent (the appearance of) a conflict of interest.

Furthermore, until recently FTX (EU) Ltd had a MiFID II license granted by the Cypriot regulator. How could this be, Tinagli wonders. In addition, at FTX, client funds were not segregated from the company’s own assets. In fact, the customer coins turned out to be completely absent and mixed with funds from SBF’s own trading company, Alameda Research. Clients’ funds must be segregated from a crypto company’s assets and serve only to satisfy certain creditors, particularly those clients who have entrusted their coins to the company, the chairman said.

As a final spearhead, Tinagli wondered whether the crypto market could pose a threat to financial stability due to its growing interdependence with the broader financial system. And did the FTX debacle lead to that?

Stephen Berger

Stefan Berger (reporter of MiCA) was the first to shed light on the FTX debacle. According to him, it makes it clear that the crypto sector needs regulation and adequate supervision. Berger also emphasized that this is not the failure of one technology, but the failure and overconfidence of one person.

MiCA will create a common regulatory framework for the European crypto sector. Berger believes that MiCA should come into effect as soon as possible. Especially since the sector is currently dealing with a crisis of confidence. Subsequently, countries outside Europe could use MiCA as a legal framework.

Alexandra Jour-Schroeder

Alexandra Jour-Schroeder (deputy director of FISMA) then spoke. FISMA is the Commission department responsible for EU banking and finance policy. Jour-Schroeder said that we still don’t know enough to make a good judgment about recent events.

Clear governance mistakes have been made, she says. FTX has also taken enormous risks, there was no separation between the funds of customers and the company and there may be fraud. Remarkably, Jour-Schroeder also underlined that the FTX debacle is not a failure of the underlying technology.

FISMA’s deputy director also addressed the question of whether the FTX debacle could have happened had MiCA already gone into effect. She stated that no company with a MiCA license can be as poorly organized as FTX. In principle, it could not happen.

She ended by emphasizing the urgency of MiCA with the caveat that not everything can be solved with European regulations. That is why the European Union must enter into consultations with other countries to arrive at an international framework and supervision for cryptocurrencies.

Stephen Kern

The last specially invited guest was Steffen Kern (head of risk analysis and economics at ESMA). ESMA is the European Securities and Markets Authority. A kind of umbrella Authority for the Financial Markets (AFM) for Europe. He opened with the fact that ESMA has already warned several times about the risks and dangers of cryptocurrencies.

FTX consisted of a complex web of over a hundred entities across five different continents headquartered in the Bahamas. This complex corporate structure creates little transparency, according to Kern.

MiCA is also a step in the right direction, according to him. This will certainly benefit the corporate governance (good management and supervision) of crypto companies.

Question answer

Members of Parliament could then put questions to the speakers. One of those questions was how it was possible that FTX (EU) Ltd had obtained a MiFID II license from the Cypriot regulator. The representative of ESMA could not answer this, because ESMA is not the supervisor. He did say that this was not a license for cryptocurrencies, but for the provision of various financial services. FISMA’s deputy director added that FTX’s problems are more international and not necessarily in Cyprus.

The member of parliament, Ondrej Kovarik, who co-wrote MiCA, also commented on this. He argued that while the FTX debacle is hitting the crypto sector hardest, it is a broader problem. Many entities of FTX were already subject to existing regulations, but there was insufficient supervision, he says. In the Netherlands, for example, FTX was active without registration from De Nederlandsche Bank (DNB).??

Kovarik then warned of cross-border problems as a result of MiCA. Not only crypto companies with a license, but also payment service providers and payment institutions may be affected by crypto companies that are located outside Europe and are therefore not subject to MiCA. This is therefore more of a global challenge, concluded FISMA’s deputy director.

MiCA 2.0

Although MiCA will probably not come into effect until the summer of 2024, the President of the European Central Bank (ECB), Christine Lagarde, has already called for the need for MiCA 2.0 on several occasions. The debate also discussed whether MiCA provides sufficient coverage. For example, MiCA does not regulate DeFi , NFTs , lending and staking .

ESMA has the power to temporarily restrict or prohibit the marketing, distribution or sale of certain financial instruments (art. 40 MiFIR). A member of parliament therefore suggested that ESMA should make use of this power.?? The ESMA representative ?? explained that the European watchdog has already used this power in the past when selling CFDs ( contracts for difference ).

He further emphasized that ESMA will certainly continue to use this power in the future, but that there are limitations. For example, a product intervention must be justifiable. At the moment there is not enough evidence and data available to justify this measure, he said.

A Dutch touch

Michiel Hoogeveen, a Dutch member of the European Parliament, also spoke. He stressed that the FTX debacle is not Bitcoin’s failure. He also expressed his concerns about the phenomenon of ‘ reverse solicitation ‘ and sees this as a possible shortcoming in MiCA. This means that a crypto company offers services on the exclusive initiative of the customer. In other words: not actively targeting the European market. An argument that Binance has used to operate in the Netherlands without registration from DNB. It was made clear by several speakers that this is on the agenda of regulatory and supervisory authorities and that a solution is being worked on.

MiCA is still a long way off

Technological developments follow each other in rapid succession. Several members of parliament therefore think that the summer of 2024 is actually too far away and wonder whether MiCA cannot enter into force earlier. FISMA’s deputy director said that regulation for the crypto sector is a top priority. However, before the entry into force of MiCA, binding technical standards and guidelines must also be adopted by the European Banking Authority (EBA) and ESMA. This will not happen overnight and so MiCA will most likely not come into effect sooner, according to Jour-Schroeder.

There were more questions from MPs, but time was up. This makes it clear that the FTX debacle is alive in a European context, especially now that MiCA is almost final. It is also worth noting that some look past the FTX debacle and realize that this is really just another scandal in our financial history, with which Bitcoin in a sense has little to do with.

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