Bitcoin ETF in Europe Already? Not So Fast. 

Europe bet big on two major transitions recently. The green and the digital one. Whilst dust has now settled on the green transition, the process for the digital transition has just started. And it comes with great emphasis on crypto assets.  

As it was to be expected, the digital transition in Europe brings an avalanche of new regulation. The just released European rules on the markets in crypto assets (MICA) are the first of their kind worldwide. Authorities in Europe plan to create a broadly encompassing regulatory framework to tackle the new risks posed to retail investor markets by exposure to this new asset class.  

In the US, the SEC has recently approved the first set of Bitcoin ETFs. That was done without endorsing Bitcoin as an asset class as such. In Europe, a recent ESMA call for evidence on eligible assets under the UCITS directive has the crypto world excited about a Bitcoin ETF in Europe soon.  

Is that realistic? Not unlikely to have a Bitcoin ETF in Europe in our view, but not so fast either.  

Why Is ESMA Consulting on the Eligible Assets Directive 

It is knowledge diffused also in the US that the UCITS directive contains provisions to specify investable assets, in one with rules on risk diversification and exposure limits. Not as widespread though is the knowledge about a separate directive – the Eligible Assets Directive (EAD).  

Introduced back in 2007, the EAD defines the scope of UCITS eligible assets. The European Commission mandated ESMA already in 2023 for a review of the applicable eligibility rules under UCITS. Nearly sixteen years lapsed since the first introduction of the EAD. Markets in financial instruments, related regulations and practices also evolved concurrently. It makes sense to analyse again whether UCITS eligibility rules are still in line with market developments.  

The mandate received by ESMA on the review of the EAD is indeed articulated. The European Commission suggests that a general assessment of the implementation of the directive is carried out, with a view to identify divergences in national practices. At the same time, a recommendation for revisions shall be made by ESMA to keep the directive in line with market developments.  

As part of the mandated assessment of the EAD, ESMA should come up with clarifications on the key definitions and criteria used to assess eligibility of assets. In this regard, ESMA is also requested to evaluate cross-references to other European regulatory frameworks with a view to finetune consistency amongst them. All to offer additional support to UCITS management companies as well as to contribute heightening investor protection standards.  

Broadening the Scope of UCITS Eligible Assets  

One of the high-profile aspects of the mandate received by ESMA on the EAD review pertains to the evaluation of risks and benefits for UCITS in gaining exposure to currently out of scope asset classes. Exposure obtained via so-called delta one instruments, derivatives and financial indices. For what concerns this part of the broader mandate, ESMA will work in concert with National Competent Authorities across Europe and, where required, also with market participants.  

One of the potential outcomes of the EAD revision is that new definitions and eligibility criteria could materialise that allow for exposure of UCITS to new asset classes. ESMA shall nevertheless assess first whether any such potential new exposure is appropriate and adequate considering the characteristics of the underlying markets, including valuation, liquidity and safekeeping.  

The notion of liquidity represents one of the most controversial aspects of this assessment. On the one hand, the term liquidity is used frequently both in the UCITS and the EAD directives without any detailed specification of sort. On the other, there seems to be evidence that liquidity of certain investable instruments is sometimes presumed by UCITS managers and not necessarily a reality of a specific market or instrument.  

The ESMA EAD consultation opens the door to Bitcoin ETF in Europe 

What does the ESMA EAD consultation have to do with talks of Bitcoin ETF in Europe? Crypto assets are indeed mentioned in the list of out-of-scope assets which UCITS might have gained exposure to and that, further to evaluation, could be potentially allowed as eligible assets in the future. It is legitimate to speculate at this point about the potential opening of crypto assets to UCITS, which will then pave the way to a Bitcoin ETF in Europe.  

ESMA is working at the same time on another related endeavour under MICA. That is the consultation on the conditions and criteria to categorize crypto assets as financial instruments. The aim of this work is to define the perimeter of application of both MiFID II and MICA. That is done by creating criteria and identifying conditions for crypto assets to be considered financial instruments under existing sectorial regulation. The ones which fall out of MiFID II could be qualified as financial instruments under MICA, but not automatically.  

What transpires from this consultation is that the current list-based approach on financial instruments under MiFID II might be too simplistic for the current state of markets evolution. There are no criteria or conditions that can assist in identifying financial instruments and related practices vastly diverge across Europe. Some member states use a list-based approach and others concept-based definitions to categorise financial instruments. The results of this work will allow to create convergence in practices across Europe.   

Conclusions 

In the US the SEC approved the Bitcoin ETF, yet without endorsing the Bitcoin as such. Apparently, it wasn’t a precondition. One of the reasons behind the approval this time was that any prior authorisations denial by the SEC was unsubstantiated. That is what was claimed by the US Court of Appeal for the district of Columbia.   

The rulebook on financial services in Europe has grown much more robust and intertwined since the financial crisis of 2008. Notions like the one of financial instruments are defined differently under sectorial regulations applicable in Europe. Coordination amongst these regulations will be required to pave the way for the approval of a Bitcoin ETF in Europe.  

The introduction of MICA bodes well for that European authorities have demonstrated to have accepted that crypto assets are here to stay. On the point of the eligibility of crypto assets under UCITS, questions remain.  

The feasibility of a Bitcoin ETF in Europe by and large depends on whether crypto assets will be embraced fully as an eligible asset for UCITS or subject to limitations.