The Global watchdog Financial Stability Board recently raised concerns that a booming crypto-assets market could pose a serious threat to financial stability if left unregulated. Regulatory and crypto lawyer Biba Homsy and LHoFT research and strategy manager Jérôme Verony discuss the Luxembourg eco-system and the opportunities that regulation can create for startups.
How do you place Luxembourg in the international context for crypto assets?
JV: Luxembourg was the 1st jurisdiction to regulate crypto-exchanges in the EU and to authorise EU credit institutions to provide crypto services to their investor client base. The study, State of Crypto-Asset Management in Luxembourg, which we published with PwC earlier this year reflects the views of more than 120 institutional respondents and conveys a desire for Luxembourg to take a proactive stance.
The most frequently cited constraints to the further development of the crypto-assets sector in Luxembourg were a lack of clear regulatory guidance, a lack of a conducive legal framework and obstacles to cross-border business pending the implementation of the EU framework.
Switzerland and the US are viewed as leading jurisdictions and we note that the Cayman Islands remain a top domicile for crypto-funds. Since we conducted our study, the CSSF published 2 FAQs addressing important questions around the inclusion of virtual assets in certain investment vehicles and rules of the game for credit institutions wishing to provide related services. Market participants have welcomed these FAQs as a step in the right direction.
“We expect continued growth in blockchain- and crypto-asset-related services here in Luxembourg”
Jérôme Verony, LHoFT research and strategy manager
Ms Homsy, how do you compare the crypto assets approach in Luxembourg with that in Switzerland, where you also practise?
BH: As you know, Switzerland is not part of the EU and may for this reason move quicker when it comes to adapting legislative framework and regulation. It has quite a flexible and pragmatic approach and has developed a regulatory practice about which it has strongly communicated over the years. However, each jurisdiction has its strong skills.
Luxembourg has great expertise in funds, and in asset management in general, and this kind of expertise can really be a strong asset for the country in the future. Comparing two countries is sometimes like comparing apples and pears. There are strong positions in both countries. If you want to develop more in the EU you may be more interested in Luxembourg. If you want to develop globally and with specific aspects like DoA, metaverse and NFTs, you may also be interested in what Switzerland can offer.
Between the three pillars of the digital finance strategy: MiCA, the DLT pilot regime, and DORA, which will be most beneficial for Luxembourg’s startup ecosystem?
JV: By providing clarity at EU level, MiCA is poised to benefit startups developing, for instance, virtual asset custody services or crypto-AML (anti money-laundering) solutions. The DLT pilot regime aims to use digital ledger technology to develop novel market infrastructure. Strategically, it’s a crucial piece of legislation for the EU because it provides an opportunity to do things that can’t easily be done with traditional financial market infrastructure (FMI), such as combining trading and settlement.
The pilot regime foresees a sandboxing exercise open to both incumbents and innovators, but certain provisions included in the pilot regime are a limiting factor for pure fintech players. Consortia between Fintech innovators and sector incumbents, on the other hand, would make a lot of sense. Traditionally, multilateral trading facilities (MTFs) have not been a focus of Luxembourg’s financial sector expertise, but there is a significant opportunity for Luxembourg to build on existing expertise all the while developing new capacities as part of this sandboxing exercise, not least in the settlement space. With DORA, the need for financial institutions to mitigate ICT-vendor related risks could prove beneficial to innovative Fintechs and cybersecurity-focused startups.
BH: MiCA has the merit of attempting to find a delineation between the different EU and national authorities’ jurisdictions over crypto-assets. It may sometimes appear as quite fragmented when relating to financial markets (distinction between banking supervision, financial capital markets, in the EU and at national level). It also has the merits of providing a framework for crypto-assets that do not fall under any financial regulations, such as the so-called stable coins and utility tokens. Outside of the scope of MiCA, you may still see regulations applying to other crypto-assets such as financial instruments. In addition, the impact of the Pilot Regime is also of great importance for Luxembourg given the significance of securitisation in Luxembourg. Finally, the latest Regulation on Transfer of Funds (applicable to crypto-assets) will also impact for the EU Anti-Money Laundering/Countering Financing of Terrorism (AML/CFT) regime.
“Luxembourg has everything to become a key player”
Biba Homsy, Regulatory and Lawyer at Homsy Legal
What are your predictions for the next five to 10 years for Luxembourg’s fintech ecosystem?
JV: On the hypothesis that the virtual assets ecosystem is here to stay and that the EU framework will materialise in the near future, we expect continued growth in blockchain- and crypto-asset-related services here in Luxembourg. We also expect to see continued growth in regtech as institutions focus more on cost savings. At its General Assembly, the ABBL made a strong statement: one out of five banks is not profitable, which translates into 3,000 jobs being at risk.
Over the years Nasir [Zubairi, LHoFT CEO] has been vocal in addressing the underperformance of European banks compared to their international peers. The pursuit of efficiency gains, through the augmentation or in some cases replacement of manual operations within the financial sector, seems like an inevitable evolution here in Luxembourg.
A segment where we might see progress is insurtech, which has been a little slow to pick up steam locally but where there’s ample room for development. At LHoFT, we back initiatives that foster collaboration in the sector by facilitating proof of concept work, by mutualising redundant processes and by getting more funding to R&D projects. We hope to see more of all of the above.
BH: I have been approached by many participants interested in setting several types of “crypto-funds”. Funds are definitely a key element for Luxembourg in this area. With the right and appropriate framework around it, and key participants ready to provide support in this new class of assets (which means assessing rightfully their risk framework), Luxembourg has everything to become a key player.
What do stakeholders need to do to make this happen?
JV: For Luxembourg to “remain on the map” internationally, we need to see a stream of successful collaborations. Talent is an overarching issue. To address this, LHoFT is putting significant emphasis on education. Against the backdrop of the EU lagging the US and Asia in terms of VC, there is a need for continued, active involvement of the public sector. While the EU has given itself ample resources to fund innovation, for instance through the Horizon programmes, we need to explore ways to funnel these resources to meaningful R&D more efficiently.
To that end, made-for-purpose funding schemes could be helpful, with priority areas being defined with industry input. Another area where Luxembourg could make a difference is in terms of mutualisation. One concrete example we have been working on is the Fin5Lab where together with partners, we would conduct a first layer of due diligence so you almost have a labelling exercise to say “these are high quality fintechs”, to make life easier for their potential partners in the industry. Last but not least, the ongoing reform of the right of establishment, which enshrines the second chance principle following a bankruptcy, should be a boost for the Luxembourg startup ecosystem as a whole.
BH: You need to have a collaborative approach among key participants and service providers with experts among them. Entities may want to build their expertise, in order to develop for Luxembourg a strong AML risks compliant fund’s framework for promoters while still having pragmatic providers serving the clients. If this clicks, then Luxembourg will skyrocket.
This article was first published in the Silicon Luxembourg magazine. Read the full digital version of the magazine on our website, here. You can also choose to receive a hard copy at the office or at home. Subscribe now.