The Concept of Financial Instruments: Drawing the Borderline Between MiFID and MiCAR

EU financial law has a problem with its most basic building block, the 'financial instrument'. This term defines the boundaries between key pieces of legislation such as the Markets in Financial Instruments Directive and Regulation (MiFID II/MiFIR), the Prospectus Regulation and the Market Abuse Directive and Regulation (MAD/MAR). How to precisely draw this line is becoming increasingly important, as now a further separation is established between 'traditional' financial market law—which is, among other things, composed of the acts just mentioned—and that of newly adopted rules for the crypto-economy in the Markets in Crypto-Assets Regulation (MiCAR). Yet, what constitutes a financial instrument remains unclear.

Various examples illustrate how thorny the delineation is. Are derivative-like tokens that purport to represent an official currency like the US Dollar, or commodities like gold or diamonds, 'financial instruments'? How about tokens attempting to do the same for other crypto-assets such as bitcoins? Are governance tokens, eg relating to a Decentralized Autonomous Organization (DAO), to be considered as 'financial instruments'? Does the same hold for an investment in a tree in the Amazon rainforest, coupled with a service contract?

As an ESMA study revealed in 2019, supervisory authorities of the various member states differ on these issues. No wonder there is confusion—the statutory ‘definition’ of the financial instrument in Annex I Section C of MiFID II does not provide any clear concept but merely an ambiguous, sometimes even circular, laundry list of different instruments.

To solve this problem, we have developed a new, conceptual approach for interpreting the term 'financial instruments', and in particular its backbone, the 'transferable securities'. Convinced that substance must prevail over form, we have used the economic purpose of financial regulation as a common thread for our analysis. We also have cast a comparative look at US financial regulation, in particular its term ‘securities’. While the statutory definitions diverge, the US model still can be helpful because (1) it has historically served as the blueprint for EU financial law, and (2) it tries to solve the same or at least very similar problems.

Our analysis concludes that there cannot be a single, unchangeable and rigid definition of 'financial instruments'. Rather, we advocate for a different approach, which is more adaptive and responsive to the ever-evolving landscape of financial products. We call this novel approach a 'flexible definition'. Instead of adhering to traditional definitions with rigid criteria, this approach focuses on key attributes of transferable securities and financial instruments.

As such, we have identified three key elements:

1. First, the contractual nature, creating specific financial rights and obligations, is the conceptual denominator common to all financial instruments. The latter are agreements on the prospective flow of monetary returns in the future. However, not every contractual promise qualifies; a financial instrument must embody commitments that align with the intentions of the EU legislator. Specifically, these must be functionally similar to the rights and obligations associated with the products detailed in Annex I Section C of MiFID II.
2. Second, financial instruments are more than simple contracts. The initial bargain between two parties (negotium) is embodied in an asset that can be transferred to other parties (instrumentum). However, the degree of financial instruments’ tradability varies widely—while some are traded continuously, others are transferred seldom, if ever. Consequently, tradability is best viewed as a spectrum rather than a definitive boundary. This variability highlights a key strength of the proposed flexible definition. The rationale for bringing tradable instruments under financial regulation is the objective to protect investors. This brings us to the next characteristic.
3. Third, financial instruments are characterised by their purpose, which is generating financial returns. As such, they are not empty shells but serve as legal channels for investment. To identify the function of any product, we recommend taking an ex-ante view, focusing on the endogenous characteristics of a product, the (prudent) issuer´s intentions and market communications, and the expectations they are likely to generate.

Under our flexible definition approach, these three criteria do not necessarily have to be present simultaneously but can be fulfilled to varying degrees, with more emphasis on one compensating for the lack of another. For instance, the fact that an over-the-counter (OTC) derivative is less traded than eg a share is made up for by the intensive duties and rights created by these instruments and their purpose to manage future cash flows.

The flexible approach strikes a balance between formalism and materialism. Its main benefit lies in its ability to accommodate innovations developed in the future while providing a necessary degree of legal certainty and foreseeability for market participants. We tested our flexible approach against seven different assets—Bitcoin (BTC), Uniswap (UNI), Filecoin (FIL), Tether (USDT), Paxos Gold (PAXG), Polybius (PLBT), and 21Shares Bitcoin Cash ETP (ABCH). The results can be accessed in the full paper—see for yourself!

The authors’ full paper can be found here.

Matthias Lehmann is a University Professor at the Institute for European, International and Comparative Law at the University of Vienna.

Fabian Schinerl is a University Assistant at the Institute for European, International and Comparative Law at the University of Vienna.