This year, BaFin already approved two securities prospectuses for security token offerings. In July of 2019 it approved a prospectus concerning the offering of token based subordinated bonds in the form of profit participation certificates and in January of 2019 a prospectus concerning a security token in the form of a registered bond. The approval of the January prospectus is remarkable because registered bonds are explicitly defined by German law as asset investments and not as securities. Nevertheless, BaFin approved the offering of the security token via a securities prospectus instead of an investment asset prospectus and explained the decision later in an article in the BaFin Journal of April 2019.
BAFIN: SECURITY TOKEN AS A SUI GENERIS CLASS OF SECURITIES
In the opinion of BaFin, blockchain technology blurs the boundaries between securities and asset investments. The marketability of blockchain tokens leads – according to BaFin – to a qualification of said token as a security even if the product that is embodied in the token would be qualified as an asset investment under normal circumstances. BaFin refers to tokens as a sui generis class of securities. The authority justifies this qualification with the “Substance over Form” principle of the European Securities and Market Authority (ESMA). According to this principle the legal qualification of a financial instrument relies on the content-related design of the instrument and not on the (misleading) name it is given. The market must provisionally work with the opinion of BaFin even though it can and should be criticized. The “Substance over Form” principle is useful to legally qualify and regulate new financial products but it cannot justify the legal qualification of a product as a security if it is, according to its content, in fact an asset investment. These cases do not evolve around a misleading name of a new financial product but rather around the legal qualification of it and its content.
WHAT ARE THE LEGAL REQUIREMENTS OF A SECURITY?
The decisive factors in order to qualify a product as a security are its free transferability and the marketability of the product on the capital markets, while BaFin regards crypto exchanges as capital markets in this sense. Additionally, the product must grant its holder rights that are similar to those of a security. That means shareholder or contractually designed subscription rights. Traditionally in Germany these rights are embodied in a paper document. The approval of two security prospectuses for STOs shows that the embodiment of the security rights can now also be achieved with a crypto token. If the product lacks the aforementioned free transferability, the law qualifies it as an asset investment rather than a security. The prospectus for such an asset investment has to be created and compiled according to the Asset Investment Act rather than the Security Prospectus Act and the EU Prospectus regulation. Security tokens in general are unrestrictedly transferrable between wallets of the users and therefore, according to BaFin, are generally to qualify as securities and not as asset investments.
IS IT POSSIBLE TO DESIGN A SECURITY TOKEN AS AN ASSET INVESTMENT?
Designing a security token as an asset investment can be advantageous especially when it comes to the sales of the token. Contrary to securities, asset investments cannot only be sold and brokered by BaFin authorized investment intermediaries and financial advisers but also by financial asset brokers that are (only) authorized in accordance to the Federal Commercial and Industrial Code. The inclusion of financial asset brokers in the sales network of a security token means a greater reach and additional investors for the issuer and an additional field of business for the financial broker. Neither the BaFin publication from April 2019 nor BaFin’s recently published information sheet on crypto tokens eliminate the possibility of designing a security token as an asset investment. The token terms could for example exclude the free transferability of the token by providing a mandatory consent of the token issuer for an effective token transfer to a third party. Thereby, a legal qualification of the token as a security would no longer be possible. For STO emitters wanting to initially distribute their product solely in Germany and not internationally, the design of the security token as an asset investment instead of a security can therefore be an interesting alternative.
Attorney Lutz Auffenberg, LL.M. (London)