Businesses that intend to procure funds in Germany have three basic regulatory frameworks regarding the legal design of the investment product they want to offer. This is applicable to traditional capital markets issuances as well as for the issuance of innovative tokenized financial products. Blockchain-based capital markets issuances nowadays are immediately associated with the public offering of tokenized securities better known as Security Token Offerings (STO). For this kind of capital market financing the European and national regulations such as the German Securities Prospectus Act, the European Prospectus Directive, the German Securities Trading Act and other, securities related laws are applicable. On the other hand, if the issued blockchain token has the legal properties of an investment fund share and is therefore qualified as such, the German Capital Investment Code (KAGB) respectively the European AIFM-Regulation is applicable. If the token qualifies as neither a security nor a share of an investment fund it most likely qualifies as an asset investment according to German capital markets regulatory law. If an issuer intends to publicly offer a tokenized asset investment, the rules and regulations of the German Asset Investment Act have to be observed. But can it be advantageous to design a token as an asset investment and not as a security?
BAFIN QUALIFIES TOKENIZED FINANCIAL PRODUCTS RATHER AS SECURITIES
When designing a tokenized financial product, it has to be considered that BaFin developed an administrative practice in the spring of 2019 according to which tokenized financial products are, when in doubt, more likely to be qualified as securities than as asset investments. BaFin justifies this practice with the argument that the blockchain technology substantially enhances the tradability of tokens and therefore the ability to be traded on the capital markets which is the main characteristic of a security. However, this administrative practice does not mean that tokenized asset investments are impossible in Germany. In order to design a token which would be qualified as an asset investment by BaFin, the tradability of the token has to be restricted. This can be achieved by e.g. contractual restrictions. As long as a restricted tradability and the other legal requirements, especially the subsidiarity of asset investments with regards to securities and shares of investment funds as well as to the deposit business according to the German Banking Act (KWG) are fulfilled, a tokenized asset investment is possible.
DISTRIBUTION OF ASSET INVESTMENTS WITH A LICENSE IN ACCORDANCE TO SEC. 34 F OF THE GERMAN INDUSTRIAL CODE
A massive advantage of tokenized asset investments over security tokens that are qualified as securities is the possibility to sell them via asset investment brokers that are licensed in accordance to sec. 34 f GewO. The sale of these products therefore does not require a BaFin authorized financial broker. This allows providers and issuers of tokenized financial products to utilize numerous new distribution channels.
CUSTODY OF TOKENIZED ASSET INVESTMENTS BY CRYPTO CUSTODIANS
It is still uncertain if BaFin will allow the commercial custody of security tokens by the newly introduced crypto custodians or not. According to the materials pertaining the introduction of crypto custodians into the KWG the German legislator intended to assign the custody of tokenized securities to securities deposit banks that are already licensed for the custody of traditional securities. The custody of security tokens would therefore require an authorization as a depository bank. The authorization as a crypto custodian would not be sufficient. This problem does not occur with asset investments. Asset investments are not securities, an authorization as a depository bank in order to safeguard them is therefore not required.
TOKENIZATION OPENS NEW TARGET GROUPS FOR ASSET INVESTMENTS
Traditionally, asset investments are financial products that are almost exclusive to the retail market, especially because of the restricted tradability and lack of a third-party custody option for these products. Typically, asset investments were designed as contractual agreements between issuers and investors with a relatively long duration without them being securitized in any form which made it impossible to hold them in custody. While private investors do not necessarily require an external custody option for their investments, institutional investors do. To fulfill their investment criteria, institutional investors need periodical deposit statements of trustworthy third-party custodians concerning their investments in order to enable auditors to audit these investments. Tokenization allows the commercial custody of asset investments by third-party custodians and thereby makes asset investments accessible to institutional investors. In a nutshell, tokenized asset investments have their advantages and can be an interesting choice for certain projects.
Attorney Lutz Auffenberg, LL.M. (London)
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