Tokenization of the Capital Markets – Which Financial Instruments Can be Tokenized?

Blockchain-based capital markets issuances are more and more becoming a viable alternative not only for blockchain startups but also for mid-sized companies when it comes to procuring funds at the capital markets. After the first security token offerings have already been realized by startups in very important pioneer work and the international capital markets supervisory authorities – including BaFin – are generally open to the idea of tokenized capital markets products, more and more mid-sized companies are working on blockchain-based, tokenized financial products and aim to procure fresh money from the capital markets. Even though the majority of the realized token issuances up to now was designed in a way that the issued token embodied a subordinated participation right, the tokenization of the capital markets is not limited to this kind of product. But which kind of financial products can already be tokenized according to German law and are therefore an option for companies intending to offer blockchain-based investments?

The German legislator announced last year, as part of the government’s blockchain strategy, to lay the legal foundations for digital securities and publish a first draft with regards to the private as well as the regulatory law already in 2019. In a first step, it is planned to introduce laws that allow the issuance of fully digitalized bonds. Since the legislator is behind schedule on this project there is still the problem that according to German securities law an embodiment of rights and obligations can only be achieved in paper documents and not in digital tokens. The security tokens that already have been issued in accordance to German law achieve the necessary connection of the rights and obligations of the issuer and the investor with the tokens through the underlying token terms. These tokenized corporate bonds are usually designed as identical loan agreements that grant the investor a fixed or variable interest claim in exchange for the temporal transfer of money. As to the details, the issuers have a wide scope to offer within their terms with regards to the design of the investor rights. Loss options as well as subordination clauses and special termination rights or even option rights that grant the investor the right to choose company shares instead of a repayment in money at the end of the duration are all possible design options.

The German legislator intends to introduce the legal foundations for digital stock shares after the legal foundations for digital bonds are introduced. Even though the tokenization of registered shares would already be possible in accordance to German law, there is no tokenized stock company in Germany yet. The tokenization of GmbH shares on the other hand proves to be way more difficult. Every transfer of GmbH shares needs a notarial certification to be effective. This fact does not necessarily preclude a tokenized GmbH share but it limits the tradability of such a token and moreover leads to a high cost intensity and complexity. Other company shares such as limited partner´s shares or shares of a general partnership could be tokenized but the statues for these company forms would require each and every token holder to be registered in the public company register. In contrast to the few moments a token transfer requires for being processed, the much longer processing time of the registry court makes this option rather impractical.

The possibility of the tokenization of fund shares depends on the legal design of the investment fund itself and the legal structure of participation options for the investors. If the investment fund would e.g. be designed as a limited partnership, the aforementioned problems regarding the registration of the investors would also apply to this situation. If the tokenized fund shares would be designed as claims, a tokenization of such fund shares could be realized in a comparable way as the tokenization of corporate bonds.

Attorney Lutz Auffenberg, LL.M. (London)

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