When the German legislator introduced crypto custody as a new financial service, he decided  to grant generous regulatory privileges to crypto custody service providers as long as they do not offer any other banking or financial services besides crypto custody services. Service providers which solely offer crypto custody services therefore enjoy generous exemptions from the regulations that usually apply to financial service institutions with regards to equity capital quotas pursuant to the EU Capital Requirements Regulation (CRR), liquidity requirements and capital buffers, granting major loans and remuneration of employees. Especially the facilitation regarding the capital base is of major importance to crypto custody service providers, because otherwise the safeguarded crypto assets would have to be backed by equity capital. The legislator introduced a similar regulation for operators of crypto security registries this year. But are these exemptions applicable to institutes that offer crypto custody services and at the same time operate a crypto security registry?

Exemption Intended for Specialized Providers

The exemptions regarding the equity requirements of the CRR were created as a compromise while introducing the crypto custody service as a financial service. Prior to this compromise, the legislator favored a ring-fencing solution according to which only businesses that do not offer any other banking or financial services would have been eligible to obtain authorization to provide crypto custody services. The fear of combining the IT-risks associated to crypto custody services with the IT-risks associated with other banking and financial services was the prime argument for the ring-fencing solution of the legislator. The ring-fencing solution would have meant a significant intrusion onto the constitutionally protected freedom of profession, which is also the reason why this solution was not implemented at the end. The introduction of the abovementioned privileges for crypto custody providers was meant as an incentive to the market to conduct crypto custody services solely via special and separated subsidiaries. In the case of the operators of crypto securities registries, the legislator directly decided to let them enjoy the aforementioned exemptions, if they provide no other banking or financial services.    

Are These Exemptions Also Applicable to Institutes Which Offer Crypto Custody Services and Operate a Crypto Securities Registry?

The wording of the German Banking Act (KWG) privileges financial service providers which only provide crypto custody services or operate a crypto securities registry and no other financial service pursuant to the KWG besides those. Since according to the wording only one or the other service can be provided while retaining the privileges, financial service institutes which would provide both services would not enjoy the privileges, even if they would not provide any other financial service which is subject to authorization. The explanatory memorandum of the Federal German Government corresponding to the exemption does not provide any explanation for this constellation either. Nevertheless, there are valid arguments from a legal point of view that, even though the wording indicates otherwise, businesses which provide both services should be allowed to enjoy the privileges. This because operators of crypto security registries are neither directly nor indirectly involved in the transaction of financial instruments. They are merely operators of a registry and therefore provide a technical service which is subject to special regulatory requirements. The application of equity quotas, liquidity requirements and capital buffers as with financial service institutes that are actively involved in transactions would be hard to justify and unreasonable. In the end, the matter must in any case be decided by BaFin and its interpretation of the situation will be initially binding. So far, BaFin has not yet made any statement in this matter.

Attorney Lutz Auffenberg, LL.M. (London)

 

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