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Apr 03, 2023

Europe goes Crypto (Part X) – The Crypto Exchange Under MiCAR

Operators of crypto exchanges will be defined as crypto asset service providers in the European Union as of the Markets in Crypto Assets Regulation (MiCAR) coming into effect and must obtain a license for their business operations from the competent supervisory authority. In Germany, applications for MiCAR licenses will have to be submitted to BaFin. As crypto asset service providers, the operators will be required to have a minimum capital of 150,000 euros and well-qualified and reliable directors. They will also have to provide a professional business organization that is adequate in relation to the size of their company. This includes, among other things, the establishment of functioning business processes, internal procedures and control mechanisms, especially in the areas of risk management and IT security, money laundering prevention and emergency planning. But beyond these minimum requirements applicable to all crypto asset service providers, crypto exchange operators will have to comply with additional regulatory obligations specifically tailored to the operation of a crypto exchange platform.

What Are the Specific Obligations of Crypto Exchanges under MiCAR?

MiCAR requires crypto asset exchange operators to comply with specific regulatory obligations. In particular, MiCAR provides strict requirements for the authorization of crypto assets for trading on crypto exchanges. In this context, crypto asset service providers will have to establish operating rules in a clear and understandable manner, which will have to be updated constantly. Operators of crypto exchanges will furthermore not be allowed to trade on their platforms for their own account. Matched principle trading on the other hand will only be permitted if the operator does so with the knowledge and consent of the customers concerned. To the extent that crypto exchange operators identify cases or attempts of market abuse on their trading venues, they must inform the competent authorities. MiCAR will also introduce strict obligations for crypto exchange operators in terms of trading transparency. For example, the prices, volumes and timing of transactions that have taken place must be published in real time. Operators must also ensure that this data is publicly available free of charge and without barriers for two years. Finally, MiCAR imposes deadlines on crypto exchange operators in the field of final settlement of crypto transactions. On-chain transactions must be settled no later than 24 hours after execution on the crypto exchange, while off-chain transactions are subject to a deadline of the closing of the relevant trading day.

Listing on a Crypto Exchange Available Only for MiCAR Compliant Crypto Assets

Crypto exchange operators will not have unrestricted discretion as to which crypto assets can be authorized for trading under MiCAR. For example, the regulation prohibits the listing of crypto assets for which no white paper has been prepared and published, where this would have been required under MiCAR. Further, operators of crypto exchanges will be required to conduct successful due diligence before authorizing a crypto asset for trading. In this respect, they must ensure that the crypto asset is compatible with the crypto exchange’s operating rules and also clarify the crypto asset’s suitability. As part of this review, platform operators must also investigate whether there could be links to illegal or fraudulent activities. In doing so, they are to include the technical design as well as the experience, references and reputation of the issuer and the development team. Crypto assets that have a built-in anonymization feature may not be authorized for trading on crypto exchanges under MiCAR. An exception applies to those crypto assets that increase the degree of anonymity, where the crypto exchange operator can identify the bearers as well as the transaction history. In this respect, only privacy coins that are acquired and traded on the crypto exchange itself by identified customers should be eligible.

Atty. Dr. Lutz Auffenberg, LL.M. (London)

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    Mar 27, 2023

    MAR and Insider Information – EU Intends to Provide More Legal Clarity

    In its proposal for a regulation to increase the attractiveness of public capital markets in the EU for companies and to facilitate access to funds for small and medium-sized enterprises, the EU-Commission intends to make it easier for issuers to publish insider information. The proposed amendments to the Market Abuse Regulation (MAR) will not restrict the fundamentally broad definition of insider information itself. However, the scope of the obligation to disclose insider information is to be limited and more legal transparency is to be achieved as to which information must be disclosed. The planned amendments are intended to create legal clarity as to which information must be disclosed in the case of processes, which occur in stages. A process is considered to occur in stages if it has to pass through several decision-making stages. The question then arises as to how these individual intermediate steps are to be treated under insider law.

    Facilitation of the Publication Requirement for Processes which Occur in Stages

    According to the current version of the MAR, an issuer must immediately disclose to the public insider information directly concerning the issuer. The concept of inside information also covers intermediate steps in processes that occur in stages. An intermediate step in such a process is considered to be insider information if it in itself meets the criteria for inside information. The proposed amendments do not affect the basic approach that intermediate steps can also be considered insider information. Rather, the obligation to publish an interim step is to be restricted. The intended amendments are to stipulate that in the case of a prolonged transaction, the duty to disclose does not apply specifically to the intermediate steps of this transaction. Issuers are to be required to disclose only the information that relates to the event with which a process that occured in stages is to be completed. Since the principle remains that intermediate steps can also constitute independent information, the prohibition of insider trading with such information remains in place.

    Tokenized Financial Instruments May Entail Disclosure Obligations Under MAR

    MAR’s publication obligation applies to issuers who have applied for or been authorized to have their financial instruments admitted to trading on a regulated market. Financial instruments listed on a multilateral trading facility (MTF) or organized trading facility (OTF) may also give grounds for publication obligations for an issuer. This is the case if the issuer has received a license to trade on the MTF or OTF or has applied for an admission to trading on such a trading system for its financial instruments.  The term “financial instrument” is defined by the MiFID2 Directive. This lists in its annex which instruments are considered financial instruments within the meaning of MiFID2. Transferable securities can be named as the most important MiFID2 financial instrument. The DLT Pilot Regime Regulation explicitly clarified in the MiFID2 Directive that instruments issued by means of distributed ledger technology can also qualify as financial instruments. Accordingly, securitization in a certificate is not necessary. Therefore, if instruments issued by means of distributed ledger technology are listed on a regulated market or on an MTF at the issuer’s initiative, e.g. within the scope of the DLT pilot regime, the issuer may be subject to the corresponding disclosure obligations under MAR.

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      Mar 20, 2023

      Europe goes Crypto (Part (IX) – Crypto Custody Under MiCAR

      In Germany, crypto custody is already an activity requiring a license under the German Banking Act (KWG). With the Markets in Crypto Assets Regulation (MiCAR) coming into effect, it will also constitute a regulated crypto asset service at the European level in close future, which may only be provided with a previously obtained BaFin license. However, the licensing requirement itself is not the only regulatory obligation of future crypto custodians under MiCAR. Rather, the new regulation provides for a number of special obligations for crypto custodians that they will have to fulfill both as part of the MiCAR licensing process to be completed and in their subsequent ongoing business operations. Specifically, MiCAR imposes legal requirements on the content of crypto custody agreements, the segregation of client crypto assets from the crypto asset service provider’s own holdings, sub-custody relationships and internal procedures to ensure the proper business organization of crypto custodians.

      Requirements Regarding the Content of Crypto Custody Agreements

      MiCAR also strengthens the private rights of crypto custody clients vis-à-vis crypto custodians. Thus, MiCAR establishes some minimum requirements that must be regulated in crypto custody contracts. In addition to the identities of the contracting parties, a description of the custody services, the definition of the means of communication for the contractual relationship, the regulation regarding fees as well as the applicable law, custody contracts according to MiCAR must in the future also contain explanations regarding the security systems and the custody policy of the provider. Every crypto custodian must have a custody policy. It is intended to outline the internal procedures and processes to secure clients’ crypto assets to minimize risks resulting from fraud, cyberattacks, or negligence. Crypto custody agreements will be required by MiCAR to include a summary of the custody policy. With respect to the liability of crypto custodians, MiCAR does allow for an aggregate limitation of liability to the equivalent value of lost crypto assets at the time of loss. However, it will not be possible to exclude liability for acts of ordinary negligence. Furthermore, crypto custodians will be obliged to keep a constantly updated inventory register of the crypto assets held in custody for each customer. In the event of, for example, airdrops or fork events, the customers will also be legally entitled to any new crypto assets created as a result. Crypto custodians will also have to inform their customers in advance about such events and, if necessary, obtain instructions.

      Strict Requirements for Sub-Custody

      MiCAR imposes particularly strict obligations on crypto custodians with regard to the use of sub-custodians. If crypto custodians wish to have crypto assets entrusted to them by clients held in custody by a third-party provider, they must disclose this to their client in any case. Sub-custody without prior information of the customer will therefore always be inadmissible. Furthermore, crypto custodians shall only be allowed to use crypto custodians as sub-custodians under MiCAR who themselves hold a license under MiCAR to provide crypto custody services. The use of sub-custodians that either do not possess a license at all or only possess a license from an authority outside the European Economic Area (EEA) for crypto custody is therefore not possible under MiCAR. In this respect, MiCAR will ensure that third-party custody of crypto assets for clients in Europe will only be possible under the application of MiCAR regulations.

      Atty. Dr. Lutz Auffenberg, LL.M. (London)

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        Mar 13, 2023

        NFT – BaFin Provides Guidance on the Qualification of Non-Fungible Tokens

        In a technical article dated March 8, 2023, BaFin comments on how it classifies NFT (Non Fungible Token) for regulatory purposes. BaFin understands those to be cryptographic tokens based on distributed ledger technology (DLT), whereby the main manifestation of DLT is blockchain. As already implied by the name, NFTs are not fungible among each other due to their technical properties and are therefore not interchangeable. The potential fields of application are numerous. Collectibles and digital art are likely to be considered the most popular class of NFT. In the supervisory qualification of NFT, BaFin plans to proceed in the same manner as for fungible tokens, according to its publication that has now been published. The decisive factor for the regulatory classification of the tokens should therefore not be their technical characteristic of individuality, but the rights and content assigned to them in the individual case. BaFin therefore intends to decide on a case-by-case basis whether an NFT is, for example, a crypto asset, an asset investment or a security.

        NFT May Be an Asset Investment – Classification as Security Currently Not Intended

        NFTs may qualify as securities if they embody rights similar to securities, are transferable and tradable on the financial markets. BaFin defines rights similar to securities as membership rights or pecuniary claims, for example, to payment of returns, as in the case of shares or debt instruments. BaFin considers the transferability of the tokens to be given as long as it is not artificially restricted. With regard to the tradability of tokens, the authority expects a certain degree of standardization to the effect that equal rights must be conveyed by the NFT of a tranche. However, because the rights and content associated with NFTs are fundamentally individual in nature, most of them lack the tradability required to qualify as securities under the statutory definition. According to its own statement, BaFin has therefore not yet become aware of any NFTs that qualify as securities. Even if the regulatory classification of NFTs as securities may generally not be assumed, they can nevertheless be asset investments in individual cases and thus still be regulated as financial instruments. The decisive factor in each individual case is the rights with which the token is equipped. For example, if a token serving as proof of ownership for an art object embodies the issuer’s obligation to sell the art object at a profit and to grant the token holder a repayment and interest claim, the NFT is likely to qualify as an asset investment. In the case of a public offering of an NFT qualifying as an asset investment, there is an obligation to prepare a capital market prospectus, unless an exemption from this obligation is applicable.

        NFT May be a Crypto Asset – Service Providers May Require BaFin License

        In specific cases, an NFT may qualify as a crypto asset within the meaning of the German Banking Act (KWG) or the German Investment Firm Act (WpIG). Crypto assets are digital representations of a value that are accepted by third parties as a means of payment or serve investment purposes. Use as a means of exchange or payment can usually be ruled out due to the lack of interchangeability of NFTs. The situation is different, however, with the second alternative of use for investment purposes, which may well be the case with NFT. In this regard, however, BaFin clarifies that the mere fact that, for example, users speculate on price gains with an NFT, is not sufficient for the assumption of an investment purpose. When examining the legal classification of an NFT as a crypto asset, BaFin rather intends to take into account which rights are associated with the token and which marketing activities are undertaken in its distribution. If, for example, the expectation of price gains is stoked in the course of offering the token to the market, this may be an indicator for the regulatory classification as a crypto asset. To the extent that an NFT must be classified as a crypto asset, this may lead, in particular in the secondary market, to a situation in which the involved service providers require a BaFin license for their business dealings with the tokens, i.e. for proprietary trading, investment brokerage or financial commission business.

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          Mar 06, 2023

          Securities Issuances of SMEs – EU Commission Plans Attractive Facilitations

          In order to ease the documentary burden associated with the issuance of securities for small and medium-sized enterprises when raising money on the capital markets, the EU Commission has proposed amendments to the Prospectus Regulation (EU) 2017/1129. According to these, the threshold for an exemption from the prospectus requirement for small public offerings of securities is to be increased. Small and medium-sized enterprises (SMEs) currently have the option of creating a so-called EU growth prospectus instead of a regular prospectus. Its requirements in terms of content are less extensive than those of a regular securities prospectus. The current EU growth prospectus is to be replaced by a new EU growth offering document with fewer requirements. The EU growth prospectus can also be used for cross-border offerings within the EU. This system is also to apply to the EU growth issue document.

          Threshold for Exemption from Prospectus Obligation to be Increased to EUR 12 Million

          The EU Commission’s proposal provides for the amendment of the Prospectus Regulation to the effect that a uniform harmonized threshold of EUR 12 million is set. According to the EU Commission’s proposal, no securities prospectus is to be prepared, approved and published for public offerings of securities that remain below this threshold. The threshold of EUR 12 million is to be calculated on the basis of the total amount of aggregated offers by a single issuer in the EU within a period of 12 months. Currently, this threshold is EUR 8 million, with issuers being allowed to prepare a prospectus on a voluntary basis. In the future, the EU Commission would also like to retain the restriction of the exemption clause, according to which member states may require disclosure documents under national law for public offerings of securities below EUR 12 million, provided this does not represent a disproportionate burden for issuers. The German legislator, for example, made use of this option in the current regime by stipulating the obligation to prepare a three- or four-page securities information sheet for public offerings in Germany with a total value of up to EUR 8 million. It remains to be seen whether the German legislator will change the structure completely or whether the current provisions will simply be increased to EUR 12 million.

          New EU Growth Document Intended to Facilitate Cross-Border Fundraising

          According to the proposal, a new EU growth issuance document would also be introduced to replace the EU growth prospectus permanently. According to the proposed amendments, the preparation and publication of an EU growth issuance document would in principle be mandatory for public offers of securities by certain categories of issuers, including SMEs. However, preparation and publication would not be required if an exemption from the obligation to publish a prospectus pursuant to the EU Prospectus Regulation would be applicable to a public offering. The EU growth issuance document should have a standardized format and order and be drafted in a language commonly used in the international financial community. If the EU growth issuance document is prepared for an offering of equity securities, the document will not exceed a certain number of pages. For securities other than equities (so-called non-equity securities), a limited number of pages is not intended. Nevertheless, due to the new standardized format, the size of the offering document for non-equity securities is expected to be smaller than for an EU growth prospectus.  In accordance with the systematics of the EU Prospectus Regulation, the EU growth issuance document shall also be applicable for cross-border public offerings of securities by SMEs.

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            Feb 27, 2023

            Europe goes Crypto (Part VIII) – The Capitalization of Crypto Asset Service Providers under MiCAR

            Crypto asset services are expected to be subject to authorization by the competent supervisory authority once the provisions of the new Markets in Crypto Assets Regulation (MiCAR) come into force presumably at the end of 2024. The crypto asset service providers who will then be regulated will only receive the authorizations necessary to conduct business if they comply with the comprehensive regulatory requirements provided by MiCAR. A key requirement will be the obligation of crypto asset service providers to hold at all times sufficient capital to back up the business operations. However, despite MiCAR being fundamentally similar to securities regulation, the actual amount to be held is regulated differently than under the second Markets in Financial Instruments Directive (MiFID2). This is because under MiCAR there will be two methods for determining the amount of prudential safeguards, of which the one resulting in the higher amount will be applicable to the crypto asset service provider.

            Minimum Capitalization Amounts for Crypto Service Providers under MiCAR

            Crypto asset service providers will have to maintain at least a regulatory minimum capital level when applying for a MiCAR authorization and also after the authorization has been granted, the amount of which will depend on the specific business model they operate and the crypto asset services they provide. In this respect, there will be three classes of crypto asset service providers, each of which will be subject to a different minimum capital amount for safeguard purposes. Crypto asset service providers who only offer their customers services related to order acceptance and transmission, advice, order execution, placement, portfolio management or transaction execution in relation to crypto assets will be assigned to class 1 and will need to hold a minimum capital of 50,000 euros. In contrast, the minimum capital for crypto custodians and crypto administrators as well as crypto asset exchange providers (class 2) amounts to 125,000 euros. For crypto asset exchange platform operators (class 3), the minimum amount required will be at 150,000 euros according to the wording of MiCAR.

            Determination of the Regulatory Minimum Capital via the Fixed Operating Costs

            The minimum amount of capital for crypto asset service providers specified in MiCAR will only be sufficient as a safeguard if it is higher than one quarter of the previous year’s fixed overhead costs. On the other hand, if this amount is higher, the crypto asset service provider will have to show this amount as minimum regulatory capital. MiCAR will require all crypto asset service providers to calculate their fixed operating costs annually, so the relevant amount will not be a static amount as it is under the MiFID regulation. In summary, crypto asset service providers can expect that they will always be required to maintain at least one quarter of their fixed overhead costs of the previous year as their minimum regulatory capital, and that this amount shall not be less than the minimum amount as specified in MiCAR for the applicable specific class of crypto asset service providers.

            Atty. Dr. Lutz Auffenberg, LL.M. (London)

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              Feb 20, 2023

              The Blockchain-Based Dual Class Share – New Financing Opportunities for SMEs for Equity Raising

              The EU Commission presented proposals at the end of 2022 to facilitate stock market access and financing for small and medium-sized enterprises (SMEs). Among other things, the EU-Prospectus Regulation, the Market Abuse Regulation, the Markets in Financial Instruments Regulation, and the Markets in Financial Instruments and the Listing Directive are to be revised. A draft directive on dual class shares (Dual Class Shares Directive) was also presented. Up until 1998, dual class shares were permitted in Germany on the basis of a ministerial exemption, insofar as this was necessary to safeguard overall macroeconomic interests. Currently, the issuance of dual class shares is not permitted in Germany. This is about to change as a result of the new dual class shares. What is striking is that the EU Commission’s package of measures corresponds very closely in large parts to the proposals made by the German Federal Ministry of Finance in its key issues paper for a Future Financing Act.

              What is the Advantage of Dual Class Shares for Company Owners?

              According to the EU Commission, one of the main reasons for the reluctance of founders and families to go public is the fear of losing control over the company. A listing dilutes ownership, so founders and families lose influence over important investments in the company and operational decisions. Ownership structures with dual class shares are an effective way for a company’s owners to retain decision-making power in the company while obtaining financing through public markets. According to the draft Dual Class Share Directive, dual class shares are shares that belong to a specific and separate class and carry higher voting rights than other classes of shares that provide voting rights for resolutions of the general meeting of shareholders. According to the draft, member states must ensure that companies are allowed to introduce structures with dual class shares upon authorization of previously unlisted shares for trading on an SME growth market in one or more member states. A corresponding statement on the (re)introduction of the dual class shares in Germany is also contained in the Federal Ministry of Finance’s key issues paper for a Future Financing Act.

              Blockchain-Based Dual Class Shares in Germany

              The Future Financing Act is intended to enable companies to issue shares based on blockchain technology in addition to bearer bonds. The digitalization of share trading is intended to take a further important step towards increasing the attractiveness of the capital market in the process. To make this a reality, the Electronic Securities Act (eWpG) is to be opened up to shares. Even though it is already legally possible to issue blockchain-based registered shares today, an expansion of the eWpG to explicitly enable the issuance of shares in the form of crypto securities should provide more legal certainty in this area. This is because, as crypto securities, the shares would have the same legal effect as a security issued by means of a certificate. This should lead to an improved tradability of the shares, especially with regards to the possibility of a bona fide and unencumbered acquisition.

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                Feb 13, 2023

                Europe goes Crypto (Part VII) – The Compliance of Crypto Asset Service Providers According to MiCAR

                Providers of crypto asset services will be subject to licensing requirements when the European Union’s new Markets in Crypto Assets Regulation (MiCAR) comes into effect, presumably in 2024. In addition to the obligation to obtain an authorization prior to commencing business, crypto asset service providers will also have to fulfill far-reaching due diligence and conduct of business obligations in the new regulatory regime during ongoing business operations. In this respect, the legislator wants to ensure a professional, integer and transparent European crypto market. Admittedly, financial instruments within the meaning of the Markets in Financial Instruments Directive (MiFID2) will not be crypto assets itself, and thus will not be subject to the provisions of MiCAR. Nevertheless, the compliance requirements for crypto asset service providers are, to a large extent, closely aligned with the securities compliance obligations under the regulatory regime of MiFID2. But which due diligence and conduct of business obligations will crypto asset service providers in Europe have to fulfill specifically in the future?

                What Are the Compliance Obligations of Crypto Service Providers According to MiCAR?

                Like investment service providers regulated in accordance with MiFID2, crypto service providers will have to act honestly, fairly and professionally as well as in the best interest of their clients in the course of their business activities in the future according to the MiCAR regulations. Their business- and marketing-related communications will always need to be clear, unambiguous and not misleading. Marketing statements and communications must also be identified as such by crypto asset service providers pursuant to MiCAR. They will also always have to advise their clients of risks associated with crypto transactions and, to the extent that they operate a crypto trading platform, provide exchange services in relation to crypto assets, crypto advisory services or crypto portfolio management services, provide their clients with hyperlinks to white papers published about the crypto assets they provide crypto asset services for. Crypto asset service providers will always have to publish the prices of their services prominently on their website. Similarly, they will have to publish information on their website regarding the environmental and climate impact of the consensus mechanisms of those crypto assets that are the subject of their crypto asset services. Details regarding the future compliance obligations of crypto asset service providers are to be developed by ESMA within the framework of technical standards and published no later than twelve months beforeMiCAR takes legal effect.

                Specific Requirements for Crypto Custodians and for Customer Funds

                Specific obligations, however, are provided by MiCAR for crypto asset service providers that want to offer custody of crypto assets to their clients. In particular, crypto custodians will have to strictly separate crypto assets of clients from their own holdings. In the event of insolvency, crypto asset service providers should have effective processes and mechanisms in place to effectively protect customers’ crypto holdings from loss. Which specific processes and mechanisms these may be must be provided by the national insolvency law applicable in each individual case. In Germany, there are as of yet no specific legal regulations for the treatment of customer crypto assets in the insolvency of a crypto custodian, but the legislator has already announced that special regulations will be introduced in near future. Crypto asset service providers must also never mix customer funds with their own assets. Crypto asset service providers will therefore have to transfer customer funds to a segregated bank account at a central bank or an authorized credit institution at the end of each business day.

                Atty. Dr. Lutz Auffenberg, L.MM. (London)

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                  Feb 06, 2023

                  The Self-Issuance Privilege – What Are Issuers Permitted to Distribute Themselves?

                  Issuers of investments or securities with relatively small issue volumes, i.e. in particular small and medium-sized entities, often have the understandable desire to market their products on their own. In Germany, the German Asset Investment Act (VermAnlG) and the German Securities Prospectus Act (WpPG) in conjunction with the EU Prospectus Regulation (ProspektVO) define the regulatory requirements that must be met by an investment or security before it can be offered to the public in Germany. In addition to the requirements relating to the prospectus and documentation obligations to be fulfilled by issuers and providers, these requirements also include restrictions and specifications relating to the distribution channels and the possibility of the self-issuance of the individual products. So is the direct distribution of financial products by their issuers in Germany not possible at all?

                  Type of Product and Issue Volume Are Decisive

                  Requirements with regard to the distribution of individual financial products result in particular from both the type of product and the intended issue volume. For example, in the case of securities with an issue volume of between EUR 1,000,000 and EUR 8,000,000 calculated over a period of 12 months and which are issued on basis of a securities information sheet instead of a securities prospectus, it is generally necessary to distribute the securities through an investment services company authorized to provide investment brokerage or investment advice, provided that the offer is also directed at non-qualified investors. In the case of asset investments, in principle only those asset investments may be authorized for public offering in Germany which are distributed by way of investment advice or investment brokerage by an investment services company or a financial investment intermediary. This is the case without exception for asset investments issued with the help of a swarm financier, although it should also be mentioned that distribution can only take place via an Internet service platform operated by the swarm financier, which must not have any interconnections with the issuer.

                  What Options Are There for Self-Distribution in Germany?

                  A proprietary sale of securities or investments is always possible if the planned public offering of securities or investments is subject to one of the legally regulated exceptions that exempt the issuer and offeror from the obligation to prepare a prospectus, a securities information sheet (WIB) or an investment information sheet (VIB). Such an exemption exists, for example, if the group of investors to be addressed by the offer is kept small or the offer is directed only at qualified investors. Another possibility for issuers of securities to market their investment products by way of self-distribution is to prepare a comprehensive securities prospectus in accordance with the ProspektVO instead of a WIB. This is because securities offered on the basis of a full securities prospectus are not subject to the restrictions regarding self-distribution. This arrangement has the additional advantage that the securities could also be offered in other member states of the European Economic Area on the basis of the securities prospectus and also on a proprietary basis via a comparatively simple notification procedure. Finally, the tokenization of products can also enable self-distribution for products which in principle would have to be classified as asset investments. This is because, according to BaFin’s current administrative practice, such products must be classified as securities sui generis for regulatory purposes, at least if tokenization leads to increased tradability. They are then subject to the provisions of securities regulatory law with all its disadvantages and advantages despite their legal design as an asset investment. In particular, securities sui generis can also be offered across borders in accordance with the ProspektVO.

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                    Jan 23, 2023

                    Europe goes Crypto (Part (VI) – Passporting Crypto Asset Services According to MiCAR

                    The current regulation of cryptocurrencies in Germany and Europe is particularly grotesque because it regulates a market only at the national level that has always been international. Cross-border business models must therefore be regularly harmonized with all affected national regulatory regimes. One of the most important objectives of the European Union is the advancement of the European single market and the reduction of legal hurdles for the realization of cross-border cooperation of the European economy. It is therefore about time that the patchwork of crypto regulation that still exists within the EU is abolished and that the European single market is realized also in the crypto market. To this effect, the future EU Regulation on Markets in Crypto Assets (MiCAR) provides rules and regulations for the uniform offering of crypto services in more than one Member State. The legislator bases the new rules for cross-border crypto services largely on the rules of the so-called EU passporting in the area of investment services. As a result, crypto service providers will be able to offer their services in other EU states with comparatively little effort in the future, without requiring additional permits under MiCAR in the target countries.

                    MiCAR Passporting Requirements for Crypto Services

                    Providers who intend to offer crypto services across borders in the European Union are in any case required to be authorized in one of the member states in accordance with MiCAR. The responsible authority for the passporting procedure will initially be the authority that issued the MiCAR permit, i.e. BaFin in Germany. In order to successfully apply for passporting, the crypto service provider must submit a list to the authority indicating in which specific member states which specific crypto services are to be provided. It must also indicate from which time onwards the provider intends to actively offer the crypto services in the respective target countries. In addition, it is necessary to specify which other business activities that are not regulated under MiCAR the crypto service provider intends to offer. This includes activities that are not regulated at all as well as those that are subject to authorization and supervision under other regimes. Examples include payment services as defined in the Second Payment Services Directive (PSD2), investment services under the Markets in Financial Instruments Directive (MiFiD2), or other commercial activities not subject to authorization, such as e.g. the manufacture of hardware or the rental of buildings.

                    Short Procedure Period in MiCAR Passporting

                    BaFin will have to forward the information received to the national competent authorities in each of the target countries as well as to the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) within 10 working days. ESMA will subsequently publish the information on its single European crypto service provider registry maintained on its website in order to allow all market participants in Europe to verify whether a provider’s offering is legal and covered by a MiCAR authorization. Immediately after forwarding the information to the aforementioned bodies, BaFin will inform the crypto service provider about the forwarding that has taken place. As soon as the crypto service provider has received this notification from BaFin, but no later than 15 calendar days after the information has been forwarded to BaFin, the crypto service provider may actively offer its crypto services regulated under MiCAR in the selected target countries. The requirements for successful passporting under MiCAR are thus the existence of a MiCAR license in the home country and the transmission of the aforementioned information to BaFin. If this information is not complete, for example because the crypto service provider has concealed another commercial activity it provides, passporting under MiCAR may be inadmissible. Applications for MiCAR passporting will thus have to be prepared with maximum diligence.

                    Atty. Dr. Lutz Auffenberg, LL.M. (London)

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                      Jan 16, 2023

                      Decentralized Autonomous Organization – What Are DAOs and How Are They Regulated in Germany?

                      Decentralized Autonomous Organizations (“DAOs”) are usually defined as organizations established for perpetuity that consist of program code executed and stored in a decentralized manner. They are allocated own capital in the form of crypto assets, which are directly managed by the capital providers according to the automated and fixed rules of the program code. These definitions are of limited help to the average user or interested investor. In particular, they do not provide any information on how DAOs or their shares are to be classified legally. However, it is precisely these questions that are naturally of decisive importance both for initiators of DAOs and for participants in a Decentralized Autonomous Organization. Thus, the first question that arises in this context is whether DAOs can qualify as companies under German corporate law. In this context, it is not possible to make a generally valid statement as to whether a DAO is a company. Should it be assumed on the basis of the specific structure of the DAO that the DAO is founded on a contractual basis, then a DAO could qualify, for example, as a partnership under civil law or as a general partnership. If the DAO in the individual case would be a structure under corporate law, then the subsequent question arises as to the supervisory qualification of such DAO shares.

                      Regulatory Classification as an Investment or as a Security (Sui Generis) Through Tokenization

                      If the DAO were to be a company, shares in a DAO which grant their owners a participation in the results of the DAO would generally be classified as an investment within the meaning of the German Asset Investment Act (“VermAnlG”). If these were tokenized, which is likely to be the rule, BaFin would – according to its administrative practice – qualify the respective tokens as securities of their own kind with the consequence that the provisions of the German Securities Prospectus Act (“WpPG”) would apply to the tokens. This would be the case if the transferability and tradability on the financial market of the tokens as well as the mediation of rights similar to securities through the tokens were achieved by the tokenization. Even in the case that the tokens would not convey a participation in the result of the DAO and thus would not be legally qualify as an asset, a qualification of the tokens as securities of their own kind is nevertheless possible, provided that the aforementioned characteristics of transferability, tradability and conveyance of rights are fulfilled. An example would be that a token does not grant any participation in the result of the DAO concerned, but conveys membership rights in the DAO, e.g. in the form of voting rights. A prospectus or securities information sheet would then have to be prepared and published prior to a public offering of such tokens.

                      Applicability of MiCAR to Shares in DAOs

                      In general, the EU Regulation on Markets in Crypto Assets (“MiCAR”) will not be applicable to the shares of DAOs described above. This is because the described shares are transferable securities and thus financial instruments within the meaning of the Markets in Financial Instruments Directive II (“MiFID II”). To such, however, MiCAR will precisely not be applicable. Should this not be the case for a specific DAO, i.e. in particular in cases where the shares of the DAO do not qualify as transferable securities in the aforementioned sense and thus not as financial instruments, the provisions of MiCAR would arguably be applicable to the shares. Here, as generally in this very complex subject area, a precise review will have to be carried out in each individual case in order to minimize liability risks and to achieve a legally compliant arrangement.

                      FIN LAW

                      I.  https://fin-law.de

                      E. info@fin-law.de

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