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Category: blog EN

Dec 06, 2021

European Crowdfunding Service Provider Regulation: Alternative for Token Offerings Without Prospectus?

The European Crowdfunding Service Provider Regulation (ECSPR) (Regulation (EU) 2020/1503) went into effect on the 10th of November 2021. It provides issuers with the possibility to issue token in the form of tokenized financial instruments with a volume of up to 5 million euros in the EU. There is no necessity to publish a BaFin approved prospectus or securities information sheet (WIB). This however requires the utilization of a licensed crowdfunding service provider. The service provider has to provide a special platform for the offer. The new regulation thereby provides a valid alternative, especially for smaller projects to the traditional issuance. Those would usually include a security prospectus or a WIB. The possibility to conduct the issuance without a prospectus or any other offering-documentation is not the only potential advantage for issuers which intend to offer their tokens with a crowdfunding service provider.

No Subordination Requirement for Offers Pursuant to the Crowdfunding Service Provider Regulation

In its scope of application, the ECSPR takes precedence over certain other regulations of the financial supervisory law. An example would be the German Banking Act (KWG). Tokenized debenture bonds are often issued with a qualified subordination clause so that their issuance and the procurement of funds from investors does not qualify as deposit business for the issuer. The qualified subordination of the investors serves to eliminate the unconditionality of the repayment claim of the investors. This is a legal requirement of the deposit business. All this is unnecessary for offers pursuant to the ECSPR. Tokenized financial instruments can therefore be designed in an even more attractive way for investors.

Cross-Border Offers with a Simple Investment Information Sheet Pursuant to ECSPR

The issuer of tokenized investment products offered via a crowdfunding service provider must create an investment information sheet for the offer. This is a maximum of six pages long. The information contained in such investment information sheet must be checked for completeness, correctness and clearness by the crowdfunding service provider. There is no need for approval by BaFin. Should the crowdfunding service provider also offer its services in other member states, the investment information sheet must be made available to investors in either the official language of the respective member state. Alternatively in a language accepted by the competent authority of the respective member state. Should these requirements be fulfilled, the offer may take place in more than one member state of the EU.

Attorney Dr. Konrad Uhink

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    Nov 29, 2021

    The Crypto Asset Transfer Regulation – The Last Paper Tiger of the Grand Coalition?

    The grand coalition passed the Crypto Asset Transfer Regulation of the Federal Ministry of Finances nearing the end of its tenure of office in late September 2021. It thereby subjected the crypto industry to yet another piece of regulation. The regulation intends for comprehensive obligations for crypto service providers which are involved in transactions of crypto assets. These obligations are similar to those of the European Funds Transfers Regulation (EU/2015/847) which stipulates obligations for payment service providers. According to the latter, banks and other payment service providers are obligated to collect, store and submit detailed information concerning payors and payees of transactions of fiat-money in which they are involved. The reason for the grand coalition to pass this regulation is their aspiration to implement the recommendation of the Financial Action Task Forces (FATF). This with the intention to transpose the so-called Travel Rule into respective national law. The Travel Rule has been published already in 2019. The FATF recommends their members to obligate crypto asset service providers that are involved in crypto transactions to collect, store and submit data related to the payor and payee of the crypto transaction.

    Crypto Asset Transfer Regulation Went into Effect Despite Fierce Criticism of the Industry

    During the very short consultation period of just two and a half weeks, fierce criticism was raised by the German crypto industry. This in the end could not stop the transposition of the ministries’ draft and the Crypto Asset Transfer Regulation went into effect. One major criticism was the fact that it would be impossible for the affected crypto asset service providers to implement measurements to fulfil the obligations in such a short period of time. After all the regulation went into effect on the first of October 2021. While the collection, storage and transfer obligations resulting from the EU Funds Transfers Regulation for payment service providers of traditional fiat payment transactions is taken into account by the respective Core Banking Systems (CBS) used by the individual payment service providers and technical solutions exist within these CBS, as of now there are no technical support tools in existence for the implementation of the Crypto Asset Transfer Regulation and the obligations stipulated by it. The time period of six days between the passing of the regulation and it going into effect was simply too short for developing. Another very valid criticism was the fact that the EU commission presented it’s draft bill concerning the expansion of the obligations from the EU Funds Transfers Regulation to crypto asset transfers in the summer of 2021 – and thereby prior to the Crypto Asset Transfer Regulation going into effect. It was therefore obvious from the moment in which the Crypto Asset Transfer Regulation went into effect that the German regulation will be a short-term solution until the European regulation goes into effect. Therefore, German crypto service providers are at this moment at a severe disadvantage compared to their European competitors, because they have to fulfil the additional administrative obligations resulting from the Crypto Asset Transfer Regulation.

    BaFin Provides Form for Making Use of Exemption

    The Ministry of Finance included a transitional regulation into the Crypto Asset Transfer Regulation in order to provide the market participants with the option to correctly fulfil the obligations from the Crypto Asset Transfer Regulation. According to the exemption, affected crypto asset service providers which were already involved in crypto transactions prior to the first of October 2021 may inform BaFin until the 30th of November 2021 that they are guiltlessly unable to completely or partially comply with the regulation. BaFin provided a form for this last week. The appendix of the form also contains the information, that a justification for the utilization of the exemption has to be provided until December 31st, 2021. According to the appendix, a valid reason and justification is e.g. the lack of a technical implementation possibility. Crypto asset service providers have to verify that they are indeed investing serious effort to find a technical solution, e.g. by joining professional associations that are working on a technical solution. Crypto asset service providers may be exempt from the obligations of the Crypto Asset Transfer Regulation for up to twelve months. An extension for another twelve months is possible according to the regulation. The complete utilization of the transitional regulation could mean that German crypto asset service provides may not have to fulfil the German Crypto Asset Transfer Regulation at all, depending on the speed of the European legislator. Should the revised version of the EU Funds Transfers Regulation go into effect within the next two years it will take precedence over any national regulations. It is therefore possible that the Crypto Asset Transfer Regulation of the grand coalition turns out to be an expensive and useless paper tiger. Only businesses which become active after the notification period is over will be directly affected and they will have to fulfil the obligations of the regulation immediately.

    Attorney Lutz Auffenberg, LL.M. (London)

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      Nov 22, 2021

      NFTs as Crypto Assets – Are Non-Fungible Tokens Regulated Financial Instruments?

      Non-Fungible Tokens are the talk of the town. It is no exaggeration to call what has taken hold of the crypto community for almost a year now a hype. The special feature of NFTs is that they are individually definable tokens which can be transferred directly between users on a compatible blockchain. Prior to the emerging of NFTs, crypto tokens were usually created via smart contracts in a predetermined quantity and they also were identical in terms of the underlying issuance and therefore fungible. From a technical point of view, NFTs therefore allow for the digital, tokenized representation of individual objects. Currently, examples for NFTs can be found especially in the art business, where the tokenization of pieces of art has become an ever-growing trend. There are also a lot of NFTs that can be found on the internet which are merely connected via a link with a video or a sound file, e.g. with a certain song or an interview. The idea behind is that the ownership of the NFT shall represent the authorization for the usage of the content which is connected to the individual NFT. The individually applicable national civil law determines if and how this is legally possible. Within the German jurisdiction, especially operators of exchanges for NFTs often are exposed to the question whether the individual tokens do qualify as financial instruments in the regulatory sense.

      Trading Activities with Financial Instruments May Trigger Authorization Obligations

      Blockchain tokens are based on blockchain technology, just like Bitcoin and comparable cryptocurrencies. Because BaFin very early qualified cryptocurrencies as financial instruments, the question arises, if blockchain tokens such as NFTs also generally qualify as financial instruments in Germany. At the latest since 2013, BaFin is of the opinion that Bitcoin and comparable units are units of account which are a category of regulated financial instruments in Germany. In early 2020, the German legislator introduced crypto assets as a new type of financial instrument into the German Banking Act (KWG). Commercial activities with blockchain tokens may qualify as a regulated activity if the respective tokens qualify as financial instruments. If so, market participants that are intending to conduct such activity require a prior authorization by BaFin. Conducting an activity which is subject to authorization without BaFin’s authorization is a criminal offense. Especially, trading financial instruments in a professional extent – e.g. as the operator of an exchange – can trigger authorization obligations.

      Can NFTs be Units of Account or Crypto Assets?

      BaFin defines units of account as alternative means of payment which are used by virtue of private-law agreements or customary exercise in multilateral settlement accounts. NFTs generally do not fulfill the payment characteristic of the aforementioned definition. This is due to their individual design, which makes them unsuited as a means of payment. A qualification of NFTs as units of account will therefore almost never be viable. In comparison, the legal definition of crypto assets is not limited to a payment characteristic. A qualification of specific objects as crypto assets may also be viable, if the objects in question serve investment purposes. This cannot be categorically ruled out with NFTs. NFTs have enjoyed a substantial increase in market values over the last couple of months. Should in certain cases the motivation for the creation of an NFT be based on the mere intention to generate monetary gains by trading the token, the NFT may actually qualify as a crypto asset, because in these cases the investment purpose is the driving reason behind the creation of the NFT. Of course, all the other legal requirements of the definition of crypto assets must also be fulfilled for triggering the regulation.

      Attorney Lutz Auffenberg, LL.M. (London)

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        Nov 08, 2021

        What are IDOs and Which Regulatory Obligations may be Applicable to Initiators?

        The option to sell self-created crypto tokens to investors as a means to procure capital has grown ever more popular with companies at the latest since the end of 2017. There are different types of these so-called token sales. The probably best known type is the so-called Initial Coin Offering or ICO which also kicked off the hype concerning token sale events in late 2017. In this process, companies create their own crypto tokens via smart contracts on suitable blockchain infrastructures which they subsequently sell to interested investors. If tokens are connected to security-like rights, e.g. a claim on return or participation rights, the public offering of them may qualify as a so-called Security Token Offering (STO). About two years ago, various international crypto exchanges also began to expand their range of services to include so-called Initial Exchange Offerings (IEOs). In this process, the involved crypto exchange does not only offer the token issuer the technical programming of the subsequently offered tokens, but also a listing of the tokens on the exchange to enable interested investors to directly acquire and trade the tokens. Probably the newest type of token sale is the so-called Initial DEX Offering (IDO). Token issuers thereby utilize a Decentralized Exchange (DEX) as the connected trading venue for the initial public offering and possibly also for the secondary trading of the tokens instead of a centralized crypto exchange.

        How Do IDOs Work?

        The token issuer offers his tokens during an IDO to investors via a decentralized exchange platform.  These so-called DEX are autonomously, decentralized, on suitable blockchains via smart contracts functioning programs which are not directly operated by any specific entity. The last feature is the decisive difference to centrally designed crypto exchanges. The later are always operated by a specific and responsible operator which matches supply and demand through his services and which will facilitate the settlement of contracts in cases in which a contract is agreed upon. With DEX, the matching of offeror and investor as well as the settlement of crypto transactions is performed automatically via an accordingly programmed smart contract. Token offerors as well as investors may independently interact with the smart contract and may acquire or sell tokens via the DEX from or to other trading participants of the DEX. Trading participants of a DEX provide a blockchain address with which they intend to participate in the decentralized trading. Token issuers are therefore able to offer their tokens by listing a blockchain address on the DEX which contains the offered tokens as a credit balance. In order to acquire the crypto tokens, investors may then transfer other cryptocurrencies with an amount equivalent to the intended investment amount to a blockchain address provided by the issuer to the DEX. The DEX will then automatically transfer crypto tokens equivalent to the investment amount to the investor.

        Which Regulatory Obligations May Be Triggered by an IDO?

        Even though the actual trading on a DEX is performed in a decentralized way and without a clearly responsible operator, the participants may nevertheless be addressees of regulatory obligations. Should the offered tokens e.g. qualify as securities in the sense of the EU Prospectus Regulation, a security prospectus or other required documentation has to be provided by the issuer for the first public offering. Regarding the DEX itself, the initiators of the platform might be subject to authorization obligations, depending on their specific contribution to enable the DEX for operation. Should the initiator of the DEX for example reserve administrative rights that enable him to influence the trading on the DEX or should transactions on the DEX trigger transaction fees for the benefit of the initiator, a case for the regulatory responsibility of the initiator could well be made. In summary, there are therefore no real regulatory simplifications for the issuers of tokens via IDOs compared to other types of token sale events. For the initiators of the DEX, the question of profiting from regulatory simplifications depends on the actual autonomy of the DEX and on the connection of the initiator to the operation of the DEX, for example through the reception of transaction fees stemming from the trading activities on the platform.   

        Attorney Lutz Auffenberg, LL.M. (London)

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          Oct 25, 2021

          Prospectus, WIB or Nothing at All – Which Documentation is Required for Which Security Token Offering?

          Tokenized securities have been issued in many European countries over the course of the last years. The competent national supervisory authorities as well as the European Securities and Markets Authority (ESMA) do not view any critical regulatory obstacles for security token offerings and deem the stipulations regarding traditional securities and securities products also applicable to tokenized securities. Public offerings of security tokens are consequently generally subject to the EU Prospectus Regulation, which is directly applicable to the market participants. Issuers and offerors of security tokens are therefore in most cases required to draw up a security prospectus for the public offering of the tokens which contains detailed information regarding the issuer and if necessary, the offeror, the nature of the offered product, the conditions of the offer as well as the essential risks associated. Subsequently, the prospectus must be approved by the competent supervisory authority and it must be published prior to the start of the public offering. But there are also exemptions from the obligation to draw up and publish the prospectus.

          Facilitations for Token Sales with a Low Volume

          With regards to the public offering of securities with a total consideration within the European Union of less than 8,000,000 euros calculated over a period of twelve months, the EU Prospectus Regulation intends for the member states for the option to omit the prospectus obligation. This obviously also applies to offers of security tokens. The specifics of the exemption from the prospectus obligation are left to the discretion of the EU member states which has led to vast differences within the EU on this matter. In Germany for example, security token offerings of up to 8,000,000 euro in volume may be offered on basis of a four-page securities information sheet (WIB), if the distribution of the tokens is conducted via a licensed securities service provider and if retail investors can only invest up to specific maximum amounts. Other EU member states did not make complete use of the scope of the possible issuing volume. Austria for example allows security token offerings with a total consideration of up to 2 million euro to be conducted on basis of an information document. Other member states have decided on yet different maximum amounts and may also have different requirements to make use of the exemptions. WIBs and comparable documents cannot be used for offerings in other EU member states because the exemptions are for domestic use only. Should it be intended to conduct a security token offering in more than one member state, the requirements of each and every individual member state have to be fulfilled and possibly more than one documentation must be drawn up.

          Neither a Prospectus nor a WIB in Certain Cases

          The EU Prospectus regulation intends for a complete exemption from the obligation to create a prospectus for certain issuing projects, which can also be applicable to STO issuers. The most important exemptions relate to offers which are targeted solely at qualified investors, meaning primarily institutional investors and offers with a minimum investment or minimum denomination of 100,000 euros. Offers which are targeted at not more than 150 retail investors per member state can also be conducted without a prospectus, WIB or other documentation. In these cases, it must be observed that the offer really only targets 150 retail investors per member state, no matter if these 150 investors end up acquiring tokens or not. The prospectus obligation in accordance to the EU Prospectus Regulation is also not applicable to security offerings which do not exceed a total consideration of 1,000,000 euros. Regarding these offerings, member states have the option to obligate issuers and offerors with other disclosure obligations. In this context, the German legislator decided to permit such offerings on the basis of a WIB resulting in the fact that in Germany security token offerings with an issuing volume of between 100,000 and 8 million euro can be conducted on basis of a WIB provided that the aforementioned distribution requirements are met.

          Attorney Lutz Auffenberg, LL.M. (London)

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            Oct 18, 2021

            Cross-Border Crypto Services – How Does the EU-Passporting Work for Crypto Businesses?

            The crypto market is international. Transactions merely require the installation of a wallet software on an internet-capable device and a connection to the internet. National borders and different jurisdictions do not hinder users from a technical point of view to conduct crypto transactions with transaction counterparts around the globe. It is therefore logical that the biggest and most successful market participants now strive for an international roll-out of their business models. In the European Economic Area (EEA), banks and financial service providers as well as investment profit from the harmonization of the European single market through the European Union in this context. Accordingly, businesses of the finance industry have can extend their business operations to other EU member states via the so-called passporting-rules without the necessity to previously obtain an additional regulatory authorization. Instead, they are merely required to conduct a comparatively simple notification procedure with the supervisory authority of their home state. But can also crypto businesses invoke the rules of the EU-passporting for themselves?  

            No Uniform Regulation for Crypto Assets in the EU Yet

            Even though the phenomenon of cryptocurrencies has existed for already more than ten years now, as of today there is no uniform regulation of crypto assets in the EU. On a national level, the German legislator decided to introduce crypto assets as financial instruments to the German Banking Act (KWG) as well as to the Investment Firm Act (WpIG). As a result, most crypto services in Germany are regulated activities and subject to authorization. The legislators in other member states of the European Union mostly did not go that far. Even though the currently applicable fifth European AML directive requires that the member states include virtual currencies as well as the respective exchanges and custody service providers in their AML regulations, a lot of European states decided to implement this requirement merely by imposing an obligation to register upon the according crypto businesses. However, there is no full-fledged authorization requirement with ongoing supervision connected with it as it is the case with banks and investment firms.

            EU-Passporting Only Works If the Supervision in the Home-State is Comparable

            The EU-legislator’s idea which justifies passporting-solutions is the assumption that the supervision of the transactions of an already in its home-state fully supervised business does not make sense. Effective and comprehensively informed and uniform supervision can best be realized, if the competence for the entirety of the institute is pooled at just one supervisory authority. However, this approach can only work, if the supervisory requirements in the home-state as well as in the target-state are comparable. Only on such basis it be ensured that the supervisory authority can comprehensively take into account the overall risk profile and the economic situation of the business. It is therefore e.g. not possible for a business that is authorized to conduct financial commission business with securities in the Netherlands to conduct such business with crypto assets in Germany. EU-passporting is not possible in this case. The reason is that the crypto assets related business is not subject to supervision in the Netherlands and a supervision in Germany would not be conducted. As of today’s legal framework, the Dutch business would therefore need to obtain an authorization for its business in Germany.   

            MiCA Regulation Will Probably Solve this Problem

            The currently discussed draft of the future Markets in Crypto Assets Regulation (MiCA) will be directly applicable in all member states of the European Union without the need of transposition into national law. The current draft also intends regulations for cross-border crypto services in the EU. According to the current iteration of the draft, a uniform contact point for crypto service providers is intended, which will coordinate cross-border offers of crypto service providers. Crypto businesses will have to provide the contact point with a list of target-states in which they intend to offer crypto services. Furthermore, they will have to state the crypto services which they intend to offer in each target-state and the respective starting date. The creation of passporting-options for crypto service providers is an essential goal of the MiCA Regulation. It can therefore be assumed that after the regulation goes into effect, probably in 2023, cross-border-offers of crypto services without the requirement of a multitude of national authorizations will be possible in one form or another.

            Attorney Lutz Auffenberg, LL.M. (London)

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              Oct 11, 2021

              When are Crypto Custody Service Providers and Operators of Crypto Security Registries Exempt from the Regulatory Equity Capital Regulations?

              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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                Sep 20, 2021

                Right of Revocation and Security Token Offering – What Must Be Observed by Issuers and Providers

                The participation in economic life is steadily being digitalized and that even prior to the outbreak of the current pandemic. An increasing number of everyday contracts is entered into via the internet. Consumers that enter into contracts with entrepreneurs via the internet are generally entitled to a legal right of revocation versus the entrepreneur under German law. The effective exercise of such a legal right of revocation leads to the rescission of the revoked contract. However, the legally stipulated fourteen-day revocation period only starts, if and when the entrepreneur correctly informs the consumer about the right of revocation. Consumers may also have such a right of revocation for contracts concerning financial services which are entered into via the internet. But what about the distribution of security tokens via the internet? Who has an obligation to inform the consumer about the right of revocation when it comes to the public offering of tokenized investment products?

                Legal Right of Revocation Only in Certain Constellations at the Capital Markets

                To begin with, a legal right of revocation in accordance with German private law is only granted to investors that do not act as entrepreneurs. For the field of investment this means that a legal right of revocation is not granted to institutional investors that invest on a professional and commercial scope. The differentiation between a consumer and an entrepreneur with regards to the investment activities may be difficult when it comes to private, wealthy individuals who are experienced in the capital markets and also when it comes to smaller family offices. Regardless of the degree of professionalism of the respective investor, the features of the security token itself may determine the existence of a legal right of revocation. According to German law, consumers are not entitled to a legal right of revocation for contracts on the acquisition of goods and services of which the prices are dependent on fluctuations on the financial markets the entrepreneur has no influence on and which may occur during the revocation period. This may for example be the case with security tokens, which immediately show a market price because they are directly listed for trading on a crypto exchange. Tokenized investment products granting an unconditional repayment and interest claim to the investor and which are not tradable with a fluctuating market price are most likely not subject to this exemption.

                Who is Subject to the Information Obligation During a Security Token Offering?

                Subject to the obligation to inform the consumer about an existing legal right of revocation is the entrepreneur, who enters into a contract concerning the subscription of the respective tokenized investment product with the consumer. This may first of all obviously be the issuer of the tokens when selling them to the investor via the internet. Nevertheless, it is also possible that a professional interim owner, e.g. an issuing house, is the one that sells the product to the consumer. In these cases, the contract regarding the purchase of the respective security tokens is entered into by the consumer and the interim owner who now acts as a provider. Then, the obligation to inform the consumer lies with the provider. On the other hand, issuers or providers should refrain from informing investors of a right of revocation where a legal right of revocation does not exist – for example if the investor is not a consumer – because an unnecessary information about a right of revocation may be interpreted as a voluntary granting of a contractual right of revocation.

                Attorney Lutz Auffenberg, LL.M. (London)

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                Abstract:

                Is there a legal right of revocation in Security Token Offerings? What must be observed by issuers and providers in this context and what may be the legal consequences in case of unfulfilled obligations?

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                  Sep 13, 2021

                  Crypto Fund Shares Shall come – What is the KryptoFAV about?

                  The Electronic Securities Act (eWPG) went into effect in June of 2021. According to the unambiguous intention of the legislator, the eWPG relates solely to unsecuritised bearer bonds and it is in its current iteration intended as somewhat of a test for the possible introduction of other unsecuritised financial instruments such as e.g. electronic stocks. With the introduction of the eWPG, the legislator nevertheless also altered a number of provisions in other codes of law regarding securities and capital markets law. The legislator e.g. amended the Capital Investment Act (KAGB) to provide for the option to introduce crypto fund shares. The specific legal design of these crypto fund shares is delegated by the legislator to the Federal Ministries of Finance (BMF) and Justice (BMJ) which are authorized to issue executive ordinances in this matter. The two Federal Ministries acted on this authorization last week and published a draft for a Crypto Fund Shares Regulation (KryptoFAV).

                  What is Supposed to be Regulated by the Crypto Fund Shares Regulation?

                  The published draft of the KryptoFAV consisting of just four paragraphs is rather short. According to the draft, crypto fund shares are intended to be electronic participation certificates that are registered in a crypto security registry. Next to the legal definition of crypto fund shares it also regulates the mutatis mutandis applicability of the eWPG provisions concerning crypto securities and crypto security registries to crypto fund shares. The draft intends for a special feature for the depository of crypto fund shares, which in contrast to those of electronic securities, mandatorily has to be the registry operator for the registration of the issued investment fund so that it can fulfill its legal control and information obligations towards the investors of the fund. Crypto fund shares will therefore not differ much from crypto securities pursuant to the eWPG other than in this particularity. The supervisory regulations of the KAGB will be applicable to crypto fund shares in the same way as they are applicable to traditional fund shares.

                  Can Fund Shares Be Tokenized in a Different Way?

                  The KryptoFAV intends to provide market participants with the option to issue tokenized shares of investment funds which may be acquired in an unencumbered, bona fide way by investors, similar to securitized participation certificates. Crypto fund shares will then be just as suited for an organized secondary market as traditional securitized fund shares. That being said, capital management companies are not restricted to crypto fund shares, if they intend to issue tokenized shares of investment capital. There will still be the option to tokenize fund shares without the registration in a crypto security register and observation of the requirements of the KryptoFAV by creating a legally valid contractual connection between the shares and the tokens representing it. The advantages of crypto fund shares regarding a bona fide, unencumbered acquisition is in this case lost, but on the other hand a registration in the crypto security registry of a depository that is also authorized as a crypto securities registry operator is also not required.

                  Attorney Lutz Auffenberg, LL.M. (London)

                  1. https://fin-law.de
                  2. info@fin-law.de

                  Abstract:

                  Last week, the Federal Ministry of Finance published its draft for a new Crypto Funds Shares Regulation (KryptoFAV). How will crypto fund shares be legally designed according to the ministries publication and what are the possibilities for investment funds arising from it?

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                    Sep 06, 2021

                    EU Commission Tackles the Implementation of the FATF Travel Rule

                    In almost no other field the EU Commission is as active as in the field of regulation of the combat against money-laundering and terrorism financing. The fourth Anti-Money-Laundering Directive had only been released in 2015 and had to be transposed by the member states until the 26th of June 2017. Even prior to the expiration of this deadline, the issuance of the fifth Anti-Money-Laundering Directive had already been initiated. The fifth Anti-Money-Laundering Directive was the first piece of regulation that included virtual currencies into the regulatory regime of European anti-money-laundering prevention and it also regulated certain crypto exchange and crypto custody service providers as obliged entities in the sense of the AML regulations. In June of 2021 the EU Commission announced that it intends to fundamentally revise the European money-laundering and terrorism financing regulation again and published drafts for a total of four very far-reaching regulatory projects: The centerpiece is the new European AML Regulation, which as a so-called Single-Rule-Book will provide uniform regulations for the entirety of the Union and which is intended to be directly applicable to all market participants. The sixth Anti-Money-Laundering Directive will especially be focused on the regulation of the cooperation of the national and European authorities that are tasked with money-laundering prevention. The new AMLA Directive intends to create a new centralized European authority, which is supposed to facilitate the flow of information between the competent national authorities and the market participants being regulated as obliged entities. The fourth project is focused on the implementation of Travel Rule, as it is recommended by the Financial Action Task Force (FATF).

                    How Does the EU Commission Intend to Implement the FATF Travel Rule?

                    The FATF included the critically discussed Travel Rule already in 2019 in its recommendations to the member states regarding effective anti-money-laundering and terrorism financing measurements. According to the FATF Travel Rule, member states are supposed to obligate service providers that are involved in crypto transactions to collect comprehensive information about the individual transaction itself as well as about the transaction participants and to share this information with each other. The recommendation calls for data such as the names and addresses, the national identification numbers and the whereabouts of the transaction participants as well as the transaction date, associated wallet addresses and banking information where applicable. The EU Commission now tackles the implementation of the Travel Rule and chooses a rather obvious way to do so. By amending the European Money Transfer Regulation to include crypto service providers, the FATF regulations are intended to be uniformly implemented in Europe. The actual implementation seems somewhat unimaginative, because the obligations that are already applicable to service providers engaging in the transaction of book money are merely amended to also be applicable to crypto service providers and crypto transactions.

                    Is the Inclusion of Crypto Transactions in the European Money Transfer Regulation the Right Way?

                    The approach of the EU Commission to expand the scope of application of the Money Transfer Regulation to include crypto service providers is at first sight natural. Nevertheless, this approach does not take into account the technical features and intricacies of crypto transactions. Transactions of crypto assets generally work in a decentralized way, so that the involvement of crypto service providers is not compulsory. Especially transactions for money-laundering or terrorism financing purposes will therefore seldom or rather never include transaction participants that actually choose to involve a crypto service provider, but instead will be settled directly between the transaction participants. Therefore, these measurements will affect primarily the honest and fair users and service providers. The application of a Money Transfer Regulation which is also applicable to crypto transactions will nevertheless substantially limit the options of money-laundering and terrorism financing, especially when it comes to the exchange of crypto assets to fiat money. Furthermore, the market participants will collect a huge amount of data for the prosecution authorities, which will probably increase the effectiveness of backtracking crypto transactions in the European Union considerably. A targeted regulation that takes the technical features and intricacies of crypto transactions into account would nevertheless be preferable for the future. A new regulatory proposal which tackles this subject could be put forward at the latest in the year after the next, should the EU commission keep up its pace regarding AML regulations.

                    Attorney Lutz Auffenberg, LL.M. (London)

                    1. https://fin-law.de
                    2. info@fin-law.de

                    Abstract:

                    The EU commission intends the implementation of no less than four regulatory measurements to the European Anti-Money-Laundering regulation. In the process it will also tackle the implementation of the FATF Travel Rule.

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                      Aug 30, 2021

                      Preliminary Authorization for Operators of a Crypto Security Registry – What are the Requirements?

                      The rising interest in cryptocurrencies, especially of professional investors and the steadily growing acceptance of tokenized investment products on the capital markets prompted the German legislator to introduce crypto securities as a new sub-type of securities. These are a special form of electronic bearer bonds which do not require securitization in a paper document. With crypto securities, the ownership of investor rights resulting from the bearer bond are represented through the ownership of the crypto token. The German legislator chose a registry-based solution in order to implement the aforementioned system in a legally sound way. The ownership of the tokens which represent the crypto securities as well as the current terms of the bearer bonds and additional base-data regarding the issuance will be displayed in a crypto security registry. The operation of such a registry will be reserved for so-called registry operators, which are authorized by BaFin to conduct this activity. It is for this reason, that the financial service of operating a crypto security registry has been introduced to the German Banking Act (KWG).

                      What is the Activity of Operators of Crypto Security Registries?

                      The registry operators for crypto security registries must keep the registries on a recording system that is forgery-proof, records the data in the correct chronological order and is secured against unauthorized deletion and subsequent changes. DLT solutions are therefore especially well suited as infrastructures for crypto security registries. The applicable law is nevertheless worded in a technology neutral manner which leaves room for future innovations. Beyond the obligation to register the the owner and the issuer of the securities, registry operators must also register the nominal amount, the issuance volume, the essential rights that are connected to the respective security as well as the associated securities identification number (ISIN). It is within their responsibility, that the current ownership of a crypto bond is at all times comprehensibly and accurately displayed. The public may legally rely on the correctness of the displayed data in a crypto security registry.

                      What are the Regulatory Requirements that Operators of Crypto Security Registries Must Fulfill?

                      The law sets out strict requirements for obtaining an authorization for operation of a crypto security registry, even though these requirements are considerably lower for businesses which intend not to offer any other financial services, but instead exclusively operate a crypto security registry. To begin with, operators of a crypto security registry have to dispose over a regulatory starting capital of 150,000 euros. They are furthermore required to have a fit and proper director, reliable owners and especially important, a proper business organization. Should it be intended to exclusively operate crypto security registries and no other financial services, the requirements regarding the disposable funds, overall liquidity, required capital buffers and the remuneration systems for employees are considerably lower in comparison with those placed on other financial institutions.

                      Transition Period Allows Operators of Crypto Security Registries to Obtain a Preliminary Authorization

                      For not interfering with already existing business models and for facilitating the transition of the crypto market to the new rules, the KWG provides for transitional rules for businesses which intend to offer crypto security registry operation or already do so. Operators of crypto security registries may obtain a preliminary authorization for their business, if they begin the business activity until the 10th of December 2021 and notify BaFin at least two months prior to the start of their activities. The last possible date for a valid submission of such notification to BaFin is therefore the 10th of October 2021. The submission to BaFin must set out that a sufficient starting capital is indeed in place, that the director/directors is/are fit and proper and that the applicant has worked out a sustainable business plan with regards to the intended operation of a crypto security registry. In case of filing a valid notification to BaFin, the applicant must submit a full and comprehensive application for operation of crypto security registries at least six months after the date of the notification.

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                        Aug 23, 2021

                        Good-bye to Virtual Currencies – The New EU Anti-Money-Laundering Regulation will regulate Crypto Assets

                        In 2018, the first first piece of codified regulation regarding blockchain and DLT units was introduced in the European Union with the creation of the so-called fifth Anti-Money-Laundering Directive. Since then, virtual currencies are defined by the European AML regulation as a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically. A month ago, the EU Commission published its draft version of a new EU Anti-Money-Laundering Regulation (EU AML Regulation), which is supposed to be applicable in the future in the member states without the requirement of a transposition into national law. The EU Commission seeks to standardize the anti-money-laundering prevention within the union in order to enhance the efficiency of the combat against money-laundering and terrorism financing. But the EU AML Regulation shall not set out the term of a virtual currency anymore.

                        Crypto Assets Instead of Virtual Currencies 

                        The new EU AML Regulation will provide a definition for crypto assets instead of one for virtual currencies. The departure from the term of virtual currencies is consistent and logical, because firstly, the recommendations of the Financial Action Task Force (FATF) utilize the term crypto assets since 2019 and secondly, because there have been considerable problems with the definition of virtual currencies since Central and South American countries openly consider making Bitcoin their legal tender. By becoming a legal tender, Bitcoin would no longer be subject to the definition of virtual currencies. A definition of crypto assets is not provided in the draft version of the EU AML Regulation itself. The Commission in a rather eager attempt to create homogeneous regulation will define the term crypto asset in the Markets in Crypto Assets Regulation (MiCA), which is also in a draft state. This definition will be applicable to the EU AML Regulation as well. Consequently, crypto assets will be defined in the EU as digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology. The requirement of a lack of status of a legal tender will no longer be included into the definition, so Bitcoin will be qualified as a crypto asset regardless of the developments in Latin America.

                        The German Legislator Must React Anyways

                        The German Federal Government, on the basis of its blockchain strategy initiated in early 2020 a national solo-effort and instead of regulating virtual currencies in the Anti-Money-Laundering Act regulated crypto assets in the German Banking Act (KWG). In close resemblance to the definition of virtual currencies in the fifth Anti-Money-Laundering Directive, the German KWG defines crypto assets as digital representations of value that are neither issued nor guaranteed by a central bank nor any other public authority and that do not possess the legal status of currency or money, but are accepted by natural or legal persons as a means of exchange or payment on basis of an agreement or actual practice or which serves investment purposes and which can be stored, traded and transferred electronically. There is no way for the German Legislator to keep this definition in effect, because MiCA as a European regulation will take precedence over German national law.   

                        Attorney Lutz Auffenberg, LL.M. (London)

                        1. https://fin-law.de
                        2. info@fin-law.de

                        Abstract:

                        The draft version of the new Anti-Money-Laundering Regulation of the EU Commission does not refer to the definition of virtual currencies anymore that had just been introduced with the fifth Anti-Money-Laundering Directive and will instead regulate crypto assets.

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