Initial meeting

Category: blog EN

Sep 02, 2019

Let´s Build an Equity Token – Why don´t We Bring Stocks to the Blockchain?

Tokenizing is one of the hottest topics at the capital markets right now and with the authorization of the first security token offerings by the national supervising authorities the subject is picking up speed. BaFin, the competent authority in Germany, already approved two security prospectuses for security token offerings and it is just a matter of time until more will follow. However, the approved prospectuses were related to blockchain based bonds that grant the investors return and repayment claims. But would it also be possible to issue blockchain based stocks? If so, investors would not only be able to profit from the issuing companies business success but could also determine the company’s fate by executing their voting rights at shareholder meetings. Such equity tokens would turn investors into shareholders. So, can stocks be emitted as blockchain tokens according to German law?

MUST STOCKS IN GERMANY BE ISSUED AS PAPER DOCUMENTS?

According to German law, stocks do not necessarily have to be issued as paper documents. Registered shares can be also created by a mere declaration of the shareholders within the shareholders agreement when a stock company is founded. In order to be recognized by the company as shareholder of registered shares it is however necessary that the new shareholder gets listed in the share register of the company instead of the old shareholder. This registry includes information such as the name and address of the shareholder, the date of birth, the amount and serial numbers of the shares the shareholder holds. The shareholder can only execute his rights with legal effect vis-á-vis the company if he is registered. Bearer shares on the other hand are shares that grant rights and claims to its holder. They can only be issued if the right of the shareholder to demand issuance of individual share certificates is excluded in the shareholder agreement. Furthermore, a global certificate of the issued shares has to be kept with either a securities depository bank, an authorized central securities depository (CSD) or a comparable security depository according to foreign law. The decisive factor for the question whether bearer shares can be issued in the form of an equity token under German law is therefore if the global certificate has to be a paper document or not.

WHAT IS A GLOBAL CERTIFICATE?

The German Securities Deposit Act (DepotG) defines global certificates as securities that evidence in writing a multitude of rights which could be individually certified in securities of the same kind. The wording of this definition leaves almost no room for interpretation. An “evidencing in writing” without a paper document seems hardly possible. If the Securities Deposit Act would instead use the word “representation”, a global certificate in the form of a smart contract token would at least hypothetically be possible. As it stands with the current wording of the law, a paper document is unavoidable for creating a global certificate. Issuing bearer shares in form of a blockchain token without a global certificate in paper form is therefore currently impossible under German law.

ARE REGISTERED SHARES IN THE FORM OF AN EQUITY TOKEN A POSSIBILITY?

Uncertified (in this case meaning “not in paper form”) registered shares can, according to German law, be transferred by simple assignment and therefore theoretically with nothing more than a handshake to the new shareholder. As long as the transfer by assignment can be displayed by a smart contract on the blockchain, the issuance of equity tokens that represent uncertified registered shares is generally possible. In order to be recognized as a shareholder by the issuing company, the shareholder has to be registered with the share registry of that company. It would therefore be useful if the smart contract would not only settle the issuing and transferring of the token but also automatically run the company’s shares register on the blockchain. A problem with a blockchain based shares register is however that the former shareholders have the right to demand that their personal data is erased from the shares register once they have sold their shares. If the register is blockchain based, a complete deleting of the data from the blockchain would be impossible, due to the unforgeable and uneditable technology of the blockchain. This general problem, which is also controversially discussed with regards to the European General Data Protection Regulation (GDPR), massively complicates a blockchain based shares register.

Attorney Lutz Auffenberg, LL.M. (London)

I.  https://fin-law.de

E. info@fin-law.de

subscribe to Newsletter

    Contact

    info@fin-law.de

    Aug 26, 2019

    Crypto Custody vs Securities Deposit Business – Who Will be Allowed to Store Security Tokens?

    Security Tokens of German issuers so far have been issued solely as securities according to the German Securities Prospectus Act respectively the EU Prospectus Regulation. They are designed as identical and freely tradable blockchain tokens that grant its owners certain investor rights such as a return on investment and a repayment claim. Security tokens can be held by the owner on a blockchain address to which only he knows the private key. But what are the options for investors who want their tokens stored and managed by a service provider? Can security tokens be professionally stored by service providers or does that kind of service require a BaFin authorization?

    HOW ARE TRADITIONAL SECURITIES DEPOSITED?

    In German private law, securities are traditionally paper documents and therefore objects that can be owned and transferred according to German property law. This means that an unencumbered, bona fide acquisition is possible if e.g. the seller of the security was not the owner or the security was burdened with third-party rights. Even though security transactions in Germany are (corresponding to international standards) these days done by simple account postings at the security depository banks, the legal construction of the transfer of the security in question still includes and depends on the transfer of ownership of the paper document that embodies it. As long as the securities are not traded at stock exchanges or any other public marketplace, the paper documents can be held by the investors themselves. Alternatively, they can be handed to banks that are authorized to handle customer securities. If, on the other hand, the securities can be traded on the capital markets the EU Central Securities Depositories Regulation (CSD) requires that the securities are booked into a securities register at an authorized securities depository bank. This enables the quick, non-physical and electronic transfer of securities at stock exchanges and other public marketplaces.

    HOW DID THE GERMAN LEGISLATOR DESIGN THE CUSTODY OF CRYPTO ASSETS?

    The German legislator decided to define the custody of crypto assets as a financial service that will require prior authorization from BaFin as of 2020. In the future, crypto assets will be defined in the German Banking Act (KWG) as financial instruments. According to these plans, the definition of crypto assets will include crypto assets that are used either as alternative means of payment or as investment vehicles. Both can be crypto assets as long as they are digital embodiments of value that are electronically transferrable, storable and tradable and that are not issued by an official authority. Security tokens will fall under that definition. Therefore, they can only be stored as crypto assets by service providers that are BaFin authorized for the new financial service of crypto custody. These crypto custody service providers are, according to the legislative plans, exclusive service providers. This means that BaFin can only authorize service providers as crypto custody service providers if these companies do not engage in any other activity that requires authorization according to the German Banking Act (KWG). According to the explanatory memorandum to this law, the legislator wanted to prevent that IT-related risks that arise from crypto custody services impact banking or other financial services.

    CAN CRYPTO CUSTODY SERVICE PROVIDERS STORE SECURITY TOKEN?

    According to the German Banking Act (KWG) the depository and management services for securities are subject to authorization. It is, as of this point in time, legally unclear if security tokens qualifying as securities in the regulatory sense are also to be qualified as securities in the sense of the securities deposit business. In support of this, the German Banking Act does not explicitly specify that securities have to be paper documents and that from a regulatory point of view, security tokens are digitalized securities. On the other hand, “deposit” in the sense of the depository business means “physical storage with custody” which is obviously unnecessary, even impossible, when it comes to the storage of digital tokens respectively the digital private keys. This legal uncertainty in German regulatory law will be eliminated with the exclusivity of crypto custody services in the future. If security tokens were to be defined as securities in the sense of the depository business, they could neither be stored for customers by security depository banks nor by crypto custody service providers. Due to the exclusiveness of the new financial service, the crypto custody service providers could not additionally get licensed for the security depository business and the security depository banks could not be authorized for offering crypto custody services. Investors could only rely on holding and storing the tokens themselves. This means that the depository banks in the future will not be able to serve the tokenized securities market and will have to leave the field to the crypto custody service providers.

    Attorney Lutz Auffenberg, LL.M. (London)

    I.  https://fin-law.de

    E. info@fin-law.de

    subscribe to Newsletter

      Contact

      info@fin-law.de

      Aug 19, 2019

      Security Token as Asset Investment – Is that Possible?

      This year, BaFin already approved two securities prospectuses for security token offerings. In July of 2019 it approved a prospectus concerning the offering of token based subordinated bonds in the form of profit participation certificates and in January of 2019 a prospectus concerning a security token in the form of a registered bond. The approval of the January prospectus is remarkable because registered bonds are explicitly defined by German law as asset investments and not as securities. Nevertheless, BaFin approved the offering of the security token via a securities prospectus instead of an investment asset prospectus and explained the decision later in an article in the BaFin Journal of April 2019.

      BAFIN: SECURITY TOKEN AS A SUI GENERIS CLASS OF SECURITIES

      In the opinion of BaFin, blockchain technology blurs the boundaries between securities and asset investments. The marketability of blockchain tokens leads – according to BaFin – to a qualification of said token as a security even if the product that is embodied in the token would be qualified as an asset investment under normal circumstances. BaFin refers to tokens as a sui generis class of securities. The authority justifies this qualification with the “Substance over Form” principle of the European Securities and Market Authority (ESMA). According to this principle the legal qualification of a financial instrument relies on the content-related design of the instrument and not on the (misleading) name it is given. The market must provisionally work with the opinion of BaFin even though it can and should be criticized. The “Substance over Form” principle is useful to legally qualify and regulate new financial products but it cannot justify the legal qualification of a product as a security if it is, according to its content, in fact an asset investment. These cases do not evolve around a misleading name of a new financial product but rather around the legal qualification of it and its content.

      WHAT ARE THE LEGAL REQUIREMENTS OF A SECURITY?

      The decisive factors in order to qualify a product as a security are its free transferability and the marketability of the product on the capital markets, while BaFin regards crypto exchanges as capital markets in this sense. Additionally, the product must grant its holder rights that are similar to those of a security. That means shareholder or contractually designed subscription rights. Traditionally in Germany these rights are embodied in a paper document. The approval of two security prospectuses for STOs shows that the embodiment of the security rights can now also be achieved with a crypto token. If the product lacks the aforementioned free transferability, the law qualifies it as an asset investment rather than a security. The prospectus for such an asset investment has to be created and compiled according to the Asset Investment Act rather than the Security Prospectus Act and the EU Prospectus regulation. Security tokens in general are unrestrictedly transferrable between wallets of the users and therefore, according to BaFin, are generally to qualify as securities and not as asset investments.

      IS IT POSSIBLE TO DESIGN A SECURITY TOKEN AS AN ASSET INVESTMENT?

      Designing a security token as an asset investment can be advantageous especially when it comes to the sales of the token. Contrary to securities, asset investments cannot only be sold and brokered by BaFin authorized investment intermediaries and financial advisers but also by financial asset brokers that are (only) authorized in accordance to the Federal Commercial and Industrial Code. The inclusion of financial asset brokers in the sales network of a security token means a greater reach and additional investors for the issuer and an additional field of business for the financial broker. Neither the BaFin publication from April 2019 nor BaFin’s recently published information sheet on crypto tokens eliminate the possibility of designing a security token as an asset investment. The token terms could for example exclude the free transferability of the token by providing a mandatory consent of the token issuer for an effective token transfer to a third party. Thereby, a legal qualification of the token as a security would no longer be possible. For STO emitters wanting to initially distribute their product solely in Germany and not internationally, the design of the security token as an asset investment instead of a security can therefore be an interesting alternative.

      Attorney Lutz Auffenberg, LL.M. (London)

      I.  https://fin-law.de

      E. info@fin-law.de

      subscribe to Newsletter

        Contact

        info@fin-law.de

        Aug 12, 2019

        Would a BaFin issued Crypto Custody License be EU-Passpotable?

        In less than six month the new financial service of crypto custodian services will be introduced to the German banking regulatory law unless the German legislator does not change his mind. The decision to subject crypto custodians to BaFin authorization is currently being criticized and discussed massively. Especially the proposed introduction of section 32 subsection 1g into the German Banking Act (KWG) that would, if passed, only allow authorizations for companies that do not offer any other regulated banking or financial services is the subject of the criticism. The German blockchain community is asking itself if such a massive interference in the occupational freedom of the crypto custodians can be legally justified. The German federal government promised in 2018 within its coalition treaty to promote a sensible and reasonable legal framework for international and European crypto and token trading. It seems obvious that this idea has been abandoned in the meantime. Instead it seems as if the federal government plans a national solo effort in the regulation of cryptocurrencies.

        UNDER WHAT CIRCUMSTANCES IS IT POSSIBLE TO USE A BAFIN LICENSE IN OTHER EUROPEAN COUNTRIES?

        With the so-called European Passport, banks and financial service providers can use a license to operate their business that they obtained in a member state of the European Economic Area (EEA) also in other member states as long as they report the intended use to the authority that originally issued the license. As long as the regulatory supervision of the offered service in the issuing member state is comparable to the standards of the target member state the supervision is solely conducted by the originally issuing authority. Most of the laws regarding banking and financial services originate from European regulations and directives. A comparable standard of regulation is therefore in most cases ensured within the European Union. If e.g. a BaFin regulated German private bank wanted to offer loans to commercial customers in France it would be sufficient for them to inform BaFin about this intention and BaFin would inform the French ACPR.

        WHAT ARE THE LIMITS OF EU-PASSPORTING?

        The EU-Passporting of a license is not possible if the regulatory standards of the member states in question are not at a comparable standard. Consequently, EU-Passporting is not applicable if a member state decided to regulate an activity that it is not obligated to regulate according to the EU directives. The regulation of such an activity is unnecessary in the other member states because the activity in question is not subject to authorization there. Therefore, the standards of regulation are not comparable between those member states and so the EU-Passporting is impossible for a license regarding this activity. Regularly, the companies in these cases will not have any interest in passporting their license because they will be able to offer their services in the target member state even without any license. This becomes problematic if two or more member states regulate an activity differently from each other. In these cases, companies that operate in more than one member state or even in the entirety of the EWR would have to apply for a license in each of these member states separately in order to ensure a proper regulated business operation.

        IS THE REGULATION OF CRYPTO CUSTODY SERVICES BASED ON THE 5. EUROPEAN AML DIRECTIVE?

        The German legislator used the transposition of the provisions of the 5. European AML Directive as an opportunity to regulate crypto custody services as financial services that are subject to authorization by BaFin. Nevertheless, the EU-Passporting will not be applicable to crypto custody services because the directive does not call for it to be a financial service that is subject to approval by the competent authority of the member states. The directive merely obligates the member states to order custodians of virtual currencies to comply with the due diligence obligations of the AML regulations. This primarily means that they have to identify new customers (KYC) and that they have to verify the identity when and if the customer receives or authorizes a bigger transaction or any if any other suspicious facts should arise. In this respect the introduction of crypto custody services as a financial service that is subject to authorization is a national solo effort that is not based on the AML Directive. Therefore, the German federal government massively hinders the European freedom of services of crypto service providers with this proposed legislation.

        Attorney Lutz Auffenberg, LL.M. (London)

        I.  https://fin-law.de

        E. info@fin-law.de

        subscribe to Newsletter

          Contact

          info@fin-law.de

          Aug 05, 2019

          Crypto Custody Service – New Financial Service Providers as the Future Centers of Power of the Crypto Market?

          On 29th of July the German federal government resolved its draft proposal for the transposition of the provisions of the 5. European AML Directive into national law. It can be expected that this draft in its current form will be passed into law by the end of 2019. As of 1st of January 2020, crypto assets will be included in the catalogue of financial instruments in the German Banking Act (KWG) and crypto custody services will be considered as a financial service that is subject to authorization from BaFin. While the inclusion of crypto assets in the catalogue of financial instruments in the German Banking Act will not significantly affect the current regulation of blockchain units in Germany, the proposed regulation and creation of crypto custody services will lead to a situation in which the German crypto market cannot function without BaFin supervised services of this kind.

          CRYPTO ASSETS EXPAND THE CATALOGUE OF FINANCIAL INSTRUMENTS IN THE GERMAN BANKING ACT (KWG)

          The criticized administrative practice of BaFin according to which Bitcoin and comparable cryptocurrencies are units of account and therefore financial instruments according to the German Banking Act (KWG) will be accompanied by the explicit qualification of crypto assets as financial instruments within the German Banking Act (KWG) itself. The German legislator does not want to leave any doubt that the German crypto market is regulated and that crypto service providers need a BaFin approval prior to the start of their business operations. After this law will be passed it will be irrelevant for the qualification as a financial instrument if a blockchain unit is meant to be an alternative means of payment such as Bitcoin or if it is meant to be an investment vehicle. The decisive factor will be if the coin in question will fit the definition. More precisely if it is the digital representation of a value that is not issued by a public institution and that is useable as a means of exchange because of a private agreement or actual practice and that can be transferred, stored, and traded electronically.

          CRYPTO CUSTODY SERVICES AS THE NEW CENTER OF POWER

          As of the 1st of January 2020, the storage, management and safeguarding of customer crypto assets or private cryptographic keys that are meant to store or transfer crypto assets will be a financial service that requires prior BaFin authorization. The decisive difference between the draft proposal of the German Ministry of Finance from May 2019 and this (now resolved) draft by the German federal government is the newly introduced section 32 subsection 1 g into the German Banking Act (KWG). According to this new provision, BaFin can only license companies as crypto custody services if these companies do not offer any other banking or financial services that would also require BaFin authorization. That means that companies that currently offer their customers the permanent or temporal storage of crypto assets in addition to their BaFin licensed other business model will not be able to continue doing so without outsourcing the crypto custody service to a licensed crypto custody service provider. An application from these companies for obtaining a BaFin license as a crypto custody service cannot be successful. This will especially affect centralized crypto exchanges but also financial portfolio managers and crypto payment services that have a credit balance function for their customers. Especially centralized crypto exchanges depend on the temporal storage of client crypto assets to settle the customer transactions. The German crypto market will then be regulated in a similar manner as currently the securities market, where customer securities must be stored by central securities depositories such as Clearstream AG.

          WHAT IS THE REASON FOR THE EXCLUSIVE LICENSING OF CRYPTO CUSTODY SERVICES?

          By the decision to design crypto custody services as an exclusive financial service (meaning that a company can only offer crypto custody services and no other financial or banking service that requires a BaFin license), the German legislator wants to centralize the crypto market. The exchange of cryptocurrencies or other crypto assets via service providers shall in the future require the commission of a BaFin licensed crypto custody service. The legislative decision to centralize the German crypto market is most probably influenced by the latest FATF recommendations. The FATF recommended to the global legislators to regulate crypto service providers in general in order to combat money laundering and terror financing. To achieve this, the FATF suggested that every crypto service provider that is involved in a crypto transaction should be obliged to collect information about the recipient and the sender of that transaction and provide this information to the counterpart of the transaction, specifically the other crypto service provider, as well as to the competent supervision authority. These obligations and corresponding systems can be implemented much easier in a centralized system than in a decentralized one. The basic idea of decentralization as the fundamental technical innovation of blockchain technology will however be put in tight shackles with the centralization of the crypto market.

          Attorney Lutz Auffenberg, LL.M. (London)

          I.  https://fin-law.de

          E. info@fin-law.de

          subscribe to Newsletter

            Contact

            info@fin-law.de

            Jul 29, 2019

            Crypto Assets vs. Units of Account – What would be the Impacts of the Introduction of Crypto Assets as Financial Instruments?

            The German Ministry of Finance caused a stir to the German cypto community in May 2019 with its first draft for the transposition of the provisions of the 5. European AML Directive into national law. The ministries draft would not only implement the mandatory regulations from the directive to the German Anti Money Laundering Act but go beyond and define crypto assets as financial instruments according to the German Banking Act (KWG). While the 5. European AML Directive requires the EU members to create a definition for virtual currencies that includes not only crypto currencies but also other forms of alternative money such as computer game currencies, the ministries draft explicitly targets crypto assets and therefore transferrable blockchain units. It is questionable if this first draft of the German legislator is sufficient to implement the European requirements. If, however the elevation of crypto assets to financial instruments in the sense of the German Banking Act becomes legislative reality, the big question would be what regulatory effects this would have on blockchain related Fintech companies?

            LANDMARK RULING FROM THE COURT OF APPEAL IN BERLIN REGARDING BITCOIN AS UNITS OF ACCOUNT

            Already since 2011 BaFin qualified Bitcoin and comparable cryptocurrencies in an established administrative practice as units of account and therefore as financial instruments according to the German Banking Act. When the Court of Appeal in Berlin in a criminal case in September of 2018 ruled (Urt. v. 25.09.2018, Az 161 Ss 28/18) that Bitcoins cannot qualify as units of account as defined in the German Banking Act BaFin was quick to announce that it would stick to its established administrative practice as long as the competent administrative courts would not declare this practice unlawful or until the German legislator would regulate the subject otherwise. It can therefore be assumed that the aforementioned ruling motivated the German legislator to regulate the subject by specifically defining crypto assets as financial instruments according to the German Banking Act.

            CRYPTO ASSETS AS FINANCIAL INSTRUMENTS WOULD BE A GERMAN SOLO EFFORT

            The fact that the definition of crypto assets as financial instruments would be a solo effort within the European Union by Germany is problematic and has faced a lot of criticism during the course of the discussion that ensued after the first draft of the ministry was released. A base for such a legislative action cannot be found in the European directives or provisions regarding the banking or financial service regulations. As stated, the 5. European AML Directive requires the member states merely to define virtual currencies. That those emerge into a full-fledged financial instrument with all the regulatory implications that come along with this kind of qualification is not required by the directive. Interestingly enough, the regulation of units of account likewise does not have any legal basis within the European directives. The German legislator incorporated these into the catalogue of regulated financial instruments because he wanted to regulate the trading of units of account in the same way in which the trading of foreign currencies is regulated. Because the trading of cryptocurrencies is an international phenomenon, it should be undesirable to have different regulations for crypto assets within the European Union’s member states. The German legislator could instead campaign for the incorporation of marketable cryptocurrencies in the catalogue of the second Markets in Financial Instruments Directive (MiFID II). This would ensure a homogeneous regulation of cryptocurrencies throughout the European Union.

            WHAT EFFECTS WOULD THE QUALIFICATION OF CRYPTO ASSETS AS FINANCIAL INSTRUMENTS IN GERMANY HAVE?

            The effects of the proposed draft on blockchain affiliated Fintech companies in Germany would be very limited because neither under the current regulatory situation which qualifies Bitcoin and Bitcoin-like cryptocurrencies as units of account nor under the proposed regulation those cryptocurrencies would qualify as financial instruments as defined by MiFID II. While the regulations of the German Banking Act would still be applicable, the other capital markets regulations that result from e.g. the German Securities Trading Act, the European Market Abuse Directive or the German Securities Prospectus Act would only be applicable if the crypto asset in question fulfilled the additional prerequisites to qualify as an financial instrument according to the law in question. The EU Passporting, that is the usage of a German BaFin license in other EU member states, would still be impossible because the regulation would still not be harmonized within the EU. Positive from a solely German point of view would be that the German legislator reacts to the legitimate criticism from the Court of Appeal in Berlin regarding the current regulatory situation in Germany and that the regulatory situation would get the necessary legal clarification.

            Attorney Lutz Auffenberg, LL.M. (London)

            I.  https://fin-law.de

            E. info@fin-law.de

            subscribe to Newsletter

              Contact

              info@fin-law.de

              Jul 16, 2019

              Seminar on Anti-Money-Laundering Regulation and Virtual Currencies

              On 30th September 2019 Lutz Auffenberg, LL.M. will inform about the regulatory obligations of BaFin-regulated institutions and possible pitfalls regarding virtual currecnies and crypto assets in a daytime seminar of Forum Institut für Management GmbH in Jumeirah Hotel in Frankfurt on Main. Next to the current state of regulation on basis of the EU’s fourth AML directive, the upcoming new regulations as a result of the transposition of the provisions of the fifth AML directive until 10th January 2019 as well as the recent amendments to the FATF’s recommandations on regulation of crypto assets will be discussed and explained. The seminar addresses both decision makers in institutions as well as representatives in AML- and other compliance functions.

              Forum Institut für Management GmbH grants a discount of 20% when signing in to the seminar via the following link:

              https://www.forum-institut.de/check-out/1909303-virtuelle-waehrungen-geldwaesche/17/N/0/161860/93c1f96

              subscribe to Newsletter

                Contact

                info@fin-law.de

                Jul 01, 2019

                Decentralized Exchanges – Crypto Exchanges Without a BaFin License?

                Decentralization was one of the main motivations of the authors of the Bitcoin whitepaper in 2008. The Bitcoin ecosystem was supposed to enable payments between the users without the necessity of intermediaries such as payment processors or banks. While the possibility of peer-to-peer payments is an inherent use case with all cryptocurrencies the trading of cryptocurrencies took a rather centralized path right from the beginning. The majority of all crypto transactions take place on crypto exchanges which act as a centralized entity for the matchmaking between the buy and sell orders of their customers. From a regulatory point of view these exchanges are, depending on the way they operate, either a multilateral crypto trading facility, a crypto exchange bureau or a crypto broker. The operating of a crypto exchange in Germany is a regulated business that requires a BaFin approval.

                WHAT IS A DECENTRALIZED EXCHANGE?

                Decentralized Exchanges (Dex) differ from centralized crypto exchanges due to the fact that the cryptocurrencies of the users are not stored with the operator of the exchange to settle the trades that are made on the exchange. Instead users can settle their trades directly via a Blockchain address that they control. To do so, they have to interact with a smart contract that works as a decentralized App (dApp). This dApp automatically matches the participating parties of the trade and settles the transaction. The participating parties of the trade transfer the cryptocurrencies to be exchanged to a blockchain address associated with the smart contract instead of transferring them to a blockchain address that is controlled by the operator of the crypto exchange. As soon as the smart contract received the transactions of both parties it will automatically settle the trade.

                IS A BAFIN LICENSE REQUIRED TO OPERATE A DECENTRALIZED EXCHANGE?

                The questions if and how a Decentralized Exchange has to be regulated under German law depends on how the exchange in question is designed. In a constellation in which the underlying smart contract is operated by a determinable administrator the aforementioned advantage of not having to store the traded cryptocurrencies on a wallet associated with the exchange is retained. Nevertheless, in this example the administrator might be operating a multilateral crypto trading facility, if he matches the buy and sell orders of his customers concerning cryptocurrencies (and therefore financial instruments) according to a pre-determined system via the smart contract. This kind of activity is cannot be carried out in Germany without the prior approval of BaFin. If however the Decentralized Exchange would be designed as an open source project without a determinable administrator it would lack an operator that could be addressee of an authorization obligation. This kind of exchange would also cater to the original idea of decentralization as promoted by Satoshi Nakamoto.

                DOES THE OPERATION OF A DECENTRALIZED EXCHANGE HOLD REGULATORY ADVANTAGES FOR THE OPERATOR?

                A decentral design of a crypto exchange does not only protect the customers of said exchange from the insolvency risk of the exchange. The provider himself might have substantial benefits from operating a decentralized exchange instead of a centralized one. First of all, the provider does not have to protect the cryptocurrencies of his customers in his own wallets with private keys against cyber-attacks because these cryptocurrencies are at no point in time in his possession. In order to be approved by BaFin centralized crypto exchanges have to design risk management concepts that explain in detail how they intend to deal with the added risk that arises from the custody of customer assets. Second of all, the starting capital requirements can be higher for centralized crypto exchanges than for their decentralized counterparts. If the operator of a multilateral crypto trading system for example stores security tokens of his customers in his own wallets he has to show a starting capital of at least 125.000 euros to BaFin instead of the 50.000 euros that would be required in case of not storing securities or funds of customers. Furthermore, a Decentralized Exchange is an interesting option with regards to the German Ministries of Finance draft legislation for the transposition of the 5. European AML Directive. The draft proposes that crypto custodian business shall be regulated as a financial service. Decentralized Exchanges would not subject to this regulation because they will never be in possession and therefore never have custody of their customer’s cryptocurrencies.

                Attorney Lutz Auffenberg, LL.M. (London)

                I.  https://fin-law.de

                E. info@fin-law.de

                subscribe to Newsletter

                  Contact

                  info@fin-law.de

                  Jun 24, 2019

                  Security Token and The German Debenture Bond Act – Are They Mutually Exclusive?

                  The approval of the first security prospectus for a security token offering by BaFin at the beginning of this year came like a thunderbolt to German capital markets regulation. The Authority proved itself open for innovations. At the same time, the German legislator is laying the groundwork for facilitating the emission of security tokens in the future. In March 2019, the Ministry of Finance and the Ministry of Consumer Protection released a joint paper on the subject outlying the problems and possible solutions for the emission of security tokens in accordance with German law. The phenomenon of blockchain based capital markets emissions offers the long-awaited opportunity to reform and adjust the outdated German debenture bonds regulation and the corresponding civil law in order to adapt these important regulative tools to the technical and digital possibilities of our time.

                  DO SECURITIES REQUIRE PAPER DOCUMENTS UNDER GERMAN LAW?

                  The German securities laws developed over a long period of time. The German legislator failed for decades to adjust the substantive law to the changing technical circumstances and developments. The market therefore had to adjust its systems with an array of legal constructions that including indirect security custodies and transfer statements in order to legally enable the nowadays common practice of transferring securities electronically. The end product of aforementioned constructions is always a global certificate in paper form that certifies the security. That it is, at least according to BaFin, indeed possible to create securities in accordance to German law without a paper document is displayed by the above mentioned approval of the securities prospectus for a security token offering in which the offered securities only exist in the form of token from a smart contract that is mounted on the Stellar blockchain. From a legal perspective, there are good arguments for and against non-paper-based securities under German law. A definitive legislative regulation would however be the only possibility to eliminate the legal uncertainty and would therefore be much appreciated.

                  WHAT IS INVESTOR PARTICIPATION ACCORDING TO THE GERMAN DEBENTURE BOND ACT?

                  Emitters usually choose to issue a bond, e.g. a profit participation right, if they do not want the investors to have a say in the company decisions. Bond investors obtain only contractual claims versus the issuer like a fixed or variable rate of return and a repayment claim. They cannot interfere in the corporate decisions of the issuer. On the other hand, it might be desirable for an emitter to grant investors participation rights that go beyond the aforementioned contractual claims. According to the German Debenture Bond Act emitters can decide that the conditions of the issued security may be changed with a majority vote of the investors. Especially for emitters that plan to issue bonds in the form of a security token the possibility to change the token conditions after the token is issued can be a desirable and decisive advantage. Without this possibility the emitter would have no option to adjust the token conditions to e.g. a legislative change. Also, a lifetime extension of the token in order to long-term finance the company and a postponement of the repayment claim or an adjustment of the rate of return are de facto impossible without this option because an individual agreement with every security token holder to individually contract these changes is unrealistic.

                  IS THE GERMAN DEBENTURE BOND ACT APPLICABLE TO SECURITY TOKEN OFFERINGS?

                  The ministries in their paper as well as numerous authors in the legal literature assume that the German Debenture Bond Act in its current version is only applicable to bonds that are certified in a paper document. They refer to the so-called principle of scripture that is stated in sec. 2 of the German Debenture Bond Act. According to this principle, the conditions of a bond must be laid out in the document of said bond. The amendment of the German Debenture Bond Act and the abolition of the principle of scripture would be a much-appreciated project. However, it can already be argued with good reasons that the German Debenture Bond Act in its current form is already applicable to security tokens. The German legislator explicitly stated in the justification documents for the last amendment of the Debenture Bond Act in 2009 that this law is supposed to be applicable to all bonds regardless of the form of the certification. This argument of the legislator can be understood as an indication that blockchain based bonds should be included in the scope of the German Debenture Bond Act as well.

                  Attorney Lutz Auffenberg, LL.M. (London)

                  I.  https://fin-law.de

                  E. info@fin-law.de

                  subscribe to Newsletter

                    Contact

                    info@fin-law.de

                    Jun 17, 2019

                    The New Proposal for Crypto Regulation of the FATF – Crypto User Data For All and Full Transparency in Crypto Transactions?

                    Mitigating money laundering and terrorist financing are tasks that can only be addressed with internationally coordinated actions because of their global context. The Financial Action Task Force (FATF) is since its establishment in 1989 the driving force of these agendas. Even though the Paris based institution as an intergovernmental organization does not hold legislative powers itself, it periodically updates and publishes recommendations and interpretive notes concerning the regulation of anti-money laundering and terrorist financing measures. These recommendations are acknowledged as the international standard on this subject by the FATF member states and for the most part these recommendations are implemented in those states via self-commitment.

                    WHICH NEW CRYPTO REGULATION IS FATF CURRENTLY PROPOSING?

                    Cryptocurrencies and other virtual assets have been part of FATF standards for the last couple of years. At first, FATF discussed a general licensing obligation for Virtual Asset Service Providers (VASPs). In the current draft of an update of the interpretive note to FATF recommendation no. 15, FATF plans to introduce a far more extensive interpretation guideline. In subsection 7 (b) of the draft of the interpretative note FATF proposes that its member countries should ensure that VASPs in their jurisdiction obtain and hold information on the originator as well as the beneficiary of all crypto transactions that they processed and that this information is submitted to any beneficiary VASP if the cryptocurrency is transferred again. Furthermore, FATF suggests in this draft that abovementioned information is to be made available to the competent supervision authorities on request. FATF already announced that it plans to decide on the adoption of these changes in June of 2019.

                    WHAT WOULD BE THE CONSEQUENCES OF FATF´S REGULATION PROPOSAL FOR CRYPTO TRANSACTIONS?

                    For service providers offering their customers crypto transactions and wallet services the new interpretive note on recommendation no. 15 would mean that they would have to create systems that enable them to obtain, transmit and receive the aforementioned required customer data. This would pose a serious threat to the financial privacy of their customers. These systems would have to be operated on an international level and therefore meet the more or less rigid data protection regulations of the FATF member countries. Therefore, smaller VASPs in countries with low IT security requirements could be targeted by data thieves who so could steal sensitive financial information from a vast number of crypto users. The targeted crypto transactions, those that are made with the intend to launder money or to finance terrorism on the other hand could simply avoid VASPs and instead use peer-to-peer transactions to and from wallets that are kept on local devices. A storage or transmission of the involved party data between VASPs would not take place in this case. FATF’s objective of mitigating money laundering and terror financing therefore seems unachievable with this kind of regulation.

                    WHAT ARE THE CONSEQUENCES OF THE FATF PROPOSAL FOR PRIVACY COINS?

                    The fate of so-called Privacy Coins such as Monero or ZCash could, if the proposal is implemented, be a complete prohibition of use through VASPs. Privacy Coins focus on the financial privacy of their users by obfuscating the participating blockchain addresses as well as the transferred amounts of coins. In these blockchain systems the data required by the VASPs for compliance with the FATF Proposal could not even be obtained for technical reasons. Privacy-focused blockchain based payment systems trying to implement the basic ideas of banking secrecy and financial privacy into blockchain transactions would therefore only be available on an unregulated peer-to-peer basis. It seems questionable that FATF considered these consequences prior to drafting this proposal.

                    Attorney Lutz Auffenberg, LL.M. (London)

                    subscribe to Newsletter

                      Contact

                      info@fin-law.de

                      Jun 11, 2019

                      8 Million Euros via Security Token Offering without a Prospectus – What are the Prerequisites?

                      [et_pb_section fb_built=”1″ admin_label=”section” _builder_version=”3.22″ global_colors_info=”{}”][et_pb_row _builder_version=”4.10.6″ _module_preset=”default” global_colors_info=”{}”][et_pb_column type=”4_4″ _builder_version=”4.10.6″ _module_preset=”default” global_colors_info=”{}”][et_pb_button button_text=”for German version click here” _builder_version=”4.10.8″ _module_preset=”default” custom_button=”on” button_text_size=”13px” button_border_width=”1px” button_border_radius=”0px” hover_enabled=”0″ global_colors_info=”{}” button_url=”/8-millionen-euro-ueber-security-token-offering-ohne-prospekt-was-sind-die-voraussetzungen/” sticky_enabled=”0″][/et_pb_button][/et_pb_column][/et_pb_row][et_pb_row admin_label=”row” _builder_version=”3.25″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” global_colors_info=”{}”][et_pb_column type=”4_4″ _builder_version=”3.25″ custom_padding=”|||” global_colors_info=”{}” custom_padding__hover=”|||”][et_pb_text admin_label=”Text” _builder_version=”3.27.4″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” global_colors_info=”{}”]

                      In the summer of 2018 the German legislator decided to allow security emissions in Germany with a volume of up to 8 million Euro without a BaFin approved prospectus. This not only applies to traditional securities but of course and with no restrictions also to those Security Token Offerings that offer a token which BaFin qualifies as a security in accordance to the German Securities Prospectus Act (WpPG). This opens up an interesting possibility for startups and medium-sized companies to procure capital without the laborious procedure of creating a prospectus that would then also have to undergo the BaFin approval process while at the same time a dependency from VC-investors or banks can be avoided. So is it really that simple to procure 8 million Euro without a prospectus or are there other prerequisites that have to be fulfilled instead?

                      SECURITIES INFORMATION SHEET INSTEAD OF A SECURITIES PROSPECTUS

                      Obviously a Security Token Offering with a Hardcap of 8 million Euro is still subject to supervisory provisions. The legislator exempts emitters of said Security Tokens of the normally mandatory prospectus only if they instead create a Security Information Sheet (WIB) that has to be approved by BaFin prior to the public offering of the token. This Security Information Sheet (WIB) has to provide the essential information regarding the token offering and may not exceed 3 pages. It has to include information regarding the design of the Security Token and the rights that are associated with it as well as information about the issuer, the risks that are associated with the investment and the intended use of the procured capital. Compared with the creation of a comprehensive security prospectus the expenditure for the issuer seems manageable.

                      DISTRIBUTION ONLY VIA BAFIN APPROVED FINANCIAL SERVICE INSTITUTIONS

                      The Security Information Sheet contains less information than a comprehensive security prospectus. Therefore, the legislator decided that in order to utilize this issuing method the emitter of a security that falls under the aforementioned regulation has to partner with a BaFin licensed investment intermediary or advisor in order to sell the security to investors. STO emitters that want to offer security tokens on basis of a Security Information Sheet cannot distribute the tokens themselves e.g. via their website but instead have to hire a professional BaFin licensed financial distributer. The distributer is legally required to ensure that private investors do not exceed their individually determined maximum investment amount. This amount is determined by the potential investors individual financial situation but cannot exceed 10,000 euros.

                      IS IT POSSIBLE TO OFFER A SECURITY TOKEN WITH A SECURITY INFORMATION SHEET IN THE WHOLE EUROPEAN UNION?

                      Security Token Offerings that are based on a Security Information Sheet cannot be offered in other European countries via the EU-Passporting procedure. The notification procedure only applies to comprehensive prospectuses. Moreover, the German legislator defined that a security offering that is based on a Security Information Sheet cannot exceed a maximum of 8 million euros hard cap within the European Economic Area. The emitter is certainly free to undergo a comparable regulatory process in any other member state, provided that the target state offers a comparable exemption to its prospectus regulation. If an STO is supposed to address the entire EU a comprehensive prospectus that can be notified in other EU member states via EU-Passporting is most probably the cost and time efficient alternative.

                      WHAT OTHER DOCUMENTS HAVE TO BE CREATED FOR A SECURITY INFORMATION SHEET BASED STO?

                      The exemption from the obligation to create a comprehensive prospectus does not free the STO emitter from the other obligations that are necessary to successfully offer a security token. The token terms which define the legal design of the offered token as well as the terms of token sale which define the offer conditions of the STO have to be crafted with utmost diligence. Moreover, all other distribution material like e.g. the whitepaper and any advertising statements have to be legally reviewed to avoid pitfalls. Besides all of the legal documents that have to be created, the STO issuer needs to find a suited distribution partner with a BaFin license as well as developers for the programming the token. FIN LAW has access to a broad network of qualified blockchain developers with STO experience as well as BaFin licensed financial distributers and national and international legal and tax advisors to successfully support an STO project. In conclusion the Security Information Sheet based issuing of a security token can be a cost efficient alternative for STO emitters with a funding goal of 8 million euros or less.

                      Attorney Lutz Auffenberg, LL.M. (London)

                      I.  https://fin-law.de

                      E. info@fin-law.de

                      [/et_pb_text][et_pb_button button_url=”https://subscribe.newsletter2go.com/?n2g=bnenflo7-3kepbm9f-9g1&_ga=2.76407708.842992497.1570698390-510082309.1569668016″ url_new_window=”on” button_text=”SIGN IN FOR NEWSLETTER” _builder_version=”4.9.10″ _module_preset=”default” custom_button=”on” button_text_size=”13px” button_text_color=”#FFFFFF” button_bg_color=”#333233″ button_border_width=”10px” button_border_color=”#333233″ button_border_radius=”0px” button_letter_spacing=”2px” button_font=”|700||on|||||” button_use_icon=”off” animation_style=”zoom” global_module=”775″ global_colors_info=”{}”][/et_pb_button][/et_pb_column][/et_pb_row][/et_pb_section] subscribe to Newsletter

                        Contact

                        info@fin-law.de

                        Jun 03, 2019

                        Initial Exchange Offerings – What is that and Can They Be an Alternative to STOs?

                        Some of the biggest internationally operating crypto exchanges started recently to offer so called initial exchange offerings (IEO). For a couple of months now, interested companies can procure funds through this new blockchain funding method by publicly offering their blockchain tokens on platforms like Binance Launchpad, KuCoin, Bittrex IEO, Huobi Prime and OK Jumpstarter. By now some new tokens have been issued and sold to investors via Initial Exchange Offerings. Veriblock, MultiVAC and Matic can be named as exemplary IEO projects. But are IEOs actually a new form of token emission? And if so, what exactly is the difference between initial exchange offerings on the one hand and Security Token Offerings and initial coin offerings on the other?

                        CRYPTO EXCHANGES AS CENTRAL EMISSION AND SALES PARTNER

                        The essential difference to the known funding methods of STOs and ICOs is that in an initial exchange offering, a crypto exchange acts as the central emission and sales partner of the emitter. Potential issuers being interested in an IEO for their project firstly need to apply to a crypto exchange that offers IEOs. If the emitter and the exchange come to an agreement regarding the token emission the public offering of said token will be conducted via the crypto exchange. This holds the advantage for the issuer that his token will be listed on this crypto exchange after the IEO is completed. This in return means that the secondary trading of the token after the IEO is immediately possible via the platform of the partnering crypto exchange. Furthermore, the IEO exchanges provide a substantial reach for the issuer and can advertise the token sale to their customer base. This can certainly have positive effects on the sales success of the IEO.

                        WHAT KIND OF TOKEN CAN BE OFFERED VIA AN INITIAL EXCHANGE OFFERING?

                        An initial exchange offering is generally conceivable for any kind of token. Most of the projects so far offered – not unlike ICOs in the past – were based on utility tokens anyways. These tokens do not grant their owner any participation rights but instead are usable within the emitter’s business model. It is possible to issue security tokens via an IEO, if the stricter regulatory requirements that are applicable to securities are fulfilled. Most securities cannot be publicly offered without a prospectus that is approved by the competent supervision authority. Furthermore, the IEO platform itself also has to fulfill stricter regulatory requirements for the listing of security tokens in contrast to the listing of utility tokens. In accordance with the EU Prospectus Directive not only the emitter of the security tokens but also the IEO platform might be viewed as the issuer of the token and therefore as responsible entity for the securities prospectus. Moreover, EU securities regulatory law, especially MiFID II and MiFIR, is applicable in this scenario. This is most likely the reason why utility tokens right now, after their loss of significance in 2018, experience a renaissance and why security tokens have mostly not been offered via initial exchange offerings, at least not in the regulated jurisdictions.

                        CAN AN INITIAL EXCHANGE OFFERING BE OF INTEREST FOR EMITTERS?

                        The advantages of IEOs for emitters are obvious. Startups thinking about conducting an IEO should however carefully consider the fact that a utility token might not be the best funding method for their needs. Many of the former ICO investors are still frustrated by the disappointing performance of utility tokens that they invested in. So, on the one hand it seems questionable that they would invest again in a utility token and on the other hand a utility token with a very limited use case and a bad performance might tarnish the reputation of the emitting startup.

                        ARE SECURITY TOKEN OFFERINGS WITH PROFESSIONAL ADVISORS AND SALES PARTNERS THE BETTER ALTERNATIVE?

                        If a security token offering with professional counselors, programmers and sales partners is the better alternative to an IEO via a crypto exchange is the subject of debate. The decisive advantage of STOs from the investors point of view is the transparency that comes with the fulfillment of the regulatory requirements, especially with the creation, official approval and publication of the securities prospectus. For new blockchain projects that want to establish a foundation and collect funds for the financing of the technological development of their new technology through the public offering of their coins, an IEO with a crypto exchange as a partner might be a valid alternative.

                        Attorney Lutz Auffenberg, LL.M. (London)

                        I.  https://fin-law.de

                        E. info@fin-law.de

                        subscribe to Newsletter

                          Contact

                          info@fin-law.de

                          to top