A Regulatory Approach for Crypto is Congealing with the Efforts by the EU’s Most Powerful Member-States
Jennifer D’hoir is Senior Advisor, Innovation & FinTech at Gide 255, and Katja Langenbucher is a law professor at Sciences Po, in Paris, France
Financial innovation has been put under increased regulatory scrutiny, in particular at the EU level since the publication of the FinTech action plan by the EU commission in March 2018. From a regulatory perspective, the challenge is unprecedented. This is due in part to misunderstandings about the breadth of potential uses of the underlying technology (such as Distributed Ledger Technology or DLT). To help clarify positions and move policy forward, French and German regulators have started a variety of initiatives, ranging from novel legislation in France to preliminary expert hearings in Germany.
France has paved the way with the “PACTE bill” and a new regime for crypto-asset players. Germany is taking a similar path with a public consultation launched by a cooperation of the Ministry of Finance and the Ministry of Justice in early March. Given the slower pace of structuring a comprehensive answer to financial innovation at the EU level, there might be room for the development of “a Franco-German axis”, beneficial for both, development of cross-border innovative businesses and the financing needs addressed by the Capital Market Union plans.
France: a pioneer jurisdiction in the sphere of the crypto-assets regulation
In striking contrast to German law, which until this day requires securities to be evidenced by a document, French law has introduced “dematerialized” transferable securities since 1981. Taking it from there, two key legislative reforms were recently passed in France to facilitate the sustainable and orderly development of crypto-asset related activities.
Firstly, France will enable the registration of securities using DLT (and, in particular, blockchain technology). French law now provides that DLT registration of certain financial securities corresponds to registration in a securities account. DLT registration will capture both, establishing the property of a security and its transfer to a third person. The choice between using DLT rather than account registration is up to the issuer. This innovative approach is limited to securities that are not admitted to transactions by a central securities depository.
Secondly, the French PACTE bill introduces an optional regime for both, utility token issuers and crypto-asset service providers.
Utility token issuers, established in France, will have the possibility to obtain a so-called “visa” for their token offerings. This visa will be issued by the French Autorité des marchés financiers (AMF), if the offer and its issuer comply with a number of requirements, including the preparation of an “information document”. In addition, the issuer will have to comply with regulations on anti-money laundering and combatting the financing of terrorism (AML/CFT) under French law .
Similarily, crypto-asset service providers which are established in France may opt into the new regime as long as the crypto-assets in question do not qualify as financial instrument under MiFID II. If they decide not to opt-in, service providers will still be able to run their activities without a presumption of unlawful conduct in France kicking in. However, if they decide to opt-in, they will have to comply with the requirements applicable under the optional regime and will fall under the authority of the AMF as “licensed crypto-asset service providers”. The law specifies a number of crypto-assets’ related services such as (i) the provision of custodian wallet; (ii) the provision of crypto/fiat exchange; (iii) the provision of crypto/crypto exchange; or (iv) the management of crypto trading platform.
One notable exception to the optional nature of the regime relates to AML/CFT requirements. If a crypto-asset service provider offers services (i) and (ii), it will have to “register” with the AMF and comply with French AML/CFT requirements. This registration requirement is mandatory. In this context, registration means “declaration” and is different from licensing (which refers to the license that will be given by the AMF to the providers that will opt-in). Registration will require essentially a fit and proper test for the management staff of the registered entities. On this basis, the AMF will regularly publish a list of “registered crypto-asset service providers”. The provision of services (i) and (ii) will be prohibited if the providers of those services are not registered with the AMF.
Germany: modernizing its document-based securities regime
Germany, having initially opted for an observant attitude, issued a public consultation on plans to regulate securities and utility tokens on March 7. In an unanticipatedly clear move, the underlying consultation paper suggests to part with German law’s tradition of requiring a paper-based document. Instead, suggesting to follow the model of the Federal Debt Banking Act (Bundesschuldenwesengesetz), it is proposed to introduce a register-based regime. This will allow for (but not mandate) any type of electronic or digitalized security, foregoing a paper-based document. These plans entail far-ranging changes to the private law regime of transferring securities to third parties, of allowing to acquire a security in good faith, for enforcement and for treatment under insolvency laws. To tackle these issues, the consultation paper proposes two options. Digital securities could be treated as tangible objects under a property rights regime. Alternatively, the Swiss book-entry securities approach might serve as a model.
The consultation paper insists on being “technology neutral” so as to cover not only tokens but all securities in digital form. Notably, however, the plan covers bonds only, not permitting “digital shares” for now.
For digital bonds, the consultation paper has identified two key issues to be addressed in public consultation namely (1) how to run the register and (2) how to guarantee investor protection.
Tying the legal notion of a security to a register obviously raises the question of who will be running it. There is a range of possible answers with a state-controlled agency at one end of the spectrum and a more or less tightly controlled private entity at the other end of the spectrum. What the legislator will eventually settle for depends on the trust placed in technologies such as DLT, on the practicalities of including the number of decentralized entities (“nodes”) and on the potential risks of issuers manipulating their own register. Accordance with EU law on central securities depositories, so the consultation paper reminds us, will have to be assured.
Ensuring adequate investor protection is the consultation paper’s core concern and there are a number of suggestions on how to achieve this. A restriction of potential investors is pondered, such as opening an investment in digital bonds for institutionals only. Another possibility is to permit the running of a register exclusively to financial institutions. Should issuers be allowed to manage their own register, the consultation paper insists on some form of additional control. This could require a federal license to run a register. It could also mean that intermediaries have to step in, informing and advising potential investors. Yet another option pondered in the consultation paper is to require the issuer who runs his own register to publish a disclosure and information document for investors.
There are few remarks on how to treat utility token and crypto currencies in the paper. It is confirmed that these are currently not a security under German law and no analogy to prospectus requirements may be drawn. Given the risks an investment entails, the consultation paper seems undecided between waiting for EU regulation and providing an intermediate regime at the risk of having to restructure it once a EU regime is made available.
As demonstrated by the French and German recent initiatives, there is undeniably room for innovative regulatory answers. However, to ensure the integrity of the EU Single market, these answers should be, at a minimum, consistent, and, in the long run, harmonized in EU law. This next chapter remains to be written, based on the advice sent by ESMA and EBA to the EU Commission last January and international work being carried on.
(Many thanks to the Creative Commons for the Illustration above).