The German government has recently published a draft Electronic Securities Act. Among other things, the draft law allows for the issuance of bearer bonds using distributed ledger technology (DLT), introduces a new licence requirement for maintaining the DLT and addresses the most important civil law issues around tokenised securities. Meanwhile, there remain uncertainties at a European level as to the application of financial regulation to security tokens. The European Commission has been considering some of these issues in the context of its cryptoasset consultation. It will be interesting to see how the draft German law interacts with these uncertainties and the conclusions of the Commission in response to its consultation.
Draft Electronic Securities Act
Germany’s draft Electronic Securities Act is a product of its blockchain strategy, announced in September 2019. Among other things, it removes the requirement for a physical document to certify any bond issuance, which has been seen as a particular impediment to the digitalisation of the German capital markets. The new regime builds on the previous introduction of a definition of cryptoassets introduced in respect of a new licence requirement for crypto custody businesses.
We have created an English translation of the draft law which covers not only the draft provisions but also the legislative reasoning behind them.
Key aspects of the new regime
- The draft law only addresses bearer bonds (Inhaberschuldverschreibungen) where there is a significant practical need for modernisation of these instruments to allow for digitalisation. The regulation of electronic shares as well as electronic investment fund units will take place at a later stage.
- Two new forms of issuing bearer bonds electronically: (1) by way of an electronic register which is to be maintained by a central securities depositary (CSD), and (2) via a decentralised crypto securities register (Kryptowertpapierregister). The registrar maintaining such crypto securities register will require a new financial services licence under the German Banking Act (KWG).
- Bearer bond issuers will have a choice between using the existing paper form or to switch to one of two electronic forms.
- Further changes to the German civil law will also be introduced, ensuring the treatment of electronic securities as a “moveable” (Sache) and allowing for a good faith acquisition which is crucial for safe and secure capital markets.
- The draft law requires a description of the security’s underlying technology in the so-called Wertpapierinformationsblatt (a German key information document required for issuances from EUR 100,000 to EUR 1 Million for financial products where no “European” PRIIPs-KID is legally necessary).
- The draft law gives the German Federal Ministry of Finance – in cooperation with the Federal Ministry of Justice and Consumer Protection – wide reaching power to issue decrees to specify technological requirements for the underlying technology.
- As the legal nature of a security is not to be changed, the custody of an electronic security might still require a custody licence. Custody of the private key for DLT- based electronic securities will trigger a crypto asset custody licence requirement.
Legal and market impact in Germany
In our recent Insight on the topic, we discuss the impact of the draft Electronic Securities Act from a German law perspective. In particular, we explore the opportunities and requirements around maintaining a decentralised security register and the classification of electronic securities as a “moveable” under the German Civil Code.
Broader European context
The European Commission has recently led a consultation in relation to the development of a European framework for markets in cryptoassets. Its consultation, which closed in March, is intended to inform changes or clarifications to EU financial regulation, including to facilitate the use of security tokens. The consultation document stressed the need for a harmonised approach across the EU, a principle which is ostensibly supported in the German consultation document.
The European consultation document highlights that there remain various regulatory uncertainties in relation to the issuance and transfer of tokenised securities at an EU level. For example, European regulation requires that where a transaction in transferable securities takes place on a trading venue, the relevant securities are required to be recorded in book-entry form in a CSD. It is not always clear what types of tokenised security meet these criteria. This requirement may limit the impact of Germany’s draft law, by preventing certain securities recorded on a decentralised securities register from being traded on a trading venue (unless the register is maintained by a CSD).
Other jurisdictions, like France, have already implemented regimes to enable the use of DLT in the representation and transfer of securities. The French regime does not apply to tokens listed on a trading venue and thus avoids the regulatory obstacle discussed above. French authorities have proposed creating a European ‘digital laboratory’ to consider the disapplication of European requirements that are incompatible with distributed networks, subject to certain protections.
Some expect that the new law, once implemented, will provide a boost for the use of DLT in the German capital markets. The new regime would also allow new business models to be introduced (e.g. a crypto securities register).
It remains to be seen how the regime will interact with the uncertainties under European law and any action taken by the European Commission in response to its consultation.
The draft law is expected to be adopted by the German parliament after the consultation period and, subject to any possible amendments, by the end of the year 2020 – without any transition periods.
Our team is available to discuss any aspect of the proposed new electronic security regimes and the opportunities it presents.