Electronic securities are on the rise throughout the European Union (‘EU’). For the purpose of advancing the use of blockchain technology, the German Federal Ministry of Finance (‘MoF’) with the Ministry of Justice and Consumer Protection (‘MoJ’) on August 11, 2020, released a draft bill on the introduction of electronic securities (‘draft bill’). The draft bill is a step towards the Germany government’s blockchain strategy as was announced on September 18, 2019. Previously, the German regulators have also paved the way for cryptocurrencies by defining them as ‘financial instruments’, a term which had been only accorded to security tokens by the German Federal Financial Supervisory Authority (‘BaFin’) until March 2, 2020. The year has indeed favoured blockchain applications and cryptocurrencies licensing in Germany with now the new draft bill in the discussion. The draft bill will open the German financial markets to disruptive technologies such as the blockchain which may in turn help in increasing liquidity for the German economy.
The introduction to the draft bill states the need for Germany to become competitive in the financial markets as compared to countries such as Switzerland which have already structured regulations surrounding electronic securities. Through this vision, the German regulators wish to issue electronic securities, i.e. securities without a physical certificate. The draft bill also stipulates that there shall be no compliance costs placed on citizens as the draft bill does not provide any regulations for citizens. The compliance costs for the economy, as specified by the draft bill, shall be in the approximate range of EUR 44,990,000 (forty-four million nine hundred and ninety thousand) which may arise in setting up the technology for facilitating the issuance of electronic securities and updating register technology. Further, the draft bill also states a one-off compliance cost of EUR 38,000 (thirty-eight thousand) which shall arise from taking precautions or advancing the organisational technology to prevent any data loss. However, these are not an exclusive list of expenses and the compliance cost shall contain more administrative expenses as specified by the draft bill at a later stage.
The draft bill specifies the use of decentralised ledger technology (‘DLT’) to issue securities. The draft bill shall be applicable to ‘bearer bonds’ as specified by Section 1. This essentially means that if the draft bill is enacted in its current form, only bearer debt instruments would be given the legal meaning of electronic securities.The draft bill, under Section 2, identifies an ‘electronic security’ as a security that is issued by making an entry to the electronic securities register instead of issuing a security certificate. Such electronic security shall have a legal effect which is similar to a security issued through any document and shall be considered a ‘thing’ within the meaning of Section 90 of the German Civil Code (only corporeal objects are things).
While electronic securities would be given the same legal effect, the draft bill only provides for a possibility and not an obligation on the issuer to issue electronic securities, as per Section 6. Such electronic securities shall be stored in a register provided in Section 12 and Section 16 and such a central register of electronic securities should be in accordance with Article 16 of Regulation (EU) No. 909/2014 of the European Parliament and of the Council of 23 July 2014 to improve the delivery and settlement of securities in the European Union and on central securities depositories as well as amending Directives 98/26 / EC and 2014/65 / EU and Regulation (EU) No. 236/2012 (OJ L 257 of August 28, 2014, p. 1; L 349 of December 21, 2016, P. 5), which was last amended by Delegated Regulation (EU) 2018/1229 (OJ L 230 of 13.9.2018, p. 1). Moreover, the draft bill also provides for the issuance of crypto securities which are securities entered in a crypto-security register as per Section 4(2)(2). Crypto securities register, as per Section 16, is defined to be a typical DLT having features such as no modification, immutability, timestamp. This will ensure that crypto securities are issued on blockchains, increasing the scope and application of DLT in Germany. The electronic securities shall consist of both, (i) securities issue on a central register as per Section 12; and (ii) crypto securities issued on a crypto securities register according to Section 16. This is because electronic security is defined to be security that is stored on an ‘electronic securities register’, which consists of both the crypto securities register and the central register for electronic securities.
The ownership of such electronic securities shall be maintained in an electronic securities register, with specific information to be added by the registrar in both the crypto securities register and the central electronic securities register. As per Section 13, a central register for electronic securities must contain the following information about the registered security:
(i) the essential content of the law including a unique securities identification number;
(ii) the total issue volume;
(iii) the nominal amount;
(iv) the issuer; and
(iv) Information on the mixed stock in accordance with Section 9 (3).
Similarly, as per Section 17, a crypto securities register must contain:
(i) the essential content of the law including a unique identification number and identification as security;
(ii) an indication of whether the entry is individual or collective;
(iii) the holder;
(iv) obstacles to disposal;
(v) third party rights; and
(vi) information on the mixed stock in accordance with Section 9 (3).
In this regard, Section 9(3) states that “if the overall issue consists partly of a collective entry and partly of securities issued by means of a certificate or securities in an individual entry in the same register, these parts are considered to be a uniform collective inventory if this is noted in the register for collective entry.”
Interestingly, while the MoF and the MoJ provide for the use of DLT for crypto securities register, it also states in the introduction to the draft bill that the issuance of electronic securities shall be made in a technologically neutral manner. Hence, the issuance of electronic securities shall not be limited to just DLT and other technologies may be explored as well.
As stated above, electronic securities shall also be a ‘thing’ under the German Civil Code, meaning that they can be accorded the definition of moveables. This means that all the protection as granted to owners of property shall also be accorded to the owners of electronic securities and there shall be comprehensive protection given to them in the same way as to the owners of certified securities. The draft bill also provides for further transfer of ownership and acquisition in good faith as per Section 26.
The draft bill also provides for provisions with respect to electronic securities and securities certificate under Section 6 wherein there is no entitlement to ensure individual securities certificate, however, such certificates can be issued as per standards provided under Section 6.
The draft bill has defined the crypto securities register as a financial service within the meaning of Section 1(1a) of the German Banking Act. This shall provide for more regulation and investor protection while issuing electronic securities and the issuer may also be liable for fines under the German Banking Act. Such crypto registers shall also be obligated towards reporting requirements and shall come under the supervisory authority of the BaFin. Crypto securities registers are also obligated under Section 2(1) of the Money Laundering Act as provided by the draft bill. The draft bill suggests the initial capital requirement for crypto securities register to be EUR 730,000 (seven hundred and thirty thousand), which is extremely higher compared with crypto custody service which is EUR 125,000 (one hundred and twenty-five thousand).
Currently, the draft bill only addresses bearer bonds to be issued as electronic securities. More regulation shall follow in this regard after the successful implementation of standards as provided under the draft bill.
Authored by Shivani Agarwal, Founder, and Samaksh Khanna, Co-founder, BlockSuits.
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