Germany ambitious to lead the way in regulating electronic securities
The German government recently started a process towards regulating electronic securities and crypto currencies in order to open the German market generally for electronic securities. Together with the Ministry of Justice, experts at the Finance Ministry published a benchmark paper, titled ‘Enabling digital innovations – Ensuring investor protection’. It outlines underlying parameters for future regulation and is meant to be a first step on the way to ‘make electronic securities possible while safeguarding the requirements of investor protection and to create the necessary legal and application security in civil and supervisory law’.
The government is pushing the issue as part of its broader Blockchain Strategy, as agreed in the coalition treaty of March 2018. It wants to develop the regulatory framework in order to strengthen innovation made in Germany in the areas of digitisation and FinTech. And Berlin seems unwilling to wait for EU-wide harmonisation which would take several years. Discussions on Initial Coin Offerings (ICOs) at European and international level would, however, be taken into account, as to avoid the need to later abandon a ‘special German path’ in case of EU-wide harmonisation.
There is a lot of excitement in industry and politics and no shortage of advice and demands. More than 50 companies, associations and individuals participated in the public consultation process run by the two ministries to gather views and concerns regarding the issue from stakeholders, which are to be considered in the regulation.
According to the benchmark paper, legislation will need to cover a range of aspects including:
Starting with electronic bonds
A draft law will contain civil law provisions on electronic securities and adapt the applicable supervisory law. For the time being, the market will be opened only for electronic bonds; legal provisions for electronic shares will come at a later stage. Since the technical standards and requirements can change rapidly, an authorisation is to be provided to regulate the concrete technical details by statutory order. Moreover, an amendment to the German Bond Act is likely, which currently also requires the existence of a deed in order to enable changes to the bond terms and conditions of electronic bonds in particular.
Electronic securities are to be created by registration in a central register. Following the example of the Federal Debt Act, electronic securities could also be declared property by legal fiction; in this case, all provisions for the protection of property would automatically apply, in particular in the event of enforcement or insolvency.
Alternatively, electronic securities could be made into a new sui generis right; in this case, however, protection provisions equivalent to the protection of property would have to be expressly created. In any case, independent regulation on the acquisition and transfer of electronic securities and good faith protection would need to be created.
For future electronic securities the documentation function of security certificates will be replaced by recording the rights in an electronic securities register.
Investor protection on blockchain
One of the central questions is how investor protection can be ensured for electronic securities, especially when the securities register is kept on a blockchain by the issuer or a third party appointed by the issuer. In this context, regulation will have to consider that issuers could evade domestic investor protection by issuing electronic securities in accordance with foreign law and then offer them to investors in Germany nevertheless.
Utility Tokens / ICOs
Utility tokens are also on the wish list. Aiming to introduce concrete measures to regulate emissions of utility-tokens, the paper includes the option of an interim solution, thus following advice by ESMA to EU institutions on regulation for ICOs and Crypto-Assets (ESMA-157-1391) to put regulatory measures in place sooner rather than later. Current practice of issuing regular so-called “white-papers” provides, according to the government paper, insufficient information for investors as these lack substantial details on the project, related risks and conflicts of interest. A ‘bridge solution’ for national regulation until EU wide rules are in place, would require issuers to publish an information paper with specific content yet to be defined.
Blockchain may not be the only answer
The paper provides that all regulation shall be introduced in a technology neutral manner. Especially considering the high energy demand which comes with using currently available blockchain technologies and the related effects on our climate, blockchain is not to be privileged.
Innovative and safe enough for consumers?
As for now, opening the market for electronic securities is highly welcome in the public sphere. Institutions and commentators already stated their endorsement.
The German Fintech Council – a group of 29 experts who advise the government in questions of digital technology and how it impacts the financial market – calls in its assessment on the government to address legal questions related to cryptography and distributed ledgers. They furthermore stress the need for “clear rules” and call for education initiatives on blockchain and distributed ledgers, pointing to its increased use due to its benefits.
While the benchmark paper discusses the regulatory framework and various specific options, conclusions on what the regulation will actually entail for the financial sector can only be drawn once a draft law is on the table. This was originally expected to happen before summer, but the process seems to be dragging on – after all, the federal Länder need to be won over as well.
Like so often, the outcome will also depend on the interplay between innovation power and consumer protection – watch this space!
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting LLP, its management, its subsidiaries, its affiliates, or its other professionals, members or employees.