On August 11, 2020, the German Federal Ministry of Justice and the Federal Ministry of Finance published a draft law on the introduction of electronic securities. This paper is a key element of the federal government’s blockchain strategy.
Who is affected by the planned regulations?
The proposed new regulations will affect companies that
- intend to issue electronic securities,
- plan to establish an STO / eIPO,
- wish to apply for a crypto custody license or a crypto securities register maintenance license or
- have already applied for a crypto custody license.
What innovations does the draft provide for?
- Introduction of electronic securities and crypto securities
Electronic securities and crypto securities are newly introduced. This differentiation is intended to meet the practical need to manage crypto securities without or with as few intermediaries as possible.
- Electronic registration and entry in the register instead of the paper certificate
The difference between a paper and an electronic security lies exclusively in how it is issued. For electronic securities, the production of a paper certificate is replaced by an entry in a centrally managed electronic securities register as a so-called scriptural act.
What securities are covered by the new regulations?
The draft law currently only covers bearer bonds. This means that only those securities that qualify as bearer bonds can be issued as electronic securities. At present, the draft law does not cover all other securities, in particular electronic shares and sui generis securities that are structured in a way similar to securities, such as tokenized investments.
What are crypto securities?
According to the legal definition of the draft bill, a crypto security is an electronic security that is entered in a crypto security register. Crypto securities that are similar to securities but are not structured as bearer bonds are therefore neither an electronic security nor a crypto security and are therefore not covered by the draft law.
Equal protection of ownership and traffic in electronic securities
According to the current legal situation, financial instruments that are structured as securities under civil law must be securitized in a document. The paper-based securities are the starting point for the transfer of ownership under property law and for the protection of potential purchasers.
In the future, electronic securities should have the same property and traffic protection as traditional paper securities. The draft law implements this by classifying electronic securities as objects for which ownership rights can be established and whose transfer is made possible by describing the ownership structure in the registers. The acquisition in good faith should be possible from the person registered in the securities register.
Registers and registration authorities
Electronic securities are issued and administered via a central register and are reflected in the securities giro. The central register handles the documentation function of the classic global certificate. The central register does not perform any additional documentation function; in particular, neither disposals nor transactions involving securities are recorded in the central register. As in the past, the resulting changes are also made in the securities clearing and settlement system, which is still operated by custodian banks and central securities depositories. The central register can only be maintained by authorized central securities depositories. In Germany, only Clearstream Banking AG is currently authorized to do so.
In line with the objective of the new regulations for crypto securities, which is to avoid the use of intermediaries as far as possible, the draft stipulates that crypto securities should be issued and administered in a crypto security register without being reflected in the securities account. As with the central register, it should be possible to enter them in the electronic register as a collective entry, i.e. in the name of a central securities depository or in the name of the custodian. Crypto securities should also be able to be entered directly in the name of the respective entitled persons using the individual entry. The individual entry is intended to record and document both the initial entry in the crypto securities register and each transfer.
Keeping a cryptographic paper register – a new permission in the German Banking Act (KWG)
The draft law provides for the introduction of the new permission to keep a cryptographic paper register in the KWG. Accordingly, in future, the prior written permission of BaFin will be required for “keeping” a crypto securities register.
A crypto security register is only “kept” by the person who is designated by the issuer as the so-called registration authority vis-à-vis the holder. If no party is named, the issuer shall be deemed to be the registration authority. The “operation” of a cryptographic security register is to be distinguished from the “keeping” of a cryptographic security register, which does not require a license. In principle, such operation shall be possible for anyone who has the technical prerequisites to do so.
The prerequisite to be admitted as a cryptographic paper registry administrator is high, i.e. an initial capital of at least EUR 730,000 is required. Furthermore, crypto security registers must be kept in a system that meets certain minimum functional and technical requirements. Specifically, the system must ensure
- decentralized and
- forgery-proof recording and
- log data in chronological order and
- protect them against unauthorized deletion and subsequent modification.
However, as long as the crypto securities registry administrator does not provide any other financial service, he as well as the crypto custodian are subject to certain facilitations, among others with regard to equity capital, capital buffers, liquidity, large, multi-million and organ loans and the non-applicability of individual regulations of the CRR.
New regulations for the authorization of crypto custody business
The draft law is already intended to change the legal basis for crypto custody business, which was only newly introduced into the German Banking Act in January 2020. For this purpose, the draft law will be extended and limited at two points that are important for practice.
The field of activity will be extended, as in the future “the securing of private cryptographic keys, which serve to hold, store or dispose of crypto security for others” shall be a crypto custody activity as well.
Crypto securities cannot be a cryptoasset at the same time, since the regulations on cryptoassets are only designed as a catch-all and the regulations on securities must be applied with priority. As a consequence, the scope of activity of the crypto custodian is to be restricted by the draft to the extent that the custody of crypto securities, which are to be classified as crypto securities, will in future be subject to the German Securities Deposit Act and thus represent a banking transaction in the form of a custodian transaction requiring a license.
Safekeeping of crypto security is a banking transaction requiring a license
The draft thus deviates significantly from the opinion of BaFin, which has a different view on the safekeeping of tokenized securities. If the draft is passed into law in its present version, the safekeeping of crypto securities will no longer be covered by the financial services license for the crypto custody business. In addition to securing cryptographic keys that provide access to cryptoassets and/or crypto securities, the crypto custodian will only be permitted
- to hold,
- to manage and
cryptoassets if they do not meet the requirements of an electronic security. If, however, the requirements of an electronic security are met, they shall be held in safekeeping exclusively by custodian banks.
Initial issue of crypto securities is a crypto security register subject to approval
The crypto custodian has the right to keep both the private and the public key in such a way that public and private keys are generated and stored by the custodian. However, according to the wording of the draft law, this will no longer be possible for crypto securities. As this would entail that the issuer, who only issues its own crypto security, would always need permission according to § 32 KWG, this would lead to a further significant restriction of the crypto custody business.
WINHELLER advises on electronic securities and crypto securities
Would you like to finance your company in the future via electronic securities or an ICO? Are cryptoassets at the heart of your business model? WINHELLER advises companies on the innovations related to the introduction of electronic securities. Please feel free to contact us should you have any questions.
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