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German government publishes key issues paper for the regulation of digital securities and the issuance of utility-tokens

Views sought by 12 April 2019

19 March 2019

On 7 March 2019, the German Federal Ministry of Finance (BMF) and the Federal Ministry of Justice and Consumer Protection (BMJ) published a key issue paper (KIP) which discusses different proposals of regulating digital securities and the issuance of utility-tokens in Germany.

Moving ahead of any future potential EU harmonised approach, the aim of the German Federal Government is to establish a legal and regulatory environment which provides legal certainty in relation to the issuance of digital securities and utility-tokens while also securing investor protection concerns.

Issuance of Digital securities

The KIP considers a revision of German civil and regulatory laws to provide issuers with the option of digital issuance. In this respect, the current requirement that securities must be embodied in a physical certificate  would no longer be required.

The issuance of digital securities is intended to be regulated on a technological neutral basis. In this respect the use of blockchain technology will not be  prioritised or promoted above other technologies. This move also reflects some concerns with respect to the blockchain's energy consuming environmental impact.

Digital issuance would initially apply to digital bonds (elektronische Schuldverschreibungen) only with digital shares to be dealt with at a later stage.

According to the KIP, digital bonds are created with entry into an electronic register. Contrary to the current applicable regime, such registration replaces the "documentation function" of the security certificate.

With respect to the legal status of such digital securities, the KIP discusses (i) treating digital securities as goods (Sachen) and applying existing German property law,in particular with respect to ownership protection rules or (ii) classifying them as rights of their own (sui generis) which would require the implementation of new ownership protection rules. In both scenarios new rules to regulate the acquisition and transfer of digital securities as well as to protect bona fide rights would be required.

The register is generally maintained by a centralised governmental agency or a body subject to state supervision. Provided that the authenticity and integrity of the digital securities is ensured, and that manipulation is excluded, the KIP also considers the option that (by using blockchain technology) the issuer or a third party instructed by the issuer provides the register.

With respect to safe custody rules, the registration of the securities in an electronic register is not deemed as taking securities into custody. In this respect, electronic registers would not be required to comply with the requirements imposed by the German Safe Custody Act (Depotgesetz).

In relation to the choice of law under applicable conflict of law rules, the KIP suggests that the law of the country which is responsible for supervising the electronic register applies.

To ensure investor protection, the KIP considers the possibility of restricting the distribution of digital securities to retail clients.

Notwithstanding the proposals for a new digital securities regime, the KIP also confirms that digital securities would fall within the scope of existing regulation such as the German Securities Trading Act (Wertpapierhandelsgesetz), the German Securities Prospectus Act (Wertpapierprospektgesetz) and the Market Abuse Regulation, as the definition of "securities" under these rules do not require a physical certificate (körperliche Verbriefung).

Issuance of Utility Token

With respect to the issuance of utility tokens, the KIP identifies a gap in the existing regulatory framework, which leaves investors exposed to substantial risks due to a lack of quality in the information provided by the issuer.

In most scenarios, utility tokens do not qualify as a financial instrument or security and in most cases would not fall under the new digital securities regime. In this respect, lacking the requirement to publish a prospectus or information paper, the KIP addresses the need to secure investment decisions on an informed basis which "whitepapers" cannot provide.

Against this background, the KIP welcomes the proposal by ESMA (Advice on Initial Coin Offerings and Crypto-Assets of 9 January 2019) for implementing a harmonised regime for the issuance of utility-tokens on EU level. To bridge the gap between now and the implementation of a regime on EU level, the KIP considers regulating the issuance of utility tokens in Germany. A central element of such national German regulation could be the requirement that issuers have to publish an information paper subject to BaFin's prior approval before offering the utility token to the public.

Next Steps

BMF and BMJ welcome comments on the KIP until 12 April 2019. After this period, a draft law will be published which considers the comments made on the KIP.  No  timeline has been issued for the publication of the draft law. From our experience we should not expect to see a draft law before autumn 2019.