SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION

OCTOBER 2020 CONTENTS CONTENTSOverview and classification of tokens...... 3 Overview of local regulation...... 7 1. Lorem ipsum dolor sit amet animal ocurreret qui x 2.Overview Mollis of blandit EU-wide fastidii securities id ius. lawsEa audire applicable adversarium to STOs est,...... quo ei sumo suscipit 9x 3.Country-specific No erant delicatissimi analysis ofeum, STO saepe regulation convenire sed ea xx 4.across Vis Continentaletiam utamur Europe ea, vis and epicuri the UKefficiendi...... ex xx14 5. EiJurisdictions mel iuvaret where facilisi, STOs no arevim primarily nonumes regulated under traditional securities law...... xx15 6. Accusamus France ...... eloquentiam cum et, pri quem intellegebat te ...... xx15 7. Eos fugitGermany deleniti ...... no, et duo omnes iisque ....xx16 Italy ...... 17 8. Sit no habeo veniam. Cu usu essent splendide, qui mentitum suavitate cu xx Luxembourg ...... 18 9. Pro cu alia legimus xxx The Netherlands ...... 19 10. Omnesque mnesarchum constituam pri cu xxx Romania ...... 21 Spain ...... 21 ...... 22 Jurisdictions where STOs are unlikely to be regulated by securities law and no specific regime has been enacted...... 24 Czech Republic ...... 24 Poland ...... 24 Slovakia ...... 25 Glossary of defined terms...... 27 Navigate the disruption: your fintech toolkit...... 28 Contacts...... 29 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION Security token offerings, the issuance of digital tokens using or distributed ledger technology, are increasingly being seen as an alternative to mainstream debt and equity fundraisings. An evolution of the (supposedly) unregulated initial coin offerings or ICOs, security token offerings or STOs are typically structured to sit within securities law frameworks. This means much greater certainty for both fundraisers and investors, resulting in enhanced liquidity. In this report we consider how STOs are structured and some of the benefits and challenges, and explore the evolving regulatory landscape for STOs across Europe.

OVERVIEW AND number of fraudulent issuances, ICOs CLASSIFICATION OF ultimately drew the scrutiny of regulators globally, gaining a bad reputation and SECURITY TOKENS losing appeal. What are security token Summary offerings (or STOs)? STOs are the market response to this; a • STOs involve the issuance of digital STOs are a form of fundraising involving product offering many of the advantages tokens which are classed as or the offering or issuance of digital tokens of the ICO without the risks entailed by represent securities to investors. to investors, which either are themselves seeking to remain outside the regulatory or represent a security under the laws perimeter. In some jurisdictions, the form • Tokens issued under an STO will where they are issued. Typically, and process adopted for an STO may be typically entitle holders to rights distributed ledger technology (DLT), such similar to an ICO. However, in most similar to those of a conventional as blockchain, or other digital jurisdictions, subject to exemptions under security, e.g. an equity token may infrastructure which permits tokenisation, applicable securities laws, the process for grant voting or dividend rights, while is used to constitute or record the issuing security tokens should be no a debt token may grant rights to interests in the securities. Such use of different to an or IPO coupon and principal payments. DLT can provide greater flexibility, speed for equity or other traditional security • There is currently no uniform and functionality, reduce costs and, in offering, i.e. a regulated process with global or European taxonomy for some cases, enhance compliance with significant documentation requirements categorising or defining cryptoassets, legal and regulatory obligations in the and in practice often still effected through and STOs are not currently regulated issuance of securities. This can open up a chain of intermediary banks and other at an EU level. However, a number markets for fundraisers and options for financial services providers. The of EU-level regulations applicable to investors, providing enhanced liquidity, ecosystem of regulated service providers the issue of securities bring a particularly for asset classes traditionally capable of performing the traditional degree of harmonisation. viewed as illiquid. functions required to effect an STO in compliance with local securities laws is • Despite this overlying framework, Market participants may be familiar with emerging, although at varying speeds in the approach to regulation of STOs the “initial coin offerings” (or ICOs) seen in different jurisdictions. varies considerably between 2017-18, typically conducted through an member states; some have enacted online platform maintained by the issuer What is a token? legislation that supplements the EU that any investor can access directly A token is the common term applied to position, while others are unlikely to through a computer or smart phone. a digital entry whereby a person owns, classify security tokens as securities ICOs were sometimes seen as a quick or is recorded as owning, a unit or other meaning that the harmonised and easy way to fundraise outside the entitlement through a DLT-based register framework does not apply. scope of traditional regulatory or other digital infrastructure. The token • In September 2020, a draft proposal frameworks for debt and equity may, in its simplest form, amount to a for an EU regulation on markets in issuances. However, structuring of many permission to control a resource native cryptoassets was published to ICOs fell short, and they often to DLT (for example, or Ether), it improve harmonisation in this area, unintentionally triggered legal and may grant certain rights to the holder (for although it may not apply directly to regulatory obligations that were not example, use of office space or rights to many STOs. complied with. Combined with a share in profits of a company) or it may

3 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION represent an offline “real world” asset, What is a security token? such as a stock, , commodity or In an STO, the form of the token will be interest in real estate. The latter is similar to those issued to participants in commonly referred to as the an ICO in that DLT or other digital “tokenisation” of such underlying assets. infrastructure which permits tokenisation will be used to issue coins or tokens, DLT tokens can be differentiated from but, in contrast to an ICO, the tokens other forms of electronic register as a distributed are, represent or provide a DLT platform typically permits holders to right to a specific class of financial assets verify their holdings on the public chain, that are legally “securities”, such as to send direct instructions to the relevant shares, bonds, warrants or options, network to transfer their tokens, and to or otherwise provide the same rights use their tokens in other ways, e.g., to as “securities”. The definition of what interact with a smart contract or to constitutes a security will vary from implement sophisticated computing logic. jurisdiction to jurisdiction. Therefore a As the real name of the owner is not particular token may be a security token recorded in the blockchain registry, under the laws of one jurisdiction but “holding a token” often means controlling not in another. the key or other access credential needed to send the instructions to the In many jurisdictions, a token will amount network authorising the transfer of the to a security when it represents a right to token, in effect making them bearer any financial return and claim on the assets. In the case of tokenised issuer – even where such financial return securities, many investors will need or is entirely dependent on the success of a prefer to use a custodian or other service particular project. This is different from provider to hold the keys for them. In ICOs or other cryptoasset offerings with some cases this may be done by the the purpose of fundraising, but which issuer of the securities. take the form of a sale or pre-sale of specific goods and services (for example, DLT provides enhanced functionality a real-world asset, a licence or a use compared with traditional systems of right), rather than any interest in the recording ownership of assets by being issuer itself, such as a claim on its globally acknowledged as the true source revenues or the right to participate in of information on the holdings of the its governance. tokens by all members of the network, allowing them to individually verify the The tokens issued under an STO will validity of token transfers on their own, typically entitle holders to rights similar without needing to trust a central to those of a conventional security, authority or each other. However, the depending on the nature of the security flip side is that instructions can be represented by the token or the specific irreversible once sent to the network in rights granted by the token. For example, respect of the tokens – creating risks by an equity security token may represent reducing the rights over tokens to ownership over an underlying share or whoever holds that key. otherwise grant a claim to the equity in a company, voting rights or the right to DLT tokens may also be referred to as dividends, while a debt security token “cryptoassets” as they are seen as rights may represent ownership over an in respect of what a person holding a underlying bond or grant a right to token can do (claim underlying assets, predefined coupon or principal payments. update a network etc), and crypto as a reference to the cryptographic technology In this report, we generally use the term used to structure and operate a DLT “STO” to refer to security tokens that platform. An STO generally refers to that have been intentionally structured to subset of cryptoassets or other digital confer the types of rights granted in assets which constitute, represent, or conventional securities, i.e. tokenised confer the rights associated with, debt and equity. In some cases, the traditional financial securities. tokens issued in ICOs or other cryptoasset offerings might unintentionally constitute securities. In the US, for

SECURITY TOKEN OFFERINGS – 4 A EUROPEAN PERSPECTIVE ON REGULATION example, the Securities and Exchange that there is consistency across EU Commission has taken the position that jurisdictions between what would be a certain issuers of “utility tokens” in ICOs token offering regulated under this inadvertently offered securities for the regulation vs. an offering of security purposes of US law, and accordingly tokens regulated under MiFID II, the violated the registration and disclosure Prospectus Regulation and other existing provisions of the federal securities laws. regulations. However, it is likely to take many months for the draft regulation to Regulation of STOs be agreed and come into effect. Due to the legal status of security tokens as securities, the generally more onerous In the meantime, a number of EU-level regulatory regimes applicable to securities regulations applicable to the issue of will typically apply to STOs in addition to securities, including in relation to any more recent regulations specific to prospectuses and transparency, trading issuing tokens or other cryptoassets. and market abuse, bring a degree of harmonisation to the European regulatory In contrast, ICOs would typically be framework for STOs as outlined further structured to avoid the need to register below. However, notwithstanding such or comply with securities regulations and overlying framework, the approach to regulatory bodies. However, as noted regulation of STOs still varies above, this is not always clear-cut and, considerably between jurisdictions. in several jurisdictions, ICO issuers have inadvertently triggered and been in In certain jurisdictions STOs do not breach of securities laws. satisfy the requirements to be legally characterised as securities, rendering the A variety of approaches have been taken EU framework largely irrelevant. In other globally as to the regulation of STOs. cases, while the EU framework generally There is now considerable opportunity for applies, jurisdictions have begun to regulators to adapt existing securities implement specific legislation which regulation to the unique features of STOs governs the use of DLT that may impact while also maintaining similar protections STOs. The current approaches to the for investors and the financial system that regulation of STOs across Europe can underpin securities regulation. be broadly split into two categories:

Regulatory themes across the • jurisdictions that primarily regulate (EU) and the UK STOs under the traditional rules There is currently no uniform global or applicable to securities, including in European taxonomy for categorising or some cases where specific defining cryptoassets, and STOs are not legislation has been proposed or currently regulated at an EU level. enacted that facilitates the use of However, in September 2020 a draft DLT and may impact STOs (including proposal for a regulation on markets in France, , Italy, Luxembourg, cryptoassets was published to improve the Netherlands, Romania, Spain harmonisation in this area. and the UK); and • jurisdictions where traditional As currently drafted, the regulation would securities laws are unlikely to apply only apply to an STO to the extent that to STOs without further legislative the tokens are not covered by EU change, and no specific regulatory financial services legislation (unless the regime has been implemented tokens also qualify as e-money tokens). (including the Czech Republic, As outlined below, many STOs would Poland and the Slovak Republic). In currently be covered by EU financial this case, the regulatory treatment services legislation applicable to MiFID of STOs depends instead on other financial instruments and so appear to fall rules, e.g., those governing outside scope of the new proposed intangible assets in the Czech regulation. It seems likely that as part of Republic, or property law in the harmonisation measures, member states Slovak Republic. will be required to take action to ensure

5 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION No European jurisdiction has such, this paper does not consider in implemented its own dedicated detail the regulatory treatment of other regulatory regime for STOs, and that types of cryptoassets (such as seems less likely now that attention is stablecoins, which may in some cases focussed on harmonisation under MiCA qualify as electronic or e-money under and related amendments. the E-money Directive, or cryptocurrencies). A detailed Our approach consideration of the regulatory In this report we have focused on requirements that may apply when securities and related regulations, carrying on other activities relating to however, there are a wide range of legal security tokens (such as secondary and regulatory provisions that may also market trading or providing investment be relevant to participants in an STO over advice or custody services in relation to and above the frameworks that we security tokens) is outside the scope of describe, for example, in relation to data this paper. privacy, tax and other levies, cyber- resilience, corporate governance and It is also worth noting that the analysis systems and controls. How these apply has broadly been undertaken on a will depend significantly on the specific domestic basis, i.e. in relation to an STO STO and, in some cases, the corporate that is conducted and also marketed to form and status of the service provider investors solely in that jurisdiction and/or (i.e. regulated or not and, if so, how) and in relation to an STO by an issuer based so are beyond the scope of this report. in that jurisdiction. However, where there are regulatory requirements in a The focus of this paper is on STOs, i.e. jurisdiction, these may also apply to an primary market offers to the public of STO conducted elsewhere and/or by a tokens that have been intentionally foreign issuer where there is active structured to confer the types of rights marketing of security tokens to investors granted in conventional securities. As in that regulated jurisdiction.

SECURITY TOKEN OFFERINGS – 6 A EUROPEAN PERSPECTIVE ON REGULATION OVERVIEW OF LOCAL REGULATION To aid your review we have drawn together some of the high-level conclusions from this report by ranking each relevant jurisdiction on its approach to the regulation of STOs, as well as considering whether a regulatory sandbox might be available for STO participants and the general level of crypto market activity.

Level of crypto market activity

Least active

Active

Most active

Jurisdiction Does the usual Do licence requirements Is there specific local Does a regulatory regulatory framework apply to investors regulation or guidance sandbox exist? for securities apply to in an STO? relevant to STOs? STOs?

Czech There is disagreement Generally, no. No No regulatory sandbox Republic among experts. However, but a specialised the stronger argument, communication channel which is also indicated for fintech consultations by the Czech Ministry has been established by of Finance, is that the Czech National Bank. security tokens do not constitute securities.

France Yes, if certain conditions Generally, no. No, but a specific No. are met. regulatory framework governing the representation and transmission of unlisted financial securities via DLT is available.

Germany Yes, if certain conditions Generally, no. Draft legislation to No. are met. introduce the concept of digital bonds has recently been published. BaFin has also provided a guidance note on prospectus and authorisation requirements.

Italy Yes, if certain conditions Generally, no. No. A legal framework for a are met. Italian civil law may new sandbox is currently impose restrictions under consultation. around the form of securities which impacts DLT use.

Luxembourg Yes, if certain conditions Generally, no. Specific legislation exists There is no formal are met. to allow fungible sandbox. However, in securities to be held and addition to various fintech transferred via DLT. Draft incubators, such as the legislation has recently LHoFT, a specific been published to permit innovation department DLT to be used for within the regulator has issuance of been created. dematerialised securities.

The Yes, if certain conditions Generally, no. No Yes. Netherlands are met.

7 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION Poland There is disagreement Generally, no. No The KNF plans to create among experts. However, a regulatory sandbox as a the stronger argument is part of its Innovation that security tokens do Hub Programme. not constitute securities.

Romania Yes, if certain conditions Generally, no. No No regulatory sandbox, are met. but regulatory fintech hubs have been established.

Slovak No - security tokens do Generally, no. No. No regulatory sandbox, Republic not constitute securities. The legal classification of but aregulatory fintech security tokens is unclear, hub has been perhaps the category of established. rights or other proprietary values apply.

Spain Yes, if certain conditions Generally, no. The CNMV has issued Legal framework for a are met. certain guidance on sandbox is currently in regulations applicable to the process of approval tokens should they be by the Spanish considered transferable Parliament. securities.

UK Yes, if certain conditions Generally, no. The FCA has Yes. are met. published guidance on cryptoassets. Security tokens constitute property.

Note: Consideration of whether a licence will be required for investors in an STO has been based on a simple STO issuance made directly to investors, but does not constitute legal advice. Other licence requirements are likely to apply to other participants, for example, an underwriter of an STO or a custodian where tokens are issued into a custody arrangement. There may also be a statutory requirement for the involvement of an authorised central securities depository or CSD for the settlement and/or transfer of security tokens as outlined in more detail below.

SECURITY TOKEN OFFERINGS – 8 A EUROPEAN PERSPECTIVE ON REGULATION OVERVIEW OF EU-WIDE fall outside scope of the new proposed SECURITIES LAWS regulation. It seems likely that as part of harmonisation measures, member states APPLICABLE TO STOs will be required to take action to ensure STOs are not currently specifically that there is consistency across EU regulated at an EU level. However, jurisdictions between what would be a following a European Commission token offering regulated under MiCA vs. consultation on cryptoassets which an offering of security tokens regulated closed in March 2020, a draft proposal under MiFID II, the Prospectus Regulation for a regulation on markets in and other existing regulations. Multiple cryptoassets to facilitate the use of DLT steps will be required before the in financial services was published in legislative framework becomes law, and September 2020. We outline how and so MiCA is unlikely to come into effect for when this might apply to an STO below. many months yet.

A number of existing EU securities laws The draft proposal makes clear that the and regulations are potentially applicable European Commission’s intention is to to STOs. We have also summarised create an EU framework that both these at a high level below. enables markets in cryptoassets as well as the tokenisation of traditional financial For any individual STO, the regulatory assets and the wider use of DLT in analysis will need to be considered on a financial services. case-by-case basis and will be affected by various factors, including the specific MiCA introduces specific disclosure and laws and regulations of the relevant transparency requirements, such as a jurisdiction(s) in relation to STOs or requirement for a prospectus or white cryptoassets and DLT more generally, paper to be issued with a number of and its application by local regulators and crypto-specific disclosures, and a the fact that the technical infrastructure requirement that issuers are established and nature of STOs may change or as legal entities and supervised evolve very quickly. effectively. Additional obligations will apply to issuers of asset-referenced tokens (or Proposed EU-wide regulation so called stablecoins). MiCA will of cryptoassets purportedly be accompanied by There is currently no uniform global or amendments to existing financial services European taxonomy for categorising or legislation that presents obstacles to the defining cryptoassets. In an effort to use of DLT in the financial sector, such as establish a cohesive European legal those outlined below. To the extent there framework with a view to harmonising is any conflict, an EU regulation would discrepancies between EU civil law override any existing dedicated national jurisdictions in particular, the European cryptoasset frameworks that have been Commission published a draft proposal implemented within member states. for a regulation on markets in cryptoassets (MiCA) on 24 September The Commission is also building on 2020. The regulation is one part of the existing national initiatives by proposing Commission’s broader Digital Finance a pilot or sandbox regime for DLT market package, which also includes a proposed infrastructures, to allow experimentation regulation on digital operational resilience within a safe environment at an EU for the financial sector. level and which may provide evidence for possible further amendments to As currently drafted, MiCA would only existing regulation. apply to an STO to the extent that the tokens are not covered by existing EU The publication of the draft proposal financial services legislation (unless the follows a public consultation on an EU tokens also qualify as e-money tokens). framework for cryptoassets which closed As outlined below, many STOs would in March 2020, having received nearly currently be covered by EU financial 200 responses. The consultation was services legislation applicable to MiFID broad-ranging and, amongst others financial instruments and so appear to topics, included questions on the

9 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION assessment of applicable existing securities described in points (a) to (c) of legislation to STOs. In particular, as local the definition above or are equivalent. For civil or property laws represent the example, STOs with equity-like primary obstacle to (validly) creating and characteristics could be argued to confer transferring tokenised assets in a given rights similar to those of shares, thus jurisdiction, the consultation tried to potentially falling within “other securities” characterise a token under the laws of in paragraph (a) of the definition. One of the relevant jurisdiction by also taking into the STOs first approved in the EU was a account the following questions: token with equity characteristics; NEX, a profit-sharing token issued by Neon 1. Is the token an asset over which Exchange AG after its approval by the ownership rights can be claimed? Liechtenstein Financial Market Authority in late 2018. 2. Does the token embed rights enforceable against a specific person A similar argument could be made that and/or any third parties? STOs with debt-like characteristics 3. Can the token be transferred from a potentially fall within “other forms of person to another? If so, which rules securitised debt” of paragraph (b) of the of law govern its transfer? Can the definition. A relevant example here was token be transferred according to the first debt security token or token- the same rules governing the based bonds issued in Germany in July transfer of securities? 2019 by Fundament RE Germany GmbH after approval from BaFin. Security tokens in the primary markets However, in general, there is a lack of The Prospectus Regulation regulates harmonisation in the way that different “offers of securities to the public”, and member states interpret the definition of there is a reasonable argument that this “transferable securities” under MiFID II, would include the offering of security particularly in the absence of EU-level tokens under an STO. guidance on what is meant by securities being “negotiable on the capital market”. “Securities” are defined in the Prospectus According to advice issued by ESMA in Regulation by reference to the definition early 2019 on initial coin offerings and of “transferable securities” under MiFID II. cryptoassets, most member states These are defined as “those classes of interpret negotiability as potential securities which are negotiable on the transferability or tradability. However, capital market, with the exception of some member states also emphasise the instruments of payment, such as: importance of other characteristics, such as standardisation or fungibility, when a. shares in companies and other assessing negotiability. Other countries securities equivalent to shares in (such as the Czech Republic) do not companies, partnerships or other recognise security tokens as “securities” entities, and depositary receipts in at all. Nevertheless, if STO tokens are respect of shares; characterised as “transferable securities” b. bonds or other forms of securitised under MiFID II, the requirements of the debt, including depositary receipts in Prospectus Regulation will apply, unless respect of such securities; certain exemptions are applicable (e.g., offers below €1 million are exempt from c. any other securities giving the right the obligation to publish a prospectus) or to acquire or sell any such the STO falls outside of the scope of the transferable securities or giving rise Prospectus Regulation for another reason to a cash settlement determined by (e.g., there is no offer to the public). reference to transferable securities, currencies, interest rates or yields, Although the Prospectus Regulation commodities or other indices framework is generally compatible with or measures”. STOs, some of the information that is A key question to consider is therefore required to be contained in a prospectus whether the tokens being offered in an pursuant to it will likely need to be STO fall within one of the types of adapted. Risk factors relating to the

SECURITY TOKEN OFFERINGS – 10 A EUROPEAN PERSPECTIVE ON REGULATION securities will need to reflect the Regulation, there is a requirement to specificities of owning and holding detail the involvement of relevant financial securities on a distributed ledger, and intermediaries. STOs may be traded on the issuer will likely need to provide centralised platforms, or fully information on the security token’s decentralised, with peer-to-peer trading listing, as well as the applicable and no financial intermediaries involved. legal characterisation. As a result, certain risks involving the trading of such tokens may also need to For example, in compliance with the be addressed for the prospectus to information requirements under the be approved. relevant annexes to the Prospectus

Licensing considerations for STO participants Licensing requirements for participants in an STO, such as the issuer, underwriters or other investment firms involved in structuring and investors, are likely to vary from jurisdiction to jurisdiction and are very fact-dependent. For this reason, specific legal advice should be sought by each participant in an STO. A detailed analysis of such requirements is therefore outside the scope of this report, however, we list here some relevant considerations.

MiFID II requirements Where the security tokens being issued in an STO are considered to be transferable securities for the purposes of MiFID II, firms involved in the STO will need to consider whether they are carrying on any investment services or activities with respect to the security tokens, which would require them to be licensed. Most obviously, MiFID II introduces licensing requirements for placement agents or underwriters of tokens which constitute transferable securities or other categories of financial instruments.

Depending on the role of the issuer in a particular STO, and how active it is in structuring and/or marketing the tokens, the issuer may also require a licence. Our experience is that issuers in STOs tend to be more involved in structuring and marketing of tokens than a standard corporate issuer of securities and so may be more likely be considered to be carrying on investment activities by way of business that require a licence from a MiFID II-perspective.

Firms carrying on other MiFID activities with respect to security tokens (such as secondary market trading or investment advice) should also consider whether they may need to be licensed under MiFID II to carry on these activities.

AMLD5 requirements AMLD5 came into force in July 2018, giving member states until 10 January 2020 to give effect to its provisions in local law. AMLD5 encompasses a range of potentially onerous new requirements, including the introduction of several new requirements in relation to virtual or cryptocurrencies.

AMLD5 brings two types of crypto-related business within the scope of the money laundering perimeter: “providers of exchange services between virtual currencies and fiat currencies” (i.e. platforms used to exchange money for cryptocurrency) and “custodian wallet providers”, defined as those providing “services to safeguard private cryptographic keys on behalf of [their] customers, to hold, store and transfer virtual currencies”. Providers of those services will be required to register and meet the wider requirements of the EU’s money laundering regime, such as fulfilling customer due diligence obligations, assessing the money laundering and terrorist financing risks they face and reporting any suspicious activity they detect.

AMLD5 defines a virtual currency as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.

11 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION While AMLD5 was required to be transposed into national law by member states by 10 January 2020, a number of member states did not meet this deadline and have faced infringement proceedings from the European Commission. For example, Spain is still in the final stages of transposing AMLD5’s requirements into national law. Conversely, a number of member states that have already transposed AMLD5 have elected to “gold-plate” the legislation, i.e. introduce additional or extended obligations to those strictly mandated under the directive. This includes Germany, as described in further detail in the country-specific analysis below.

Security tokens may in many cases not constitute “virtual currencies” as defined under AMLD5, in particular because they may not be accepted as a “means of exchange”. However, as implementations of AMLD5 and local guidance vary significantly, it will be important for participants in an STO to consider the implementation in all relevant jurisdictions to check applicable licensing requirements.

For example, as part of its gold-plating, the UK has expanded the scope of its implementation to cover the Financial Action Task Force (FATF) standards on Virtual Asset Service Providers (VASPs). Rather than referring to virtual currencies, the UK legislation instead refers to the much broader definition of a cryptoasset which: “(i) is a cryptographically secured digital representation of value or contractual rights; (ii) that uses a form of DLT and (iii) can be transferred, stored or traded electronically”. It is difficult to envisage a security token using DLT that does not meet these criteria. The FCA has also published guidance that indicates that firms involved in issuing or arranging the issue of cryptoassets may be considered “cryptoasset exchange providers”, meaning that they would need to register as such with the FCA. The French implementation of AMLD5 is also wider and likely to apply to security tokens.

The FATF VASPs guidance was also followed by the Luxembourg legislator when transposing AMLD5 into the Luxembourg legal framework. Similarly to the UK, Luxembourg law refers to a wider definition of virtual assets which are: “a digital representation of value (including a virtual currency), that can be digitally exchanged, or transferred, and can be used for payment or investment purposes” but specifically excluding virtual assets which constitute electronic money or financial instruments. Security tokens would normally fall within the legal definition of virtual asset. Firms providing a number of services in relation to virtual assets, including exchange, transfer, safekeeping and administration and the participation in and provision of financial services related to an offer of virtual assets is subject to a registration requirement as a VASP with the CSSF.

Other requirements As outlined above, security tokens as we have defined them in this report are unlikely to meet the definition of e-money under the E-money Directive. However, for completeness we flag that for other types of cryptoassets, there are likely to be other relevant regulatory regimes and licensing requirements to be considered. For example, as well as new rules to potentially be introduced pursuant to MiCA, stablecoins may fall within the existing e-money regime, meaning that issuers would be subject to licensing and other regulatory requirements applicable to e-money issuers.

Licensing requirements for investors Generally, the onus is on issuers and underwriters to market securities in accordance with applicable laws and regulation and investors are not generally required to have a licence to purchase security tokens. However, depending on the structure of an STO and the type of security tokens offered, it may be that only a limited class of investors are eligible to purchase the tokens and so proof of eligibility is likely to be required.

SECURITY TOKEN OFFERINGS – 12 A EUROPEAN PERSPECTIVE ON REGULATION Security tokens in the secondary carry on this business. Such firms will be markets – trading subject to ongoing conduct of business Trading venues requirements with respect to their trading Once security tokens have been issued activities, including transaction reporting, on a DLT platform, the question of trading transparency rules (if certain liquidity them will arise. thresholds are reached) and requirements to execute orders in MiFID II sets out rules relating to trading clients’ best interests. for any security tokens that qualify as transferable securities or other categories MAR prohibits certain actions (including of financial instruments. The applicable insider trading, disclosure of privileged rules will depend on the way in which information and market manipulation) the security tokens are intended to relating to financial instruments traded on be traded; in particular, these rules regulated platforms. Therefore, if security distinguish between trading on tokens are traded on EEA trading venues multilateral trading venues and (including MTFs and OTFs), MAR will bilateral trading. be applicable.

MiFID II identifies three types of The Short Selling Regulation applies to multilateral trading venues. These certain financial instruments, in particular comprise two types of non-discretionary the short selling of shares and of platforms, namely regulated markets sovereign debt instruments and the (RMs) and multilateral trading facilities taking of sovereign credit default swaps (MTFs), and one type of venue where positions. Security tokens could fall within execution of orders is carried out on a the scope of the Short Selling Regulation, discretionary basis, namely organised either directly when they fall under one of trading facilities (OTFs). Bilateral trading those categories of financial instruments may be carried out via a systematic and are trading or admitted to trading on internaliser, i.e. an investment firm which, a trading venue, or indirectly if they on an organised, frequent, systematic confer a financial advantage in the event and substantial basis, deals on its own of a decrease in the value of one of the account by executing client orders aforementioned financial instruments. outside a regulated market, an MTF or The Short Selling Regulation imposes an OTF without operating a multilateral mainly transparency and disclosure system, or alternatively may be requirements, as well as restrictions considered fully “over the counter” on the short selling of certain (OTC), i.e. not on-exchange. financial instruments.

Multilateral platforms allowing the trading Issuers of security tokens that are of security tokens should generally fall admitted to trading on a regulated market under the MiFID II definition of a trading within a member state will also be subject venue, meaning that they would be to the requirements of the Transparency subject to MiFID II requirements relating Directive. The Transparency Directive to RMs, MTFs or OTFs, as relevant. It is imposes periodic and ongoing disclosure worth noting that issuance of tokens requirements such as annual financial using a fully decentralised DLT platform reports, which can be onerous. does not appear on its face compatible with many of the MiFID II trading venue Settlement and delivery requirements (such as the requirement to CSDR sets out requirements relating to have a platform manager or operator that the settlement of transactions in is a legal entity), as they imply a form transferable securities. of centralisation of the venue or its management. Pursuant to CSDR, security tokens that are transferable securities and are traded Firms trading in security tokens by way of or admitted to trading on a MiFID trading business (whether bilaterally or via trading venue will be, or become, subject to venues) will need to be authorised under requirements for the securities to be one of MiFID II, CRD IV or another recorded in book-entry form in a central national regime that permits them to securities depository (CSD), meaning that

13 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION the settlement of transactions in those 4. requirements for the settlement of security tokens would need to be the payment leg of securities performed by the CSD. transactions to be made in cash, in central bank or commercial currency, A key challenge for STOs is whether the which makes end-to-end DLT or other digital platform on which transactions conducted within a DLT security tokens are held and owned platform problematic (until such time could be recognised as a CSD. A CSD is as we see a widely accepted central defined in the CSDR as “a legal person” bank digital currency, at least). that operates a security settlement system (which in turn is defined in the Country-specific analysis Settlement Finality Directive) that is not of STO regulation across operated by a CCP and whose activity includes a notary service or central Continental Europe and maintenance service. A DLT platform is the UK unlikely to constitute a legal person in its As outlined above, pending own right and therefore qualify as a CSD, implementation of a dedicated EU unless it has been structured around a regulation on markets in cryptoassets central operator (losing some of the under MiCA, a number of EU-level benefits of decentralisation). This may regulations applicable to the issue of be an issue which is addressed by the securities, including in relation to European Commission’s Digital prospectuses and transparency, trading Finance proposals. and market abuse, bring a degree of harmonisation to the European regulatory In addition, there are several potential framework for STOs. difficulties for the application of the Settlement Finality Directive to DLT However, notwithstanding such overlying platforms that will need to be considered framework, the approach to regulation of for any STO: STOs varies considerably between jurisdictions as outlined in more detail 1. the need to identify a securities below. The different approaches to the settlement system operated by a regulation of STOs across Europe can be ‘system operator’ on which broadly categorised as follows: transactions in security tokens can be settled, which would exclude • jurisdictions that primarily regulate decentralised security token STOs under the traditional rules platforms and, more generally, applicable to securities, including in the use of public some cases where specific which are based on a legislation has been proposed or decentralised consensus; enacted that facilitates the use of DLT and may impact STOs; and 2. the requirement for access to, or membership of, the securities • jurisdictions where traditional settlement system to be securities laws are unlikely to apply intermediated by a credit institution to STOs without further legislative or an investment firm, meaning that change, and no specific regulatory natural persons are not generally regime has been implemented. permitted to have direct access to the settlement and delivery system, We anticipate these distinctions reducing which again is problematic in the in relevance in time, particularly when context of some of the advantages MiCA becomes law. It seems likely that of decentralised DLT platforms; as part of harmonisation measures 3. if security tokens are recorded in an related to MiCA, member states will be existing CSD, whether the required to take action to ensure that recognition of ownership rights at the there is consistency across EU level of CSD participants’ accounts jurisdictions between what would be an may conflict with the basis of the offering of security tokens regulated recording of the security tokens in under MiFID II, the Prospectus Regulation the distributed ledger; and and other existing regulations vs. a token offering regulated under the MiCA. No

SECURITY TOKEN OFFERINGS – 14 A EUROPEAN PERSPECTIVE ON REGULATION European jurisdiction has implemented Blockchain Order, settlement and delivery its own dedicated regulatory regime for can already be performed on a DLT STOs, and that seems less likely platform, and the securities do not have now that the focus is moving to be recorded on an account with the towards harmonisation. central depository.

In each case this country-specific AMF’s view on the EU framework analysis should be read alongside the The French Autorité des marchés broader EU analysis set out above and, financiers (the AMF) is of the view that for in particular, the separate pull out box on security tokens listed on a trading venue general licensing considerations for STO within the meaning of MiFID, the current participants including under AMLD5 on regulations (including the CSDR, pages 11-12. Settlement Finality Directive and obligations relating to custody account- Jurisdictions where STOs keeping) cannot ensure delivery versus are primarily regulated payment entirely using DLT. An overview of some of the key legal challenges under traditional here is presented in the European securities law section above.

France In February 2020, the AMF published its Legal and regulatory framework legal analysis of the application of financial regulations to security tokens. Following the publication of the PACTE According to the document: Law on 23 May 2019, there are two separate sets of rules for tokens under • the Prospectus Regulation appears French law: compatible with STOs, but the information contained in the • that of digital assets, which cover prospectus will have to be adapted “utility tokens” and virtual currencies to the specific features of security as defined in the French code tokens; and monétaire et financier. These new definitions are provided by • the exchange of security tokens exclusion from the field of financial faces major legal obstacles because instruments; and of the decentralised nature of DLT.

• that of financial instruments, which The AMF therefore suggests: cover “security tokens” and which are by nature subject to the various • the creation of a European “digital European and French financial lab” or sandbox to secure the regulations according to the settlement of financial instruments conditions of their issuance using DLT notably by suspending and trading. regulatory obstacles to token Further, Order 2017-1674 of 8 December security market infrastructure 2017 (the Blockchain Order) created in projects (in line with the pilot or French law a regulatory framework sandbox regime for DLT market governing the representation and infrastructures that has subsequently transmission of unlisted financial been proposed in September 2020 securities via a blockchain or DLT. The as part of the European Blockchain Order makes it possible to Commission’s Digital Finance issue and transfer security tokens in the plan); and form of units or shares in collective • clarification of the fact that, as a investment undertakings not admitted to matter of established law, the the operations of a central depository, financial securities registered using negotiable debt securities, and equities DLT take nominative form under and bonds not traded on a trading venue French law, and that the liability of within the meaning of MiFID (in practice, collective investment undertaking OTC and brokerage platforms). For depositaries is limited to unlisted securities within the scope of the record-keeping.

15 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION Following its legal analysis, the AMF would qualify as a security for the published a position paper which purpose of the WpHG/WpPG: discusses the scope of the trading venue, and is applicable in particular to • transferability, i.e. the tokens can be financial instruments registered on DLT. assigned to another person, irrespective of whether certificates Germany exist that register or document the Germany has not implemented a specific existence of the tokens; cryptoasset regime, but instead takes a • negotiability on the financial market technology-neutral approach by or capital market (trading platforms regulating security tokens generally in the for tokens can generally be deemed same way as other types of securities financial or capital markets according with similar characteristics. to BaFin);

Characterisation as a security • the embodiment of relevant rights in In its guidance note on prospectus and the token, i.e. either shareholder authorisation requirements in connection rights or creditor claims or claims with the issuance of cryptotokens from comparable to shareholder rights August 2019 (BaFin Guidance), the or creditor claims; and German Federal Financial Supervisory • the token must not meet the Authority (BaFin) describes security criteria for a payment instrument tokens as granting the relevant holder under MiFID II. membership rights or contractual claims on assets that are comparable to those Tokens that do not meet the above of a shareholder or bondholder (for requirements (for example, because there example, claims to dividend-style are contractual restrictions on transfer) payments, voting rights, repayment and hence do not qualify as securities claims and interest payments). In this may nevertheless qualify as capital respect, security tokens generally investments under the German Capital constitute securities under the German Investment Act (VermAnlG) which also Securities Trading Act (WpHG) and under imposes a prospectus requirement for the German Prospectus Act (WpPG). public offerings. They also qualify as financial instruments under the German Banking Act (KWG). Additional licence requirements Entities issuing security tokens in Notwithstanding the prospectus Germany will therefore need to consider requirement, the creation and initial and ensure they comply with the offering of security tokens by the issuer prospectus requirements imposed by does not generally trigger a licensing the Prospectus Regulation, just as they requirement under the KWG. Directly would when offering other types issuing tokens to investors without of securities. involving third parties as intermediaries does not require authorisation by BaFin, BaFin generally decides on a case-by- even if the tokens are financial case basis whether a token constitutes a instruments under the KWG. However, a security instrument or whether the token licence requirement under the KWG for instead qualifies as a utility token, deposit-taking business may be triggered payment token or e-money. Therefore, as if the issuer also offers tokens against a first step, entities offering tokens would legal tender and gives the buyers an need to consider carefully the structure unconditional repayment right. This would and material characteristics of the token be the case, for example, if the issuer being offered in order to determine promises to buy back the tokens later at whether or not they would be categorised a price equal to or higher than the as security tokens or some other type of issue price. (regulated) token for the purposes of the German regulatory regime. Under Germany’s gold-plated implementation of AMLD5, the offering of In the BaFin Guidance, the following custody, management and backup criteria in particular are considered services for cryptoassets or for private relevant for assessing whether a token cryptographic keys which are used to

SECURITY TOKEN OFFERINGS – 16 A EUROPEAN PERSPECTIVE ON REGULATION keep, store or transfer cryptoassets for the draft law replaces the requirement for others is subject to a licence requirement the issuance of the certificate by a two- (Crypto Custody Business). Cryptoassets part process consisting of (i) the filing here means a digital representation of (Niederlegung) of the terms and value that is not issued or guaranteed by conditions and (ii) the registration of the a central bank or a public authority and bond in the relevant electronic securities does not possess a legal status of register (Elektronisches currency or money, but is accepted by Wertpapierregister). An electronic bond is natural or legal persons as a means of deemed to be a “good” within the exchange or payment or which can be meaning of the BGB. Accordingly, even used for investment purposes and which though no longer evidenced by a can be transferred, stored and traded certificate but rather by a register entry, electronically. However, where the provisions under German law cryptoassets also qualify as securities governing securities in general (including under the WpHG/WpPG and are their in rem transfer) would be applicable exclusively managed or held in custody to electronic bonds as well. for alternative investment funds within the meaning given in the German Capital Electronic securities registers can be Investment Code, such activity falls under (i) a central register operated by a CSD, the scope of the more specific provision or (ii) a decentralised DLT or crypto of restricted custody business register (Kryptowertpapierregister) which (eingeschränktes Verwahrgeschäft). If may be operated by any adequately cryptoassets qualify as securities, licensed person named by the issuer. safekeeping activities may qualify as safe If the issuer does not name any such custody business (Depotgeschäft). If an person, the issuer itself will be regarded entity is already authorised as a central as administrator of the crypto securities securities depository under CSDR, register for the relevant security. The according to BaFin guidance from March operation of a crypto register is defined 2020, no separate authorisation under as a licensable financial service under the KWG to conduct Crypto Custody the KWG. Hence, operators require Business is required since the a banking licence under the KWG authorisation requirement stipulated in and will be supervised by BaFin as the CSDR is the more specific provision financial service institutions in this respect and has priority over the (Finanzdienstleistungsinstitut). general provision of the KWG. The draft law is currently a ministerial Draft law on digital bonds proposal (Referentenentwurf). In this In August 2020, the German Federal respect, the legislative process will bring Ministry of Finance and the Federal further changes and clarifications. Ministry of Justice and Consumer Protection published a draft law which Italy aims to digitise corporate financing in In Italy, there are currently no specific the capital markets by introducing the laws and regulations that would apply to concept of an electronic bearer bond STOs or concerning digital tokens or DLT which no longer requires the embodiment more generally. The Comissione nazionale of the respective claim in a physical per le società e la Borsa (CONSOB), the certificate. The draft law applies existing Italian securities commission, has taken a German property law requirements to a technology-neutral approach in its digital value by defining electronic bonds considerations regarding securities as goods (Sachen) under the German tokens, and is largely following a similar Civil Code (Bürgerliches Gesetzbuch, approach to the US Securities and or BGB). Exchange Commission in distinguishing security tokens from utility tokens. Differing from the current German law regime for the issuance of bearer bonds Characterisation as a security – which requires an issuance agreement In general, CONSOB considers a between the issuer and the initial holder transaction a financial investment if: of such bearer bond, as well as the • there is a use of capital; issuance of a certificate by the issuer –

17 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION • there is an expectation of a financial Luxembourg return; and In Luxembourg, there is no specific legal • the investment risk is directly or regulatory framework for STOs. The connected and related to the use general Luxembourg financial sector and of capital. capital markets legislation containing, among others, the implementation of From an Italian civil law perspective, it is relevant EU texts (and applicable less clear whether security tokens can be authorisation and licence requirements classified as securities (titoli di credito). If thereunder), such as the Prospectus a token were to be characterised as a Regulation and MiFID II, would broadly security, then it could be transferred in be applicable to STOs falling within their accordance with the transfer regime scope of application. applicable to securities. This would imply that, by transferring the token, one would Characterisation as a security simultaneously transfer to the transferee As there is no statutorily defined category the rights embedded in the token. of “securities” (titres) under Luxembourg Conversely, should a token not be law, tokens issued in an STO could be deemed a security, the transfer of the characterised as transferable securities or rights attaching to it would need to follow other categories of MiFID II financial the ordinary regime for transfers of rights instruments (such as derivatives or units (which may require notifications and/or in collective investment undertakings) or other formalities). broadly as a security (titre) on the basis of their specific features, such as As currently drafted, it would seem that transferability, tradability, fungibility or under the applicable provisions of Italian revenue or ownership rights. Such law a security could exist only in the assessment must be carried on a case- form of either a hard copy certificate or a by-case basis and should also take into dematerialised instrument held through a consideration the overall purpose of the CSD. Issuing a security token through a tokens. The Luxembourg financial sector CSD would negate some of the benefits authority Commission de Surveillance du of tokenisation (as it would require the Secteur Financier (CSSF) has not involvement of a large number of published any specific guidance on how intermediaries). That said, it might be they would assess security tokens, possible to interpret the law such that except for indicating, in relation to ICOs, the applicable framework permits the that they would assess whether the creation of securities that are neither hard financial sector laws and regulations, copy certificates, nor dematerialised including in relation to prospectuses for instruments held through a CSD. securities and anti-money laundering legislation, would be applicable to Regulatory matters generally follow such tokens. the European regulation and there are currently no additional local Relevant legislative initiatives law requirements. In February 2019, Luxembourg implemented specific legislation to permit Other relevant legislative initiatives securities accounts for the holding and In terms of legislative and regulatory circulation of fungible, book-entry initiatives, in 2019 the Italian legislator securities through DLT (or other similar tasked the Italian Ministry of Economy technological solutions). This still requires and Finance with establishing a regulatory accounts to be held with licensed sandbox to facilitate the adoption of new Luxembourg depositaries but now technologies in the financial sector, by allows such accounts to be operated simplifying the process for granting within or by virtue of a secured regulatory licences in relation to fintech electronic recording system (using initiatives and/or waiving certain DLT or otherwise). regulatory requirements. The legal framework governing the sandbox is In July 2020, the Luxembourg currently under consultation. government submitted a further bill to the Luxembourg Parliament allowing the use of secured electronic recording systems

SECURITY TOKEN OFFERINGS – 18 A EUROPEAN PERSPECTIVE ON REGULATION (including DLT) to operate issuance own account dealers in or in relation to accounts for dematerialised securities, security tokens. which is one of the specific forms of securities recognised under Luxembourg The issuance of security tokens which law (in addition to registered and bearer qualify as units of a collective investment securities). The issuance or conversion undertaking would trigger a licence (from another form) of dematerialised requirement as an undertaking for securities is carried out exclusively by collective investment for the issuer under registering the securities in an issuance the relevant Luxembourg investment account, which may be held and the funds laws and regulations, except where securities records therein may be effected such issuer would be structured as a within or by virtue of secured electronic reserved alternative investment fund recording systems, including ledgers or (RAIF) and made subject to the RAIF databases relying on DLT. In combination law of 23 July 2016 (as amended). with the 2019 law, once adopted, this law would allow an end-to-end issuance Security tokens qualifying as repayable and circulation of securities in funds could trigger a credit institution dematerialised/book-entry form in a licence requirement under the Financial DLT-based solution (relying on licensed Sector Law if the issuance of such intermediaries to hold the issuance or tokens is considered as taking deposits securities accounts). or other repayable funds from the public.

Other relevant regulatory guidance The Netherlands In 2018, the CSSF issued several press In the Netherlands there is no specific releases in the context of ICOs which regulatory regime for STOs or notified entities under its supervision that cryptoassets in the Dutch Financial investing in tokens (including security Supervision Act (Wet op het financieel tokens) through ICOs is not suitable for toezicht, or FSA). The FSA contains the all kinds of investors and investment financial regulatory framework in the objectives. In particular, according to the Netherlands and includes both typical CSSF, UCITS and other undertakings for Dutch regulatory regimes as well as collective investment open for non- European regulatory regimes including professional investors and pension funds CRD IV, MiFID and AIFMD, for example. are not allowed to invest directly or indirectly in these products. Characterisation as a security The FSA regulates activities and services As practical guidance to ICO service in relation to financial products (financiële providers and initiators, the CSSF producten). The most relevant financial indicates that ICO projects (including products and regulatory definitions in the STOs) will be assessed on a case-by- context of assessing whether security case basis. tokens fall in scope of the FSA are financial instruments (i.e. securities, Additional licence requirements derivatives), units in collective investment There are certain local law licence schemes and investment objects. requirements applicable to professionals carrying out a financial sector activity The Dutch Authority for the Financial under the Financial Sector Law, some of Markets (Autoriteit Financiële Markten, which depend on the qualification as or AFM) takes a technology-neutral “securities”, such as the licence approach to regulating security tokens. requirement for professionals borrowing Cryptoassets or tokens do not, as a or lending securities (titres) on own separate category, fall within the definition account, professionals acting as of financial instruments. Therefore it depository of financial instruments or needs to be assessed on a case-by-case processionals acting as agents holding basis if a cryptoasset qualifies as a registers of financial instruments. Such financial instrument. requirements may not be relevant to the issuer of security tokens, they would Depending on their characteristics, normally apply to professional security tokens may qualify as financial intermediaries, service providers or instruments, and more specifically, as

19 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION securities under the FSA. A security is The AFM generally decides on a defined under the FSA as: case-by-case basis whether a security token constitutes a security. Entities a. a negotiable share or an issuing security tokens in the Netherlands equivalent right; will need to consider and ensure they b. a negotiable bond or other comply with any prospectus requirements negotiable debt instrument imposed by the Prospectus Regulation, (i.e. instruments creating or as they would when offering other types acknowledging indebtedness); or of securities. c. any other negotiable instrument Characterisation as units in a issued by a legal person, company collective investment scheme or institution by which securities referred to under a) or b) may be From a regulatory perspective it is also acquired through exercising the relevant to assess whether security rights attached to this instrument or tokens may qualify as units in a collective through conversion, or that can be investment scheme, within the meaning settled in cash. of the FSA. Security tokens may qualify as units or shares in a collective The AFM has provided some practical investment scheme if they meet certain guidance on when tokens may qualify as elements: i.e. raising capital from a securities within the meaning of the FSA. number of investors with a view to The following criteria are relevant: investing it in accordance with a defined investment policy for the benefit of those • Negotiability: The concept of investors. For instance, the AFM securities relates to the term indicated that an ICO is subject to “negotiable” (verhandelbaar). For financial supervision if it concerns the instruments to be negotiable, they offering of units in a collective investment must first be transferable. It is not scheme. This is the case if an issuer of decisive whether there is a specific an ICO raises capital from investors in market for particular instruments, order to invest this capital in accordance but rather whether the instruments with a certain investment policy in the are negotiable based on their interests of those investors. The funds characteristics. A clear indication raised have to be used for the purpose that the instrument is negotiable is of collective investment so that the the extent of standardisation. The participants will share in the proceeds more standardised an instrument is, of the investment. the more likely it is to be negotiable. The AFM has provided guidance on Additional licence requirements the concept of negotiability and uses Cryptoassets may, under specific a wide and economic approach. All circumstances (e.g. certain utility constructions where the economic tokens), qualify as investment objects interest of a standardised instrument (beleggingsobject) within the meaning of is or may be transferred, directly or the FSA. Under the FSA, it is prohibited indirectly, to a third party qualify as a to offer an investment object without a negotiable instrument. Generally, licence obtained from the AFM. The tokens that are traded on an Dutch regulatory regime for investment exchange or platform will be objects does not derive from European considered negotiable. regulation. An investment object is • The embodiment of rights in the defined in the FSA as “an object, a right specific token, i.e. either shareholder to an object or a right to the full or rights (i.e. shares) or creditor claims complete return in cash or part of the (i.e. bonds or other forms of proceeds of an object, (…) which is indebtedness) or claims comparable acquired for payment at which acquisition to shareholder rights or creditor the acquirer is promised a return in cash claims. Rather than the labelling of and where the management of the object the token, the specific structure of is mainly carried out by someone other the rights embodied in the token is than the acquirer”. An object (stoffelijk the decisive factor. object) within the meaning of the Dutch Civil Code is a tangible or physical asset,

SECURITY TOKEN OFFERINGS – 20 A EUROPEAN PERSPECTIVE ON REGULATION for instance gold or art. In other words, • whether the token grants rights if a cryptoasset is backed by a physical similar to those of shares, bonds or object, it may qualify as an investment other financial instruments; object pursuant to the FSA. This is • whether the token entitles access to not likely to be relevant for most services or to receiving goods or security tokens. products; or Romania • whether the token is offered (a) There is no specific legal framework for referring explicitly or implicitly to the STOs in Romania, nor have Romanian expectation that the purchaser or regulators issued any guidance in this investor will obtain a profit as a result respect. Nevertheless, the Romanian of its rise in value or of some regulators should in principle follow remuneration associated with the the guidance issued at EU level instrument or (b) mentioning its outlined above. liquidity or tradability on a securities market or equivalent. Characterisation as a security As such, the Romanian regulators should The CNMV has stated that those tokens evaluate each STO independently to in which it is not reasonable to establish consider whether the offered tokens are a correlation between the revaluation or classified as “transferable securities” profitability expectations and the evolution based on the Romanian legislation of the underlying business or project transposing MiFID and, consequently, the should not be considered transferable national and EU legal rules must be securities. Despite that exclusion, the followed (including the Prospectus CNMV also stated that it expects most Regulation, the Transparency Directive, security tokens to be considered MiFID II, MAR, the Short Selling transferable securities. Regulation, CSDR and the Settlement Finality Directive). If a security token is considered a transferable security, the regulations Relevant regulatory initiatives applicable in Spain to securities (most of In order to encourage and support which are EU regulations either directly innovation in payment and financial applicable in Spain or implemented under services, both the National Bank of Spanish law) would be applicable to them Romania and the Financial Supervisory (e.g., regulations in connection with the Authority launched fintech hubs in requirement of a prospectus to conduct summer 2019. In this way, the Romanian certain public offerings in Spain or regulators have established an regulations governing the publicity and institutional framework for dialogue with marketing or placing of transferable companies developing fintech solutions, securities in Spain). Other Spanish which may also include issuers of regulations may be applicable even in security tokens in relation to the those cases where tokens are not assessment of the classification of such considered transferable securities (e.g., tokens as financial instruments. rules regarding publicity or, depending on the type of offering, consumer Spain protection rules). Characterisation as a security With regards to representation and The Spanish Securities Market transferability, the CNMV has confirmed Commission (CNMV) has highlighted the that its understanding of Spanish law following factors to determine the allows transferable securities to be qualification of a token as a transferable represented by means other than those security (as defined in MiFID II and in the specifically provided under Spanish law Spanish securities market regulations): (i.e., certificates (títulos físicos) and • whether the token grants rights or book-entries (anotaciones en cuenta)), confers an expectation to participate which have their own rules with regards in a potential value appreciation of to ownership evidence and transferability. businesses or projects; In accordance with that understanding of the CNMV, tokens could be represented

21 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION via DLT but, for the time being, no The FCA guidance distinguishes security specific rules have been enacted in tokens from e-money tokens, which are Spain in connection with these tokens meeting the definition of e-money alternative means for representing under the Electronic Money Regulations transferable securities. 2011, and unregulated tokens such as utility tokens and cryptocurrencies. The Additional licence requirements FCA indicates that a case-by-case In order to conduct a public offering of analysis is needed to determine which transferable securities in Spain addressed of these categories a cryptoasset will fall to retail investors but exempted from the into and that cryptoassets “may move obligation to publish a prospectus, in between categories during their lifecycle”. which any type of publicity is used, the The FCA’s categorisation of different Spanish securities market rules require types of cryptoassets is based on the participation of an entity authorised substance rather than form. Therefore, to render investment services in Spain. as a first step, firms involved in an STO would need to consider carefully the Another issue that may be important structure and substantive characteristics to consider under Spanish law is whether of the tokens being offered in order to an STO could be considered as taking determine whether or not they would in repayable funds from the public, fact be categorised as security tokens or which is an activity reserved to credit some other type of cryptoasset for the institutions (especially in those cases purposes of the FCA guidance and UK where the token is not considered a regulatory regime. transferable security). Firms offering security tokens in the UK United Kingdom will also need to consider whether those Characterisation as a security tokens qualify as “transferable securities” In the UK, security tokens are generally under FSMA, which cross-refers to the regulated in the same way as other types definition of transferable securities in of securities with similar substantive MiFID II. If so, they would therefore fall characteristics. In this respect, the UK within the prospectus regime and other regulatory regime is technology-neutral regulatory requirements that apply to and so firms offering security tokens in transferable securities. the UK will be subject to the same regulatory requirements as if they were Security tokens that do not meet the offering traditional securities with the MiFID II definition of transferable same substantive characteristics. securities (for example, because there are contractual restrictions on transfer) In its Guidance on Cryptoassets, the may nevertheless fall within the UK UK Financial Conduct Authority (FCA) crowdfunding regime and related defines security tokens as cryptoassets financial promotion rules for non-readily which provide holders with rights and realisable securities. obligations akin to traditional financial instruments such as shares, debentures Additional licence requirements or units in a collective investment Under the UK regulatory regime, scheme. They are therefore considered to security tokens include units in collective be specified investments for the purpose investment schemes. Again, a of the Financial Services and Markets Act case-by-case substantive analysis would 2000 (FSMA) and the Financial Services be needed to consider whether or not and Markets Act 2000 (Regulated the security token offering structure Activities) Order 2001, and are regulated meets the definition of a collective as such. Firms offering security tokens in investment scheme under FSMA and/or the UK will therefore need to consider an alternative investment fund (AIF) as and ensure they comply with the defined in the Alternative Investment authorisation and financial promotions Fund Managers Regulations 2013. If so, requirements of sections 19 and 21 the usual UK regulatory requirements FSMA, just as they would when offering would apply, such as the requirement for other types of securities. an AIF to have an authorised or regulated manager (AIFM) who would be

SECURITY TOKEN OFFERINGS – 22 A EUROPEAN PERSPECTIVE ON REGULATION responsible for compliance with the UK law and that smart contracts are capable regulatory requirements applicable to of constituting binding legal contracts. AIFs and AIFMs. Whilst the UKJT’s legal statement itself is Legal classification not binding, these questions have also As well as analysing the regulatory been considered by the English courts, position, key questions for firms offering notably in the case of AA v Persons or investing in security tokens relate to Unknown [2019] EWHC 3556 (Comm), the legal nature of the token (i.e. whether where Mr Justice Bryan expressly security tokens are capable of being considered the legal statement and owned and transferred as property) and, agreed with its conclusions, stating that where relevant, whether or not smart “for the reasons identified in that legal contracts used to transfer security tokens statement, I consider that a crypto asset are capable of being legally binding. From such as Bitcoin [is] property”. Therefore, an English law perspective, the UK both the Legal Statement and recent Jurisdiction Taskforce of the LawTech case law indicate that, from an English Delivery Panel (UKJT) issued a statement law perspective, cryptoassets (including in November 2019 confirming that security tokens) are capable of being cryptoassets are capable of being owned owned and transferred as property. and transferred as property under English

What impact does Brexit have? The UK left the EU on 31 January 2020 pursuant to a withdrawal agreement between the UK and the EU, which sets out the terms of the UK’s departure from the EU. The withdrawal agreement provides for a transition period during which the UK will no longer have any role in the EU’s institutions or law-making processes but will remain subject to EU law and participate in the EU’s single market and customs union. The transition period ends on 31 December 2020.

At the end of the transition period, the European Union (Withdrawal) Act 2018 (EUWA) (as amended by the European Union (Withdrawal Agreement) Act 2020) provides for the “onshoring” of EU financial services legislation that applies at that date into UK domestic law. The EUWA also grants the UK government powers to make statutory instruments remedying deficiencies in this retained EU legislation arising from the UK’s withdrawal from the EU, including in connection with the end of the transition period or other effects of the Withdrawal Agreement. This is to ensure that the UK has a functioning statute book at the end of the transition period.

Therefore, the way in which STOs are regulated in the UK is not expected to change materially as a result of the end of the transition period. However, the UK will no longer participate in the EU’s single market, and so the end of the transition period will likely involve a step change in market access between the UK and EU for financial services, which may impact the ability of UK firms to offer security tokens in the EU and vice versa. As MiCA is unlikely to enter into force before the end of the transition period, it is likely that this will mark the first potential deviation in crypto policy between the UK and EU (although MiCA’s applicability to STOs may be limited as outlined above).

23 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION Jurisdictions where transferable securities since the definition STOs are unlikely to be set by MiFID II is autonomous and independent of national law. Should this regulated by securities interpretation prevail, the regulation set law and no specific regime out in ZPKT, including the obligations has been enacted regarding the publication of a prospectus, would apply to an STO in the Czech Republic Czech Republic. STOs are arguably largely unregulated in the Czech Republic. However, there is The Czech National Bank has not issued some uncertainty around this position. any statements in relation to security tokens that might give further clarity, There is no specific piece of legislation having focussed only on exchange for cryptoassets in place in the Czech tokens to date. Republic. From a private law perspective, the general understanding is that tokens Poland fall within the definition of intangible Poland has not yet implemented any assets and are transferable, but do not specific regulatory framework applicable fall within the legal definition of securities to STOs, and official statements of the (cenné papíry) or book-entry securities regulators are scarce. In July 2020, the (zaknihované cenné papíry) under the Polish Financial Supervision Authority Czech Civil Code. This is because DLT (Komisja Nadzoru Finansowego, or KNF) lacks the necessary form prescribed by launched a consultation on its draft law for securities (cenné papíry) or book- position on cryptoassets. This marks the entry securities (zaknihované cenné first communication in relation to assets papíry), and does not meet the specific held using DLT by the KNF since a requirements for record-keeping. communiqué on offerings of coins and tokens in November 2017. In November 2018, the Ministry of Finance of the Czech Republic (MF) As security tokens are not specifically issued a non-binding public consultation regulated, there is no definitive answer document regarding cryptoassets to as to whether security tokens would evaluate whether the national legal be classified as securities (papier framework should be changed. Based wartościowy) under Polish law. While the on this document, some security tokens, analysis should be performed on a case- depending on the rights connected with by-case basis, we believe that the better them, may be seen as investment view is that they would normally not be instruments under the Czech Act on classified as such under Polish law. Capital Market Undertakings (ZPKT) This is because, as a rule, Polish law and MiFID II regulation and be securities exist either in paper form regulated accordingly. (currently, a marginal format for securities other than promissory notes) or as book- However, the current and non-binding entries in a manner specified in the opinion of MF is that security tokens do relevant legislation (the dominant format). not fall within the definition of securities Further, it is still a dominant view that the (cenné papíry) relevant for the ZPKT list of types of securities is closed-ended, regulation as the MiFID II regulation itself and specific types of securities must be does not define securities and refers to specifically regulated in the law. national laws. MF proposes changing the Therefore, it is fair to say that the legal legal definition of book-entry securities framework in Poland, at least with (zaknihované cenné papíry) so that regard to book-entry securities, is still security tokens would fall within the not technology-neutral and, subject to definition contained in the Czech the exception noted below, DLT is not yet Civil Code. recognised as a medium where securities can “exist”. Some experts disagree with MF’s non-binding opinion, arguing that for the Some scholars have expressed purposes of public law regulations (mainly dissenting views and believe (coupling ZPKT), security tokens should be seen as that belief with a technology-neutral

SECURITY TOKEN OFFERINGS – 24 A EUROPEAN PERSPECTIVE ON REGULATION approach taken at EU level, including in applicable to the transfer would be part the Prospectus Regulation) that new of the contractual framework applicable types of securities can also be created in to the DLT and entries made in the novel ways, including by using DLT. system. Enforceability would be primarily Some amendments to the Polish Act on based on the concept of freedom trading in financial instruments appear to of contract. be needed in order to provide a definitive answer. If security tokens were classified as securities under Polish law, the public With the exception of dematerialised offer limitations and prospectus shares (akcje zdematerializowane), requirements would be applicable. including shares in a simple joint-stock Whilst such interpretation is currently not company (prosta spółka akcyjna or PSA), likely to apply in most cases, in some a new type of company, introduced by specific cases the position could differ. the Polish Commercial Companies Code For example, if an STO involved the (the PCCC) amendment effective as of offering of tokens representing securities 1 March 2021, no other legislation deposited with a custodian and there is recognises distributed ledgers as a legal a possibility that the tokens could be medium where book-entries creating or converted or exchanged into actual transferring securities could be made. securities, then this would likely trigger We are also not aware of any legislative the relevant restrictions and prospectus proposal in this respect. The provisions requirements would likely be applicable of the PCCC, which will come into force to that STO. starting March next year, introduce a simplified procedure for the Given the above, it seems that dematerialisation of shares, including supplementary legislation will be required PSA shares. Records of shares may be in order to resolve doubts with regard to: kept in a distributed and decentralised (i) classification of certain cryptoassets as database, provided, however, that the financial instruments (transferable security of the data contained therein is securities or derivative instruments ensured (which seems to enable the use dependent on the price or value of other of DLT for this purpose). assets (real or crypto)); and (ii) transfer of rights to digital assets, bearing in mind As Polish contract law is generally that rights attached to book-entry based on freedom of contract, there is securities arise upon their entry in a nothing in Polish law which prohibits securities account (and accrue to a participants (be it within a permissioned person who is a holder of that or permissionless DLT system) from securities account). agreeing that records on DLT systems represent a contractual entitlement to The consultation on the KNF’s new physical assets (e.g., shares, bonds or official position on cryptoassets ended commodities deposited “traditionally” on 30 July 2020. While the outcome may with a custodian) or synthetic assets shed new light on certain ambiguities or (e.g., “phantom” shares or rights in a help achieve a market consensus in profit-sharing arrangement). In most some areas, it seems that without a cases, such assets are likely to be new legislative initiative most of the classified as “derivative instruments” ambiguities discussed above cannot within the meaning of MiFID II and, in be rectified. consequence, should be deemed financial instruments (but not necessarily Slovak Republic securities, as discussed above) under There is no specific legislation for the Polish Act on trading in cryptoassets in place in the Slovak financial instruments. Republic. From the private law perspective, cryptoassets do not fall In this scenario, we believe that Polish within the definition of assets (veci), law would recognise the relevant entries since they do not meet the criterion of on the ledger as transferring the materiality. Theoretically, cryptoassets entitlement (but not necessarily the could fall under the definition of rights or transfer of a physical asset) as the rules other proprietary values (iná majetková

25 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION hodnota), and thus would, from a civil limited to an article published in the law perspective, be capable of being the periodical newspaper issued by the subject of proprietary rights. However, National Bank of Slovakia (NBS), where we are not aware of any official guidance the representatives of the NBS provide or case law that would provide a definitive their personal opinions on the potential answer in this respect. Cryptoassets future regulation of cryptoassets. such as tokens do not fall within the definition of securities (cenné papiere). In terms of future regulation, the The primary reason is that DLT does not Government’s action plan for digital meet the specific requirements for transformation over the period 2019 to record-keeping. 2022 provides, amongst others, the task of analysing the possibilities of the From the regulatory perspective, tokenisation of assets for the purpose of cryptoassets, including security tokens, their usability on the financial markets. are not regulated under Slovak law. However, we are not aware of any Such products do not represent particular drafts of legislation that would investment products and business aim to address the deficiencies of activities connected with their distribution national law when addressing the do not fall under any specific regulation. existence of cryptoasset markets.

The official regulatory guidance with respect to cryptoassets is minimal and

SECURITY TOKEN OFFERINGS – 26 A EUROPEAN PERSPECTIVE ON REGULATION GLOSSARY OF DEFINED TERMS

AFM Dutch Authority for the Financial Markets (Autoriteit Financiële Markten) AIF Alternative investment fund AIFM Authorised or regulated manager of an alternative investment fund AIFMD Alternative Investment Fund Managers Directive 2011/61/EU AMF French Financial Markets Authority (Autorité des marchés financiers) AMLD5 Fifth Money Laundering Directive 2018/843 amending Fourth Money Laundering Directive 2015/849/EU and the Regulation (EU) No. 2015/847 on information accompanying transfers of funds BaFin German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) CCP Central clearing counterparty CNMV The Spanish National Securities Market Commission (Comisión Nacional del Mercado de Valores) CONSOB Italian securities commission (Comissione nazionale per le società e la Borsa) CRD IV Capital Requirements Regulation (EU) No. 575/2013 and Capital Requirements Directive IV 2013/36/EU CSD Central Securities Depository CSDR Central Securities Depositories Regulation (EU) No. 909/2014 CSSF Luxembourg financial sector authority (Commission de Surveillance du Secteur Financier) DLT Distributed ledger technology EBA European Banking Authority E-money Directive E-money Directive 2009/110/EC EMIR European Market Infrastructure Regulation (EU) No. 648/2012 ESMA European Securities and Markets Authority EU European Union FCA UK Financial Conduct Authority ICO KNF Polish Financial Supervision Authority (Komisja Nadzoru Finansowego), MAR Market Abuse Regulation (EU) 596/2014 MF Ministry of Finance of the Czech Republic MiCA Draft proposal for a regulation on markets in cryptoassets issued by the European Commission on 24 September 2020 MiFID Markets in Financial Instruments Directive 2004/39/EC MiFIDII Markets in Financial Instruments Directive II 2014/65/EU MTFs Multilateral trading facilities NBS National Bank of Slovakia OTC Over the counter OTFs Organised trading facilities Prospectus Regulation Prospectus Regulation (EU) 2017/1129 RM Regulated markets Settlement Finality Directive Settlement Finality Directive 98/26/EC Short Selling Regulation Regulation (EU) 236/2012 STO Security token offering Transparency Directive Directive (EU) 2013/50 amending Directive (EC) 2004/109 UCITS Undertakings for Collective Investment in Transferable Securities

27 SECURITY TOKEN OFFERINGS – A EUROPEAN PERSPECTIVE ON REGULATION NAVIGATE THE DISRUPTION: YOUR FINTECH TOOLKIT Clifford Chance’s experienced global cross-practice legal team can deliver your most innovative and transformational fintech projects.

Our clients have access to a range of free fintech resources – a selection of which are set out below:

Fintech weekly round up We offer a comprehensive weekly email round-up, summarising recent global fintech regulatory developments for you in relation to DLT, central bank digital currencies, payments, data and AI among others, along with a curated list of Clifford Chance publications and materials and upcoming fintech events.

Talking Tech Your one-stop shop for the latest legal trends and changes in the fast-moving technology sector. Talking Tech contains a range of articles on topics including AI, data, cyber, blockchain and cryptoassets and information on upcoming tech-focussed events from our global network. Recent articles include overviews of the September 2020 European Commission draft regulatory proposals on operational resilience (or DORA) and cryptoassets (or MiCA). talkingtech.cliffordchance.com

Fintech Guide This comprehensive online guide will provide you with the information you need on global regulatory initiatives and legislative developments, including the latest developments on global stablecoins such as Facebook’s Libra, as well as access to our comprehensive range of market-leading thought leadership articles, events and presentations on market developments. financialmarketstoolkit.cliffordchance.com/fintech

Events and value-added services As well as offering our clients tailored workshops on a range of topics including fintech M&A, digital assets including central bank digital currencies and stablecoins, and the fintech regulatory outlook, we regularly host fintech-related seminars, educational and networking events open to a wide audience. We regularly brief boards and senior personnel on strategic tech opportunities, risks and challenges for financial services and tech companies. In November 2020 we are hosting a webinar offering a global perspective on the regulation of security token offerings or STOs. Our international expert panel will consider how STOs can be successfully undertaken across key global financial centres and the risks and regulatory challenges to be aware of. For more information and to register, see the registration form.

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SECURITY TOKEN OFFERINGS – 28 A EUROPEAN PERSPECTIVE ON REGULATION CONTACTS Czech Republic

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Netherlands

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SECURITY TOKEN OFFERINGS – 30 A EUROPEAN PERSPECTIVE ON REGULATION Romania

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