Crypto Assets and Crypto Custody – Germany’s two sided pioneering role (February 2020)
With the official announcement of the amended German Banking Act (Kreditwesengesetz, KWG) on 12 December 2019, companies and business models in the sector of Crypto–Currencies and DLT services are going to face increasing challenges and opportunities.
The German parliament took the legislative initiative of offering a “safe haven” for private and institutional investors of crypto assets, granting a higher level of investor protection and legal certainty in comparison with the lawmakers of the still non-harmonized legislation in the European Union. The parliament took the first step towards the overarching goal of helping to develop the German Blockchain-Ecosystem into practice, as announced with the Blockchain-Strategy of the federal government.
With the recent amendments to the German Banking Act, the service of crypto asset custody is henceforth subordinated to the supervision of the German Federal Financial Supervisory Authority (BaFin).
A former draft of the German Banking Act within the course of the legislative procedure asked for a strict separation of crypto-custody services on the one hand and any other regulated financial services on the other hand, even for fully licensed banking institutions. Such institutions would practically have been forced to either outsource this service to external agents or to subsidiaries. Against the background of massive criticism, this restriction was then removed from the Act.
Another major change of the final Act is that companies providing the newly regulated service of crypto-custody experience a privileged treatment compared to a full-service bank: Noteworthy differences are for example facilitated capital and disclosure requirements.
In summary, since 1 January 2020 a vast majority of companies with a blockchain based business model are now possibly forced to apply for authorisation, if and to the extent that the respective business model is related to permanent or temporary crypto-custody.
Additionally, Germany also implemented a unifying definition of crypto assets: In Sec. 1, para. 11, no. 10 German Banking Act, a crypto asset is defined as a digital representation of an asset which has not been issued or guaranteed by any central bank or public authority and which does not have the legal status of a currency or money, but which is accepted by natural or legal persons as a means of exchange or payment on the basis of an agreement or actual practice or which serves investment purposes and which can be transferred, stored and traded electronically.
The question is whether this (uncoordinated) German rush ahead in combination with the supranational (Non-) Regulation within the other Member States of the EU bears more disadvantages and risks or opportunities for the involved market players. For example: as these additions in the German Bank Act are not applicable to the so-called European Passporting System, the business of multinational groups within the EU might be hampered. Another effect could also be the so-called “regulatory arbitration” in unregulated EU or Non-EU countries. On the other side it also seems possible that the amended German Banking Act persuades companies to enhance and establish their business in Germany as the supervision by German authorities such as BaFin promises and implies regulatory safety and is therefore considered as attractive to investors.
Blockchain strategy and security token offerings
German law does not yet provide for securities that may be issued only in electronic form. As of today, the prerequisite for a security (in a German legal sense) is still the embodiment of a right in a (paper) document. Therefore, a token, even if it reflects rights that are comparable to those connected with a share or bond, is not treated as a security. On the other hand, given a different definition of “security” under the EU capital markets legal framework, such token would be deemed a security from a regulatory perspective.
This leads to a different qualification of tokens that are modelled like a security, namely as a security under EU-based regulatory law (e.g. for prospectus requirements), but under German civil law as a simple claim without being a security.
The blockchain strategy now confirms that German law should be opened to electronic securities and that a mandatory securitization (Verbriefung) of securities should no longer be required in principle. The regulation of electronic securities should be technology-neutral, neither privileging nor discriminating the blockchain technology, which is only one of many other (existing or future) DLT-based platforms. The German government initially restricts this initiative to electronic bonds and announced it would consider the extension to shares and investment fund units only at a later stage.
Public offerings of certain crypto tokens
The federal government is also aiming for a draft bill to regulate public offerings of certain crypto-tokens that do not qualify as securities in a regulatory sense. The law is intended to serve as a “transitional regulation” until European regulation is in place. For crypto tokens that are neither securities nor investment products nor other financial instruments, there is currently no obligation to prepare a prospectus or information sheet. In order to ensure a sufficient level of investor protection, the Federal Government is planning to introduce an information sheet that, in the case of a public offer, must be prepared and published by the issuer after approval by BaFin.
Hopefully, the expected regulations will close the gap between the German securities law understanding of a “security” and the broader capital markets law understanding. Given the planned Capital Markets Union, a uniform legal framework at European level would be welcome in order to avoid a patchwork of different regulations. Initiatives are also underway at this level to create a secure legal framework for issuers and investors.