SECURITY TOKEN OFFERINGS - A EUROPEAN PERSPECTIVE ON REGULATION - OCTOBER 2020 - Clifford Chance
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SECURITY TOKEN
OFFERINGS –
A EUROPEAN
PERSPECTIVE ON
REGULATION
OCTOBER 2020
CONTENTS
Overview and classification of security tokens............................................................................3
CONTENTS
Overview of local regulation.......................................................................................................... 7
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Overview
2. Mollisof EU-wide
blandit securities
fastidii id ius. laws
Ea audireapplicable to STOs...........................................................
adversarium est, quo ei sumo suscipit 9
x
3. No erant delicatissimi
Country-specific eum,
analysis of STOsaepe convenire sed ea
regulation xx
across
4. Vis Continental
etiam utamurEurope
ea, visand the UK......................................................................................
epicuri efficiendi ex 14
xx
5. Jurisdictions
Ei mel iuvaretwhere STOs
facilisi, no are
vimprimarily
nonumes regulated under traditional securities law..................... xx
15
6. France ..eloquentiam
Accusamus ......................................................................................................................................
cum et, pri quem intellegebat te 15
xx
7. Germany
Eos fugit ....................................................................................................................................
deleniti no, et duo omnes iisque 16
xx
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
United Kingdom .........................................................................................................................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
blockchain 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
ultimately drew the scrutiny of regulators
CLASSIFICATION OF 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 and process adopted for an STO may be
where they are issued. Typically,
typically entitle holders to rights similar to an ICO. However, in most
distributed ledger technology (DLT), such
similar to those of a conventional jurisdictions, subject to exemptions under
as blockchain, or other digital
security, e.g. an equity token may applicable securities laws, the process for
infrastructure which permits tokenisation,
grant voting or dividend rights, while issuing security tokens should be no
is used to constitute or record the
a debt token may grant rights to different to an initial public offering or IPO
interests in the securities. Such use of
coupon and principal payments. for equity or other traditional security
DLT can provide greater flexibility, speed
• 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, emerging, although at varying speeds in
Market participants may be familiar with
the approach to regulation of STOs different jurisdictions.
the “initial coin offerings” (or ICOs) seen in
varies considerably between
2017-18, typically conducted through an
member states; some have enacted What is a token?
online platform maintained by the issuer
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, Bitcoin 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, bond, 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
European Union (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, Germany, 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
regulation. It seems likely that as part of
SECURITIES LAWS
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 REGULATIONsecurities 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 REGULATIONWhile 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 REGULATIONSecurity 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 REGULATIONthe 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 blockchains 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 REGULATIONEuropean 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 REGULATIONFollowing 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 REGULATIONkeep, 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 –
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A EUROPEAN PERSPECTIVE ON REGULATIONYou can also read
