Regulatory Questions about Digital Securities and Tokenization

Cashlink: Dear Matthias, thank you very much for being a guest in our interview series on digital securities and tokenization today. Why don’t you introduce yourself briefly and explain to us where Ashurst as a law firm focuses on with its blockchain/DLT team.

Matthias von Oppen: I am the co-coordinator of the blockchain/DLT team in Germany which is part of a global working group which renders innovative legal advice for leading start-ups, disruptors, corporates and financial institutions seeking to leverage distributed ledger technologies to transform the way the world transacts and interacts with one another. We advise on a broad variety of projects including (i) tokenisation projects for start-ups and digital asset issuance platforms, (ii) on the establishment of distributed ledger based trading venues and clearing and settlement systems, (iii) blockchain based registries, (iv) cryptocurrency exchanges; and cryptocurrency payment cards.

Cashlink: What are digital securities and how do they differ from traditional securities?

Matthias von Oppen: Digital securities, sometimes also referred to as security tokens, are quite a novel feature in the financial markets utilizing the benefits of the blockchain technology and of the existing smart contract features. In terms of substance digital securities can represent all types of assets including investment contracts, shares of a corporation, profit participation rights, all kinds of debt, or even a fractionalized interest and can thus have a broad spectrum of use cases. Unlike traditional securities which under German law still require the existence of a paper certificate (in practice a global certificate) and thus the services of a central counterparty like Clearstream, digital securities are detached from the paper-based certificate, i.e. dematerialized, and are registered, transferred and settled solely via the blockchain system. The common feature of both types of securities are that they are tradable and from a regulatory perspective fall within the scope of the applicable securities laws provisions and under the scrutiny of the BaFin as supervisory authority.

Cashlink: What do you pay special attention to when structuring a digital security?

Matthias von Oppen: When structuring a digital security project, we usually commence with a holistic approach by preparing a high-level feasibility memorandum to ensure that the tokenization project can be effectively realised and satisfy the relevant expectation framework both from an issuer and investor angle. In the execution phase when drafting the underlying documents it is of utmost importance that all regulatory requirements are complied with and that the offer documentation and the terms and conditions are phrased in a clear, unambiguous and highly professional manner and that the technological features can be properly implemented in a robust legal manner. As digital securities are often marketed directly via the internet, we also advise the client to ensure that the communication strategy is in line with the securities laws requirements and assist the issuer in preparing a securities laws compliant filter gateway to restrict the offering related information to eligible investors.

Cashlink: Is the legislation around tokenization clear enough at the moment? What do you think the legislator should focus on?

Matthias von Oppen: The draft bill for the Electronic Services Act is a great step forward in Germany to ensure transaction certainty for digital securities, in particular the fact that the legislator is acting in a technology-neutral way. We are quite optimistic that this legislative reform will be key to pave the way to provide a level playing field for digital securities starting with debt securities tokens. One additional issue that needs to be tackled is that there are still various regulatory hurdles for institutional investors to invest in digital assets, such as the proper custody of such securities if directly held. In order to generate sufficient demand for digital securities it is of high importance to overcome these investment hurdles for institutional investors. 

What needs to be further developed: One important missing piece in the value chain for the digital securities infrastructure is the lack of an institutionalised secondary trading market platform for digital securities in Germany and the EU. Secondary market liquidity is important to stimulate demand in digital securities, in particular for institutional investors. We are aware that there are exciting ongoing projects in this field and hopefully these will materialise soon.