The long-awaited modernization of German securities law has begun! Two Germany ministries have jointly published a draft law introducing a regime for dematerialized securities (electronic securities), including crypto securities, which provides for classic securities function such as bona fide acquisition. In the past, only certain electronic German government bonds could be issued in that way.
1. New Framework
Under the proposed draft, electronic securities can be issued by registration in an electronic securities register. The registration replaces the issuance of a security certificate. For electronic securities, which are not crypto-securities, Clearstream Banking AG, the German CSD, will exclusively operate the securities register. Securitized instruments already issued will be convertible (upon request of the issuer) into electronic securities, even without the consent of the investors.
Save for crypto securities, the draft law shall initially only be available to bonds. The inclusion of equity instruments shall only occur at a later stage once the new mechanisms have been tested and the market is more familiar with the instrument.
Given that the draft builds upon pre-existing rules already used for German government bonds in the past, there should be no need to establish new IT or other infrastructure. Electronic securities shall be eligible for collective safe custody, the most commonly used custody system in Germany, usually offering highest quality investor protection.
The proposed draft shall serve to simplify the issuance process by eliminating the need to issue an actual physical certificate and getting it printed and signed. This will limit issuance costs and also reduce operational risk. It should also provide for better interoperability and a simplified access to the German market for non-German issuers aiming at entering the German market, in particular where local laws (of the issuer) already provide for issuance of securities in electronic form by registration in a register.
2. Crypto Securities
The draft law will also – for the first time – codify a regime for crypto securities (as a subset of electronic securities). Germany will hence be amongst the first jurisdictions – together with Switzerland and Liechtenstein – to expressly provide for rules governing securities tokens on the Blockchain.
For crypto securities, a special register will be implemented, which need not necessarily be operated by a CSD. It can, for example, be operated by the issuer or any node on the blockchain. The operator of the crypto register though requires authorization for the provision of the registrar function.
The proposed draft provides for quite some innovative mechanisms. It allows crypto securities either to be issued following the rules applicable to electronic bonds outlined above or under a completely new regime for crypto securities.
- In the first case, crypto securities issued under that regime shall basically follow the mechanisms applicable to certain government bonds today and will be eligible for collective safe custody. The mechanism aims to follow well established routes and the German legislator tries to leverage pre-existing mechanisms.
- In the second case, legal ownership in a crypto securities will be assigned by law to the person registered on the blockchain (i.e. in the crypto register). Transfers of crypto securities (and rights arising from crypto securities) can only be effected by register entry. On grounds of a register entry, bona fide acquisition will be possible.
The draft is still subject to consultation by 14 September 2020. We expect the German government to prioritize its finalization, aiming for entry into force within the next couple of months. Even though the final wording of the law might actually look rather different to this initial draft, we believe that its basic ideas and principles will not be changed, allowing market participants to start structuring products based on the draft law already today, in particular in the crypto assets world.
Germany is one of the few EU jurisdictions with a substantial amount of securities token issuances. It also has a well-established administrative practice of the financial regulator around it, some very prominent use cases, a large FinTech community, and even its own market place for trading certain crypto assets. Hence Germany now aims to be a frontrunner in this area and set a new market standard for the EU.