Secondary Market for Security Tokens — The need for a new regulatory approach at the European Union level
The secondary market for security tokens is now in the process of forming. In addition to questions related to securities law, regulatory law plays a major role as well. Under civil law, the claims and membership rights that are relevant for the capital market may be issued and transferred in the form of uncertified rights maintained on Trustworthy technologies (TT, e.g. DLT and Blockchain) systems — i.e. in the form of tokens. From a regulatory perspective, questions — some of them new — arise during trading, clearing and settlement as a result of the use of TT systems. It is becoming clear that authorisation to operate an MTF or OTF is relevant for the multilateral trading of security tokens. However, the obligation to book new securities issues from 2023 and all securities from 2025 in a book-entry account with a central securities depository as well as the clearing obligation for derivatives must be observed. There are questions as to whether these obligations are necessary with respect to TT systems and, taking account of the ratio legis, whether they are reasonable. A new technology appears to make the otherwise necessary trust in intermediaries obsolete and thus to make the secondary market for financial instruments much more efficient, more transparent and therefore more secure.
In recent years, Liechtenstein has become a more attractive location for companies in the financial technology space (so-called FinTechs). In particular, companies appreciate access to the European Economic Area (EEA), the regulatory framework conditions and the oft-cited “short distances” in Liechtenstein. FinTechs use new technologies to offer new or existing services in the financial segment and often break new ground. This not infrequently poses regulatory challenges in terms of implementation, both for the service provider and for the regulatory authorities.
One of these areas involves the financing of business models.¹ Starting in 2017, utility² tokens³ — considered to be commodities from a regulatory perspective⁴ — were offered for sale to the public as part of initial coin offerings (ICO)⁵. By contrast, security tokens are financial instruments pursuant to Annex I, Section C MIFID-II⁶ (Financial Instruments) that are represented by tokens with the help of trustworthy technologies (TT)⁷, such as, in particular, DLT⁸ and blockchain systems. The term “trustworthy technologies” was defined in the TVTG (aka Liechtenstein Blockchain Act) and is also used in this paper as an umbrella term for DLT and blockchain.
Security tokens are offered for sale to the public as part of so-called security token offerings (STO)⁹. STOs are used for corporate financing as well. Compared to the public offering of commodities, however, the public offering of financial instruments is heavily regulated. Financial instruments issued in the form of tokens are subject to the same regulations as traditional financial instruments.¹⁰ As far as I can tell, the first securities prospectus for a security token in the European Economic Area (EEA) was approved by the Liechtenstein Financial Market Authority in August 2018¹¹; others followed. These new technologies are apparently well suited for the primary market¹². However, the question such offerings pose is how fungible they will be on the secondary market after their initial issue on the primary market. This is because only a functioning secondary market — consider, for example, the maturity transformation function of the secondary market — makes it possible to use security tokens over the long term and broadly for corporate financing.
Capital market law is closely associated with company law. However, the aim of the latter is primarily to protect investor assets and membership in the company, while capital market law attempts to create the legal framework necessary for markets to function.¹³ For this reason, this thesis first looks at the civil law basis for the representation and transfer of claims and membership rights to tokens before then examining the regulatory basis of the secondary market for security tokens.
“The key to identifying and addressing the legal problems involved in modern financial market transactions is precisely defining the factual basis — the facts of the case, so to speak — for assessing them from a legal standpoint.”¹⁴
Consequently, in those places where facts are classified on the basis of trustworthy technologies (TT) these facts will first be examined in a clear and precise manner. To this end, first the term token will be examined in more detail, followed by a discussion of which tokens are subsumed under the term “financial instruments” and the criteria used for delineating them. This will be followed by a presentation of the current regulated intermediaries on the secondary market. The perspective will then shift to the existing markets for tokens and their authorisation and registration obligations will be analysed in order to identify challenges and open questions and whether these developments need to be reconciled with the current regulatory concept. The question is whether the changes enabled by these new technologies have such a disruptive force and are used widely enough in practice (“factual practice”) to make new regulatory approaches necessary, in line with Jellinek and his “normative force of the factual”.¹⁵ Finally, a new regulatory approach for the secondary market for security tokens is presented for discussion.
2 The technological basis
2.1 Trustworthy technologies (TT) and TT systems
TT system refers to transaction systems that enable the secure transmission and storage of tokens as well as the services based on them using trustworthy technologies (selected DLT/blockchain systems).¹⁶ The term “blockchain”¹⁷ was coined in connection with the Bitcoin cryptocurrency and represents the technology on which various cryptocurrencies such as Bitcoin, Ether, Dash, Aeternity and Litecoin are based. To put it very simply, blockchain refers to the chain of blocks that contain the transaction data. These blocks are arranged chronologically and connected to the preceding block via a checksum.¹⁸ This transaction data forms the ledger, which is stored locally by as large a number of users as possible¹⁹ and is known as a distributed ledger. The corresponding technologies are called distributed ledger technologies (DLT).²⁰ The most commonly used²¹ blockchains are Bitcoin²² and Ethereum²³ (ETH — Ether/Ethereum); Aeternity is a blockchain developed in Liechtenstein²⁴.
TT system is thus an umbrella term for certain qualified technologies, such as certain blockchains or DLT systems. The term “trustworthy technologies” should therefore be understood to mean that the trustworthiness is engendered by technology (trust-less)²⁵ and not by an intermediary.²⁶ This fundamental idea is not only significant for the regulatory concept of the TVTG, but also leads to the question of whether and if so, which capital market intermediaries can be replaced by technology. Following this idea, it will, in particular, be worth examining where, based on the regulations, the requisite trust in the intermediary exists. Thus, settlement and custody (and regulation of the intermediary entrusted with these services) play a central role in securities law. Precisely in the area of settlement and custody, these new technologies present new solutions that ensure security and trust without intermediaries.
3 Tokens in civil and regulatory law
3.1 General classification of tokens under civil law
3.1.1 Definition of tokens according to the TVTG
It is hardly surprising that there is no uniform definition of tokens under civil law in Europe. Liechtenstein was one of the first countries in the world to introduce a legal definition when it passed the Token and TT Service Provider Act (TVTG). In Art. 2, para. 1c), the TVTG defines the term “token” as information²⁷ on a TT system²⁸ that can represent claims or rights of membership against a person, rights to property, or other absolute or relative rights and that are assigned to one or more TT identifiers²⁹. Thus, the TVTG defines the token as information that can represent rights and therefore as a new legal object (sui generis).³⁰ In practice, a distinction is often made between tokens and coins³¹, although these terms are also sometimes used as synonyms. “Coins” are understood to be the system units of protocols such as Bitcoin and Ethereum. By contrast, tokens are based, for example, on a blockchain such as Ethereum and to use it users pay in Ether, the Ethereum coin. Tokens can have a wide variety of functions. Bitcoin was invented as a form of payment that requires no intermediary and is used to transfer assets. Access tokens grant access to a network or access to a service and are often issued in order to finance the development of new blockchain protocols.³² The definition in Art. 2, para. 1c) TVTG is used below for all manifestations of the term “token”.
3.2 Basis in civil law for the transfer of tokens and the rights represented by tokens
Without transferability there is no secondary market. For this reason, the circumstances under which the rights represented by tokens can effectively be transferred first need to be described. The civil law section³³ of the TVTG specifies that the rights that are represented by tokens are transferred with the tokens.³⁴ The condition for doing so is the transfer of the right of disposal over the token³⁵. Disposal over a token requires that:
- the transfer of the token is carried out in accordance with the rules of the TT system³⁶;³⁷
- the transferor and the transferee both declare³⁸ that they want to transfer the right of disposal over the token³⁹; and
- the transferor has the power of disposal pursuant to the provisions of Art. 5 TVTG.⁴⁰
If there is effective disposal over the token, then this ex lege allows for disposal over the rights represented by the token.⁴¹ This “coordination requirement”⁴² was striking when the TVTG entered into force. If the authorised transferor and the transferee agree to the transfer of the right of disposal over the token, then the rights represented by the token, such as the right to a book-entry security, will — if permitted by law⁴³ — be transferred as well.⁴⁴
However, Art. 7, para. 2 imposes a significant restriction. Effective disposal over a token only allows for disposal over the rights represented by the token if this legal effect comes into force by law.⁴⁵ Thus, to determine the transferability of the rights represented by a token it must first be clarified whether the transfer (1) came into effect pursuant to Art. 7, para. 1 TVTG or (2) which measures⁴⁶ — if any — will result in a transfer. The first case applies to uncertified rights⁴⁷ pursuant to Art. 81a of the final section of the Liechtenstein Persons and Companies Act (SchlT PGR), but not to movable or immovable property or certificated claims and securities.⁴⁸
If the token is disposed of with no legal basis (sine causa) or if this legal basis subsequently no longer applies, then the transaction will be reversed in accordance with the requirements of the Unjust Enrichment Act⁴⁹. In this case, there is no claim to delivery of the token (replevin), but rather only a claim to have the transaction reversed under the Unjust Enrichment Act.⁵⁰
3.2.1 Transfer of claims and membership rights
18.104.22.168 Claims in general
Of particular interest for the secondary market are (the simplest possible) transferable claims and membership rights. In Liechtenstein, claims can be transferred form-free through cession, provided the underlying legal transaction has no formal requirements.⁵¹ If there are no additional formal requirements, then disposal over the token also results in the transfer by law of the claim to the new holder of the right of disposal over the token.⁵² In the case of certificated claims, by contrast, the legal effect does not come about ex lege.⁵³
22.214.171.124 Membership rights in general
Legal entities⁵⁴ may grant their members membership shares (share rights), provided there is no law or regulation to the contrary. The membership cannot be divided, sold or inherited.⁵⁵ The membership is transferred⁵⁶, in accordance with Art. 149, para. 3 PGR and provided there are no securities or uncertified rights with the character of securities⁵⁷ related to the membership, by means of a written contract⁵⁸. Thus, if membership rights are not issued in the form of securities in accordance with Art. 150 PGR or as uncertified rights in accordance with Art. 81a, para. 1 of the final section of the PGR (certificated), then they are transferred by means of a contract (see Fig. 1).⁵⁹
126.96.36.199 From physical securities to claims and membership rights to uncertified rights (“Wertrechte”) and an electronic register system
By contrast, there are special transfer requirements for securities. From a civil law perspective, the term and form of securities are defined in Art. 73 ff of the final section of the Liechtenstein Persons and Companies Act (PGR). Securities are certificates that manifest a right physically (securitization), preventing the right from being sold, claimed or otherwise transferred without the certificate.⁶⁰ They connect a right with a physical form of information , a certificate.⁶¹ The debtor of a security is obliged to make payment when the certificate is presented and delivered. The transfer of the security as property or as a limited right in rem requires a written contract and the delivery of the certificated security (see Fig. 1).⁶² The transfer of membership rights via certificates, which is, in comparison, already much simpler, was the first step towards a more efficient capital market. In most cases, certificated securities⁶³ serve as documentary evidence for claims to repayment and interest on the holder’s capital against the issuer (debt security).⁶⁴ Tokens lack the prerequisite of being physical. They are therefore not physical forms of information. They are not documents but information that is stored digitally. If a token is intended to represent a claim that is certificated by a security, the transfer of the token does not by law result in the transfer of the right certificated by the security as well as the right represented by the token.⁶⁵ Instead, the transfer must be carried out in accordance with the rules of property law (PL, “Sachenrecht”). Thus, in accordance with Art. 7, para. 2 TVTG the obliged person must ensure that the legal effect occurs.⁶⁶ The “tokenisation” of claims certificated in securities therefore makes little sense.⁶⁷ However, the problem of physical delivery occurs with global securities trading as well. The constantly growing volume of transactions has made the immobilisation⁶⁸ of securities necessary. A multi-level custodial system was developed by custodians (central securities depositories) in which certificates no longer needed to be delivered, and instead the transfer was carried out de facto by means of electronic account rebooking processes (securities transfer system)⁶⁹).⁷⁰ In some countries, such as Germany, Austria, Luxembourg and Switzerland, company shares were certificated in the form of collective certificates (global certificates).⁷¹ In the constant endeavour to improve efficiency, the (continued) requirement that a document be issued was subsequently called into question. This resulted in the so-called dematerialisation of securities, making it no longer necessary to document the security rights in the form of a certificate.⁷² The next major step in the rationalisation of securities was the complete disappearance of physical form. In place of certificates there would be purely electronic entries in a register/ledger⁷³, so-called uncertified rights (“Wertrechte”)⁷⁴.
188.8.131.52 On the civil law meaning of the term “uncertified rights” in accordance with Art. 81a SchlT PGR — “functionally equivalent securities in tokenised form”
Even before the TVTG, Liechtenstein law recognised immobilised and dematerialised securities, i.e. uncertified rights (“Wertrechte”)⁷⁵.⁷⁶ In the framework of the TVTG, uncertified rights were codified in Art. 81a, para. 1 SchlT PGR:⁷⁷
uncertified rights (Wertrechte) are “rights with the same function as securities”⁷⁸.
As a result, physical documentation in the form of a certificate is no longer necessary, and claims can be issued in digital form (uncertified rights).⁷⁹ The uncertified rights register (ledger) that the debtor is required to maintain in accordance with Art. 81a SchlT PGR may involve the use of trustworthy technologies pursuant to the TVTG.⁸⁰ In such cases, transfers (of uncertified rights in the form of tokens) are based solely on the provisions of the TVTG (see Fig 1).⁸¹
However, only those rights that can be certificated in the form of a security can be issued as uncertified rights.⁸² Since entry into force of the TVTG, any reference in Liechtenstein law on securities is also understood to include uncertified rights as well.⁸³ Whether claims and membership rights can be certificated in the form of securities and thus issued as securities depends on the selected legal form of the legal entity. In addition to joint stock companies⁸⁴, as the prime example⁸⁵, in Liechtenstein securities can, for instance, be issued via membership in (special) associations⁸⁶, registered cooperatives⁸⁷, associations with limited liability (trade unions)⁸⁸, silent partnerships⁸⁹ and institutions⁹⁰. Since the 2016 reform of companies with limited liability LLC (GmbH) the documentation of securities in certificate form is no longer possible for companies with limited liability (GmbH)⁹¹. When issuing uncertified rights⁹² via legal positions under company law the requirements related to company law must be observed in addition to the requirements related to securities law. The content of the uncertified rights is based mainly on the company’s articles of incorporation and shareholder resolutions.⁹³
184.108.40.206 Transfer of uncertified rights (Wertrechte) in securities trading
The transfer of uncertified rights can be illustrated using the example of a joint stock company and bearer shares, which are relevant on the capital market. Before they were immobilised⁹⁴ bearer shares were transferred in the form of a certificate in line with the requirements of securities law described above. Bearer shares must now be held in custody by a securities depository designated by the company.⁹⁵ Pursuant to Art. 326a, para. 2(1) PGR, this regulation does not apply to exchange-listed stock companies because of the special provisions that apply to them.⁹⁶ Uncertified rights must be booked with the securities depository when they are issued rather than stored pursuant to Art. 326a, para. 1 PGR.⁹⁷ All of the uncertified rights holdings must be booked in a holding account with the depositary.⁹⁸ Shareholders wishing to transfer bearer shares in accordance with Art. 326h PGR must notify the securities depository accordingly.⁹⁹ The transfer becomes effective when the acquiring party is entered in the register.¹⁰⁰ All of the requirements under securities law and company law must be met cumulatively. The certificate is transferred under the provisions of property law (“PL”) in the form of a notice of the transfer of ownership pursuant to Art. 503 PL¹⁰¹ by the selling shareholder as the indirect and autonomous owner to the depositary as the direct and non-autonomous owner. As a result, the security is transferred in line with the provisions of civil law. However, the company — from the perspective of company law — only recognises the person entered in the register as the shareholder.¹⁰² Applying this dichotomy to the issue of uncertified rights in accordance with Art. 81a SchlT PGR, the transfer of bearer securities in the form of uncertified rights can be carried out, on the one hand, by:¹⁰³
- entering the acquiring party in the uncertified rights register (ledger) of the legal entity pursuant to Art. 81a, para. 4 SchlT PGR; and, on the other hand, by
- entering the acquiring party in the securities depository register pursuant to Art. 326h, para. 3 in conjunction with Art. 326c PGR.
These two registers must be coordinated¹⁰⁴, whereby a securities depository pursuant to Art. 326b PRG may also maintain the uncertified rights register (ledger, “Wertrechteregister”).¹⁰⁵
3.2.2 Interim conclusion on the conditions under securities and civil law
In summary, the claims and membership rights that are relevant for the capital market may, under securities and civil law, be issued and transferred in the form of uncertified rights maintained on TT systems — i.e. in the form of tokens. The transfer of uncertified rights on an electronic register/ledger (booking-supported securities system) is especially suited for the secondary market from the perspective of civil law because of the simple transfer through rebooking.
3.3 Classification of security tokens under regulatory law
From a regulatory law perspective, tokens serve as a sort of container that can represent a number of existing rights in the digital (blockchain) world.¹⁰⁶ In terms of the representation of rights, they largely fulfil the same functions as securities with respect to the documentation of securities in certificate form; these include:
- The “legitimization function”: Rights owners identify themselves by verifying their possession of the power of disposal over the token;
- The “liberation function”: Release of the debtor upon payment of the holder of the power of disposal over the token;
- The “transport function”: The token makes it possible to transfer rights;
- The “transfer protection function”: The protection of bona fide rights; and
- A “restriction on objections”¹⁰⁷: A restriction on objections aimed at entries in the uncertified rights register.¹⁰⁸
Uncertified rights¹⁰⁹ pursuant to PGR therefore have all of the functions of a security when TT systems are used -> functional equivalence.¹¹⁰
This functional equivalence makes it possible to treat uncertified rights equally without any restrictions, including from a regulatory law perspective. First, therefore, it must be clarified which tokenised financial instruments (rights represented in tokens) are suitable to be traded on the secondary market:
In practice, tokens — depending on their (economic) function — are divided from a regulatory law perspective into the following three categories¹¹¹:
- Utility tokens,
- Payment tokens (currency coins/tokens) and
- Security tokens (equity tokens).
This classification was not included in the TVTG¹¹² and offers few advantages in practice for the following reasons: Utility tokens usually represent (discounted price) claims to services or goods and can also serve as an access key to a network or software. Payment tokens have (only) a currency (or payment means) function. The most well-known example is Bitcoin. Security tokens represent the rights of financial instruments and can, if necessary, replace the documentation of securities in the form of a certificate (certificated securities) with electronic register/ledger entries (uncertified rights).¹¹³ The foregoing alone makes it clear that in most cases tokens cannot be clearly assigned to one of these three categories and are so-called hybrid tokens. In addition to these three categories, there are highly granular classification approaches¹¹⁴ that, in addition to function, also take account of technical and legal information. The names and classifications given to tokens by private stakeholders is, of course, irrelevant for regulatory classification purposes.¹¹⁵
The Liechtenstein Financial Market Authority (FMA), when assessing the applicability of securities law provisions (see FMA communication 2019/1¹¹⁶ and FMA communication 2019/2¹¹⁷) and thus its jurisdiction, applies the principle of “substance over form”. This technology-neutral approach¹¹⁸ is to be welcomed¹¹⁹. (Security) tokens that represent, in particular, securities or financial instruments¹²⁰ should therefore be classified as such pursuant to financial market regulations.¹²¹ In this connection, Art. 3a, para. 1(42) Banking Act (BankG)¹²², which implements Art. 4, para. 1(44) MiFID II, defines transferable securities as types of securities that can be traded on the capital market with the exception of payment instruments¹²³. According to the non-exhaustive¹²⁴ list cited in this law are:¹²⁵
- Shares and other shares or units in companies, partnerships or other legal entities that are equivalent to securities as well as share certificates;
- Debentures or other debt instruments documented in paper form, including investment certificates (depositary receipts) for such securities;
- All other securities that authorise the purchase or sale of such securities or that result in a cash payout and that are determined on the basis of transferable securities, currencies, interest rates or income, goods or other indices or indicators;
According to Annex 2, Section C BankG, in addition to transferable securities financial instruments include money market instruments, fund units, certain derivatives, emission allowances and more¹²⁶. As the competent regulatory authority, the FMA approved its first securities prospectus for securities in the form of (security) tokens in summer 2018.¹²⁷ It is worth noting that this answered the question of whether securities issued in the form of tokens retained the characteristic of securities and thus approval of the prospectus by the FMA was possible. In October 2019, the FMA, in FMA, communication 2019/2¹²⁸ established additional requirements for securities prospectuses when issuing security tokens. According to this communication, the Securities Prospectus Act and EU Regulation 2017/1129¹²⁹, which is directly relevant, are also applicable if the token fulfils the characteristics of a security. By approving multiple prospectuses, the FMA affirmed this characteristic an equal number of times.¹³⁰ When assessing the fulfilment of the characteristic of a security, the FMA assesses three criteria:
- Transferability, and
For the question of tradability it is relevant whether the security can be traded on the capital market, whereby the term “capital market” must be interpreted broadly.¹³² As far as can be determined, the first “blockchain-based”¹³³ multilateral trading facility (MTF)¹³⁴ in the European Economic Area (EEA) was approved in Liechtenstein.¹³⁵ Tradability was ensured by no later than this point. The transferability criterion is usually ensured by means of the token’s transport/transfer function.¹³⁶ Finally, standardisation is also not problematic to implement from a technical standpoint. A large number of tokens of the same type¹³⁷ are created¹³⁸ on a regular basis. It is not necessary for the security to be issued in certificated form (paper).¹³⁹ The FMA holds this view as well and assesses the characteristic of securities on the basis of the aforementioned three criteria. Documentation of the security in certificate form is therefore not a mandatory condition. Here, the FMA explicitly speaks of the principal of “substance over form”.¹⁴⁰ Even when applying the principle of “substance over form” it can be concluded that when financial instrument rights are represented by tokens the regulatory provisions on financial instruments must be applied if the represented rights are subject to these provisions. By contrast, the form and designation (in tokenised form or as a certificate) play a subordinate role.¹⁴¹ Conversely, this also means that tokens that represent other rights are not to be classified as financial instruments¹⁴² and should not be subject to financial market regulations. With respect to the issue and subsequent obligations (including for the secondary market), the
FMA does not see “any significant differences between securities prospectuses for the issue of securities and securities prospectuses for the issue of security tokens”.¹⁴³
3.4 Interim conclusion on the classification of security tokens under regulatory law
In summary, it can be said that security tokens are tokens from a regulatory law perspective whose represented rights are already taken into account under regulatory law, and therefore that they are traditional financial instruments that, in order to make it easier to transfer them, are transferred and stored using TT systems (DLT/Blockchain) rather than being stored with a central securities depository and documented in the form of a certificate. Securities regulatory law allows for financial instruments in the form of tokens as well.
Trading in security tokens is subject to, as will be shown below, strict conditions regarding trading, clearing and settlement as well as the intermediaries involved.
4 Secondary Market for Security Tokens
4.1 The capital market
The capital market comprises the market for medium- and long-term capital investments and investments in companies.¹⁴⁴ It is further divided into the primary market and the secondary market. The primary market is the market on which capital market instruments¹⁴⁵ are offered for sale for the first time. This is done by issuing the securities outside stock exchanges.¹⁴⁶ As previously noted, the primary market has so far not posed an insurmountable challenge for security tokens. Secondary markets include all exchange and off-exchange markets that help with the circulation of securities that have already been issued through multiple purchases and sales. The most relevant markets continue to be stock exchanges¹⁴⁷.¹⁴⁸ Stock exchanges have established themselves as places where fungible goods, such as financial instruments¹⁴⁹, can be traded on the basis of supply and demand with the help of transparent pricing rules. They fulfil important economic functions by providing liquidity, helping to raise capital, placing a value on the traded securities and serving as an economic and sector barometer.¹⁵⁰ But MiFID II provides for markets other than exchanges (regulated markets) that can be considered when trading security tokens — some of which are even better — and which are presented below.
However, these do not include the secondary market for cryptocurrencies, which is not always subject to licensing or approval¹⁵¹ and is supplied by so-called crypto-exchanges¹⁵². The term crypto-exchange has become established to refer to centrally organised trading venues that do not list security tokens or e-money¹⁵³ in tokenised form. If they have the appropriate form, such exchanges may operate in Liechtenstein (in contrast to Germany) without regulatory approval, but with prior registration in accordance with the TVTG. Most crypto-exchanges replicate the trading that occurs on traditional exchanges and tokens can be traded in exchange for tokens or legal tender (currency)¹⁵⁴. Crypto-exchanges also offer access to a central (off-chain¹⁵⁵) order book in which offers to buy and sell are aggregated. Most crypto-exchanges hold the tokens in safekeeping for their users and users can only hold them in safekeeping themselves upon payout. In practice, there is not a very clear distinction in the way this term is used and some include platforms that settle purchases and sales for their own account.¹⁵⁶
In addition to regulated markets and crypto-exchanges, a third form has developed on the basis of TT systems, known as an “operatorless” secondary market, so-called decentralised exchanges (DEX¹⁵⁷).
The term “decentralised exchange” (DEX) describes software and protocols that allow users, thanks to the decentralised operation of this software, to exchange tokens without the need for an intermediary for trading, clearing, settlement or safekeeping.¹⁵⁸
In other words, a DEX is a purely software-based trading venue that runs — at least in part — on a¹⁵⁹ decentralised system. Because of their structure as operatorless trading venues DEXs appear to be prima facie unregulated or their operators difficult to regulate. In practice, most exchanges are a hybrid with centralised and decentralised elements. In practice, the organisation of trading is often centralised and settlement decentralised (known as hybrid models¹⁶⁰), which does not simplify the question of licensing or approval requirements. These decentralised trading venues, with as few central elements as possible, are intended to enable token transactions that have no restrictions and are secure for users.
Thus, the goals of the aforementioned centralised and decentralised markets and trading venues appear to be similar in their main features. The “new” trading venues present challenges to the current regulatory concept, which is geared towards intermediaries, but they also present opportunities. The following comparison of financial instruments transactions by centralised and decentralised trading and post-trading systems is based on a functional view in order to be able to establish the thesis of a suitable regulatory concept for the secondary market for security tokens. In particular, it must be reviewed whether harmonised securities law, taking account of the relevant goals being pursued (ratio legis) represent an adequate legal basis for the use of TT systems. To this end, the individual phases of securities transactions and their regulatory approaches will be individually presented and analysed.
4.2 Financial instrument transactions
A todays typical financial instrument transaction via centralised markets can be divided into three phases:
- Phase 1: Conclusion of the transaction (trading),
- Phase 2: Clearing of the transaction (clearing) and
- Phase 3: Settlement (delivery) of the transaction.¹⁶¹
The amount of time between the trade and settlement varies considerably for securities and derivatives. Securities typically take about three days, while derivatives can take up to several decades.¹⁶² Clearing and delivery together are referred to as the post-trade phase. This includes all activities¹⁶³ to transfer the rights from the concluded transaction.¹⁶⁴ What was initially a direct¹⁶⁵ safekeeping of the securities has developed into a multi-level indirect safekeeping system. Securities are no longer handed over physically in order to transfer ownership over them; instead, electronic account entries are made.¹⁶⁶
Sample securities transaction: A simplified example of a securities transaction now proceeds as follows: Client A gives Bank A (custodian bank) the order to acquire a security. As the agent¹⁶⁷, Bank A forwards the order to an exchange (trading venue) in its own name. The transaction concluded successfully on the exchange is cleared and reported to the central securities depository¹⁶⁸. Because the buyer maintains his custody account at Bank B and thus the physical security, from the perspective of the central securities depository, changes ownership, the central depository rebooks the security in the account booking system from the account of Bank B to the account of Bank A. Bank A issues the buyer a corresponding custody account credit and Bank B issues him a custody account debit. If the buyer and the seller are clients at the same (custodian) bank, the bank can carry out the securities transaction without the involvement of the central securities depository.¹⁶⁹
By definition, a transaction on a decentralised exchange (DEX) is carried out on TT systems without a central service provider.¹⁷⁰ The use of trustworthy technologies is a key element. For example, Ethereum¹⁷¹ uses a so-called decentralised exchange protocol for hosting. This decentralised exchange protocol¹⁷² is used as the basis for a decentralised exchange application, a form of a decentralised application¹⁷³ that, depending on the DEX, provides the order book (on-chain¹⁷⁴ or off-chain) and, in some cases, carries out the matching (see Phase 1 — trading). The TT system that is used also ensures the clearing (see Phase 2 — clearing) and settlement of the transaction (see Phase 3 — settlement) directly (peer-to-peer) between the users. In addition, in some cases graphical user interfaces (GUI)¹⁷⁵ created by central operators and interfaces are provided to ensure ease of use.¹⁷⁶ The individual functions and components of a DEX thus consist of:
- the (trustworthy) technologies used;
- the order book (mechanism for finding counterparties and matching — trading);
- the transaction settlement protocol (clearing and settlement) and
- (optionally) the graphical user interface (GUI).¹⁷⁷
The resulting advantages of DEX compared to centralised exchanges (especially crypto-exchanges) are:
- the comparatively low counterparty risk¹⁷⁸,
- low transaction costs,
- constant availability¹⁷⁹, and
- few conditions for listings¹⁸⁰ of tokens of all types,
This can lead to greater liquidity — especially for tokens that are not otherwise listed on exchanges. Users of DEX appreciate the fact that they can keep their private keys in safekeeping themselves and Phase 3 — settlement can proceed without an intermediary whom they must trust.¹⁸¹
Both centralised and decentralised systems carry out transactions in the three phases trading, clearing and settlement:
4.2.1 Trading via markets with a centralised organisation pursuant to MiFID II
Trading, i.e. Phase 1 for transactions in financial market instruments, is carried out on so-called trading systems (trading venues¹⁸³). A successful trade results in the conclusion of a capital market transaction in accordance with the law of obligations. Trading venues can be divided into markets governed by MiFID II and off-exchange derivative trading governed by EMIR¹⁸⁴ (over the counter, OTC). Markets governed by MiFID II, in turn, can be distinguished on the basis of how the trading is carried out, either multilaterally or bilaterally. Multilateral systems bring together the interests of multiple third-party buying and selling interests in financial instruments in the system. In other words, multilateral trading facilities enable trading among market participants and investors.¹⁸⁵ In addition to regulated markets (exchanges) and multilateral trading facilities (MTF) for financial instruments, MiFID II also covers organised trading facilities (OTF) for debentures, structured financial products, emission allowances and derivatives. With bilateral facilities, the system operator serves as the counterparty for all contracts concluded via the system.¹⁸⁶
220.127.116.11 Regulated market (stock exchange)
Art. 4, para. 1(21) MiFID II defines the regulated market as a multilateral system operated and/or managed by a market operator, which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments — in the system and in accordance with its non-discretionary rules — in a way that results in a contract, in respect of the financial instruments admitted to trading under its rules and/or systems, and which is authorised and functions regularly and in accordance with Title III¹⁸⁷ of MiFID II. Regulated markets can admit banks and investment firms and other persons as members or participants if these are sufficiently well regarded, have sufficient skills, competencies and experience with respect to trading and meet¹⁸⁸ the other conditions of Banking Ordinance (“BankV”)¹⁸⁹. Retail clients usually do not meet these requirements.
The operation of a regulated market requires a licence from the FMA pursuant to Art. 30s, para. 1 Banking Act (“BankG”). Trading on a regulated market is subject to public law.¹⁹⁰
However, Liechtenstein has not provided a (sufficient) public law basis in terms of an exchange law for regulated markets.
The extremely superficial rules are contained in the Banking Act. Clearly, lawmakers have so far not considered it to be relevant, and there is (also) no regulated market in Liechtenstein. A closer examination in this paper is therefore not necessary. Multilateral trading systems such as MTFs and OTFs seem to be much more relevant for security tokens.
18.104.22.168 Multilateral trading facilities (MTF)
Although securities trading in the EEA continues to be conducted mainly on regulated markets, trading via multilateral trading facilities (MTF) is becoming more common.¹⁹¹ The operator of an MTF may be a bank, investment firm or the operator of regulated markets¹⁹², which may simultaneously operate a multilateral trading facility.¹⁹³
Art. 4 para. 1(22) MIFID II defines MTFs as a multilateral system, operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests¹⁹⁴ in financial instruments — in the system and in accordance with non-discretionary rules¹⁹⁵ — in a way that results in a contract in accordance with Title II¹⁹⁶ of MiFID II. Here, system refers to both markets that consist of a set of rules and a trading platform as well as those that function solely on the basis of a set of rules.¹⁹⁷ It is not necessary to operate a technical trading facility, meaning voice-based systems are included as well. However, the term does not include telephone trading, of course, as otherwise telephone companies would be subject to approval as the operator of a trading facility, even though they do not aim to operate a trading facility with their offering. The set of rules must ensure proper trading and includes rules on membership, the listing of financial instruments, trading between members and reporting and transparency obligations.¹⁹⁸ Here, the type of system is not decisive; the following are possible:
- order-driven (orders from investors) or
- quote-driven (e.g. quotes from market makers),
and systems with:
- continuous trading; or
- periodic auctions; or a
- price request system; or
- other trading systems.¹⁹⁹
With a regulated market (stock exchange), the “facilitation” of the conclusion of a contract is sufficient, while the focus with MTFs is on “bringing together”.
Bringing together buying and selling interests in financial instruments in the system in a way that results in purchase contracts is central to the definition of a multilateral trading system.²⁰⁰
Here, buying and selling interests is to be understood broadly and includes orders, quotes²⁰¹ and (non-binding) expressions of interest.²⁰² Therefore, after the orders or interests have been brought together in accordance with the rules of the system via its protocols or in accordance with its internal operating processes there must be a contract.²⁰³ The orders or interests must be brought together in the system, i.e. the orders²⁰⁴ entered must (be able to) interact with corresponding orders entered in the system for the same financial instrument and the transaction carried out in the system itself.²⁰⁵ Systems that bring together orders or interests do not include order routing systems, information systems and passive or partially active advertising systems (such as bulletin boards, blackboards). These systems do not carry out matching and only accept preliminary orders.²⁰⁶
Another delineating feature is the way the orders are brought together. In contrast to organised trading facilities, which are permitted to exercise discretion, MTFs must bring orders together in a non-discretionary manner. Non-discretionary means that the orders are only brought together in accordance with the rules of the system or with the help of the system’s protocols or internal operating processes.²⁰⁷ ²⁰⁸ Thus, after the order has been issued the parties have no opportunity to say whether they would like to carry out the transaction with a certain counterparty in that particular instance.²⁰⁹ Nor does the operator have any scope for discretion. In particular, the operator may not execute client orders with its own funds, nor may it rely on matched principal trading.²¹⁰ In contrast to the operation of a regulated market, the operation of a multilateral trading facility represents an investment service and the MTF is operated privately, not as a public-law regulated market.
Compared to a regulated market, the lack of the corresponding provisions on the listing of financial instruments on the MTF is relevant²¹¹. Access to multilateral trading facilities is as strictly limited as access to regulated markets.²¹² The operator of an MTF has the personal autonomy to impose additional criteria for security tokens. This private-law organisation enables a more flexible structure, e.g. in the form of market regulations, which could be considered necessary with respect to trading security tokens.²¹³ In addition, unlike OTFs equity instruments can be traded as well. Looking at the primary market for security tokens, there are already some approved prospectuses for equity instruments, so trading in equity instruments in the form of security tokens²¹⁴ may, in practice, be relevant and trading security tokens, in particular, will be organised via MTFs as well.
The operation of a multilateral or organised trading facility requires licences from FMA in accordance with Art. 30t Bankin Act (BankG). In addition to being able to provide services domestically, this license also makes it possible to apply for the so-called “European passport”, also referred to as “passporting”. The application for the European passport is submitted to the authorities in the home country²¹⁵ as part of a so-called notification procedure and enables the provision of cross-border services. Thus, for example, an MTF licensed in Liechtenstein can actively offer services in Germany from Liechtenstein with no branches²¹⁶ in Germany (as the host country) and without any additional approval from the Germany regulatory authority, BaFin²¹⁷. To do so, an intermediary that has already been licensed by the FMA applies for notification in one or more member states of the EU/EEA. The FMA then discloses the intended activities on the part of the intermediary to the regulatory authorities in the host country (or countries) (in the example, BaFin).
After confirmation of the notification — which is generally just a formality — the intermediary can commence its activities in the host country²¹⁸.
The authorities in the home country remain responsible for oversight, the FMA in this case.²¹⁹
22.214.171.124 “Börse Stuttgart” MTF for cryptocurrencies
The Börse Stuttgart operates an MTF for tokens — currently, Bitcoin — which can be used as an example to show the challenges that regulated institutions face even in just listing non-security tokens based on TT systems (DLT/Blockchain):
The Baden-Württembergischen Wertpapierbörse GmbH (BWWB)²²⁰ operates an MTF²²¹ for trading cryptocurrencies²²² for (German) private and institutional clients. It operates as Börse Stuttgart Digital Exchange GmbH (BSDEX)²²³. As the license holder, the BWWB regulates trading with its own market regulations and monitors compliance with them. From a technical perspective, the MTF is operated by BSDEX. Fiduciary custody of the cryptocurrencies is carried out by — the currently²²⁴ still unregulated²²⁵ — blocknox GmbH (crypto-custodian). The EUR account for users is maintained by solarisBank AG (account-holding bank)²²⁶. BSDEX provides the website www.bsdex.de, which also serves as the shared graphical user interface (GUI²²⁷) for trading (MTF) and custody of the cryptocurrencies and account maintenance of legal currencies.
As a prerequisite for trading cryptocurrencies on the MTF and the transmission of buy orders, users must have a EUR account (at the account-holding bank) with funds equal to at least the expected transaction volume plus fees. By contrast, sell orders require users to have at least one crypto account (at the specified crypto custodian) with funds equal to the order volume.²²⁸ This mitigates counterparty risks, as the contractual relationship exists directly between the buyer and the seller, with no central counterparty. However, trading is still anonymous between the users. Orders cannot be assigned by the users to other users before or after the trade.²²⁹ The bringing together of the interests is carried out in accordance with private-law rules (market regulations). Each new order is immediately reviewed to make sure it can be executed against orders that are already in the order book. If it can be executed, the trading facility carries out the order execution; if not, the order is placed in the order book.²³⁰ New executable orders that are received are executed by rank (price-time priority²³¹) against orders on the other side of the order book. If new orders can only be partly executed, the parts of the order that have not been executed remain in the order book.²³² If the transaction is concluded and cryptocurrencies need to be transferred to the buyer after clearing, the crypto custodian²³³ carries this out based on the instructions of the MTF by rebooking the holdings to the users.²³⁴ All users indicate to the crypto custodian by agreeing to the contractual terms and conditions that they will meet the obligation to transfer crypto currencies to the buyer arising from the sale of crypto currencies on the MTF following the corresponding instructions from the MTF.²³⁵ If legal tender (currency) must be paid by the buyer to the seller after clearing, the MTF instructs the account-holding bank to make the necessary transfers.²³⁶ By agreeing to the contractual terms and conditions, users indicate to the account-holding bank their willingness to transfer the purchase price from their account to the account of the trading partner and the fees to the account of the MTF²³⁷ following the conclusion of the trading transaction(s). By submitting the buy order to the MTF via the website the user authorises the account-holding bank to pay the purchase price and fee following the successful conclusion of the transaction.²³⁸ After deducting the fees, the account-holding bank credits the sale price to the seller’s account.²³⁹
Looking at the organisation of the MTF, it becomes clear that — in what hardly comes as a surprise — no liability is assumed, particularly for custody, and this function is transferred to a limited liability company.
Settlement and custody, in particular, appear to be risky when it comes to tokens — as these are largely outside the influence of the intermediaries.
If the Bitcoin blockchain or the protocol have security gaps, there will be errors and there could be, for instance, a total failure, leading to the question of whether the intermediary should answer for this.
126.96.36.199 Organised trading facilities (OTF)
Art. 4, para. 1(23) MiFID II²⁴⁰ defines organised trading facilities (OTF) as a multilateral system which is not a regulated market or an MTF and in which multiple third-party buying and selling interests in bonds, structured finance products, emission allowances or derivatives (non-equity instruments) are able to interact in the system in a way that results in a contract in accordance with Title II of this Directive. The main distinctive feature, aside from the scope of discretion that OTFs have with respect to order execution²⁴¹, is that the financial instruments are limited to non-equity instruments. Therefore, the scope of application of OTFs is deliberately broad in order to cover the organised execution and agreement of all trading transactions that do not already fall under the regulation of, in particular, regulated markets and MTFs.
However, this does not apply to systems in which transactions in the narrower sense are not executed or agreed (so-called bulletin boards).²⁴²
If the clients give their consent, matched principal trading may be carried out on OTFs.²⁴³ OTFs do not have participants, but rather clients and thus access is not limited as is the case with regulated markets and MTFs.²⁴⁴
In summary, OTFs are only suitable for security tokens that represent non-equity instruments. Stocks are therefore explicitly not tradable on an OTF, and OTFs may therefore play a role as a secondary market for security tokens because there are relatively few access rules (retail clients are permitted). Looking at the primary market, there have already been several issues of bonds and derivatives with prospectuses²⁴⁵, and corporate financing via bonds is becoming more popular in Europe as well. Corporate financing, in particular, could become more significant in practice as a result of the lower overall issue costs.
188.8.131.52 Systematic internalisers (SI)
Art. 4, para. 1(20) MiFID II defines the systematic internaliser (SI) as an investment firm which, on an organised, frequent systematic and substantial basis, deals on own account when executing client orders outside a regulated market, an MTF or an OTF without operating a multilateral system. An SI thus conducts its own trades and bears its own market risk. As a result, OTC (over the counter) trading falls under the term SI if the OTC transactions are ad hoc and irregular, and the activities are not carried out in a planned and systematic manner.²⁴⁶ An SI is not allowed to bring together third-party buying and selling interests in functionally the same way as a trading venue.²⁴⁷ MiFID II expanded the scope of application of systematic internalisation to include equity instruments and non-equity instruments in order to increase the transparency of OTC trading as well.
It is therefore characteristic for SIs to execute client orders through proprietary trading by only concluding bilateral OTC transactions with other market participants.²⁴⁸
Most SIs in Germany are banks that use the “Xetra Best Execution”²⁴⁹ system to execute client orders. This system reviews orders to determine if they can be executed using the bank’s own supply. The price is determined by the SI, unlike with an MTF, where the price is calculated on the basis of market participants’ buy and sell offers.²⁵⁰ If the bank does not have a corresponding supply or if the quantity of the order exceeds the bank’s current supply, the order is made available in the Xetra order book.²⁵¹
There are no obvious barriers to bilateral trading of security tokens by SIs — beyond the ones that MTFs face as well. SIs will not be discussed further in this paper, nor will OTC trading be a focus of this paper either.
184.108.40.206 Interim conclusion on trading via central markets
In Liechtenstein a sufficient legal basis in public law for operating a regulated market is missing. MTFs and OTFs are suitable for multilateral trading in security tokens and may be important suppliers of liquidity. In particular, their organisation under private law enables a more flexible structure, for example, in terms of market regulations. Unlike OTFs, MTFs can also be used to trade equity instruments. Licensing as an SI is suitable for bilateral (regulated) trading.
4.2.2 Trading via decentralised exchanges (DEX)
220.127.116.11 Trustworthy technologies as the basis for decentralised exchanges
In contrast to centrally organised markets, where securities law ensures the requisite trust in intermediaries, with decentralised exchanges the selection of the technological basis plays an important role in guaranteeing the desired functionality. On the one hand, this indirectly determines — for now, at any rate — the supply of trading pairs and, on the other hand, the capability of the exchange, especially the length of trading phase 1 (in particular, matching) as well as the post-trade phases²⁵², clearing and settlement.
Most (security) tokens are currently based on Ethereum and adhere to the ERC-20 standard²⁵³. These tokens can interact with one another easily and are compatible with one another. Technical compatibility is ensured if a token follows the ERC-20 standard, provided the DEX itself is operated on Ethereum. As a result, it is relatively easy (from a technical standpoint) for a DEX on Ethereum to list ERC-20 tokens and to form trading pairs using compatible tokens. If tokens are to be traded on a decentralised exchange on the basis of other trustworthy technologies (such as XTZ, which runs on the Tezos blockchain), then the corresponding interfaces are necessary. This is the case for both central and decentralised exchanges that want to list such trading pairs based on different technologies.
18.104.22.168 DEX order books (on-chain/off-chain)
Exchange order books are primarily used to find counterparties with a (suitable) supply (mechanism for finding counterparties) as well as to display the number of bids and requests in the order book in a way that results in as many contracts as possible (matching). With central (regulated) exchanges, the order book usually brings together the parties and their orders entirely automatically, resulting in individual contracts between the parties.
Most crypto-exchanges also aggregate the orders (limit/market) of their users²⁵⁴ in a central (off-chain) order book.
Decentralised exchanges do not always maintain their order books centrally (off-chain), but may also, in isolated cases, maintain them locally on a blockchain (on-chain).
On-chain²⁵⁵ order books are hosted on a blockchain and all orders for tokens²⁵⁶ are confirmed and settled via the blockchain. Thus, they do not have an actual operator; instead, the “operators” of the TT system provide, without any information, their computing power in exchange for compensation²⁵⁷ for the operation of the order book. Consequently, the selected TT system to a large extent also determines the speed²⁵⁸, the costs²⁵⁹ and the security of the order book. As a result, everyone cannot only view the public order book, but also (co-)host it themselves and send orders to the order book.²⁶⁰ Every order²⁶¹ requires a transaction — generally subject to a charge — on the TT system. Users pay for every update to the order book and must — depending on the consensus algorithm²⁶² — wait for the consensus and confirmation of the participants. This affects the speed of the order book considerably²⁶³. The advantage of on-chain order books lies in their decentralised nature, which, in turn, creates trust and is intended to replace the trust in a central intermediary. This trust stems from the knowledge that the unauthorised manipulation of decentralised on-chain order books is highly unlikely.²⁶⁴
Off-chain order books²⁶⁵, by contrast, are not provided on a TT system, but rather via a central system, such as a web server²⁶⁶ by an (licensed) operator. The speed is significantly higher and the costs much lower compared to on-chain order books, but security is therefore a bigger issue²⁶⁷. Users have to trust that the operators are displaying the orders correctly and keeping the information up to date. For example, it would be easy for operators to choose arbitrarily not to display orders or to manipulate markets by purposely displaying incorrect orders or orders that have already been deleted.²⁶⁸ Off-chain order books pose precisely those risks that regulation is intended to prevent, such as fake orders and insider trading (front running).
“Matching” is the process that brings buying and selling interests together in the system, resulting in purchase contracts.²⁶⁹
In addition to automated (usually central) matching systems²⁷⁰, in which a computer algorithm brings together the orders (automated order filling), there are also systems in which all orders are displayed (only) and takers²⁷¹ must look for and fill orders for counterparties (makers²⁷²) manual order filling. With automated order filling, an algorithm brings the orders together. This fully automated process saves time and makes it easier to conduct suitable trading transactions. However, participants need to trust that the algorithm is performing the matching securely and in compliance with the rules.²⁷³ With manual order filling, by contrast, instead of the aggregated orders being displayed in the order book, the individual orders for each party (maker) are displayed.
Interested parties (takers) must look for²⁷⁴ and select a specific order (resting order)²⁷⁵ from a particular counterparty themselves and then be able to conduct the trade with the selected counterparty themselves (outside of the platform) (manual order filling).
Makers must delete their resting orders from the system if the market price differs significantly from the price of the resting orders; otherwise, the orders might, depending on the system, be filled by one or more takers — at unfavourable conditions.²⁷⁶ In other words, the makers remains bound to the price until they delete the orders against a fee. This process is, of course, slower than automated matching systems. In exchange, however, users do not have to rely on a centrally organised party and the proper functioning of the order book and the matching process.²⁷⁷
22.214.171.124 Operating an order book as a service subject to licensing
Decentralised exchanges generally operate order books off-chain, which is why in phase 1 (trading) they do not differ substantially from centrally organised markets.
The criteria for order books subject to licensing can be summarised as follows:
A system or mechanism that brings together multiple third-party buying and selling interests in financial instruments in the system in a way that results in a contract for financial instruments is subject to licensing.²⁷⁸
Whether trading via decentralised systems is subject to licensing depends on whether (1) the interests in the system are brought together (matching) and (2) a contract is concluded. If (decentralised) exchanges operate order books with automated matching that results in the conclusion of contracts, the service provider is obliged to obtain a license.²⁷⁹
Consequently, however, systems and therefore order books that only display multiple third-party buying and selling interests and do not bring them together (matching) and do not execute any transactions in the narrower sense are not subject to approval (bulletin boards or black boards).²⁸⁰
Pure user interfaces (graphical user interfaces, GUI)²⁸¹ that represent buying and selling interests are likewise unregulated.²⁸² However, these fall under the registration obligation as TT service providers pursuant to the TVTG.²⁸³ The second criterion for the conclusion of a contract allows somewhat more room for interpretation. If systems themselves describe the settlement process (the execution of the transaction) in a sufficient manner (e.g. in the market order), the system will, in turn, qualify as an exchange pursuant to MiFID II. In particular, hybrid trading systems that, for example, maintain the order book centrally, but are not organised in a way that results in the conclusion of contracts are difficult to classify without a corresponding understanding of the technical processes. The transactions in the aforementioned systems take place outside the central order book, i.e. on-chain on a TT system. For delineation purposes, it should be relevant whether the operator describes the necessary settlement processes in sufficient detail in its rules (e.g. in its market regulations).²⁸⁴
Thus, it is feasible for there to be exchanges that are able to offer security token trading without licensing.²⁸⁵
As already stated above, central order books, in particular, need to be protected against unauthorised manipulation in order to prevent abuse and insider trading.²⁸⁶ Irrespective of the type of token, the TVTG regulates persons who provide users of TT systems with aggregated price information on the basis of buy and sell offers or concluded transactions as TT price service providers²⁸⁷ subject to registration. In addition, it must be determined if there is an TT exchange service provider pursuant to Art. 2, para. 1q) TVTG which is subject to registration. Nor is it clear from the TVTG whether the service of operating an exchange is intended to bring together interests (multilateral system) or merely to allow the operator to trade against its own book. The term “exchange service provider” would indicate that it is only supposed to allow the operator to trade against its own book. On the one hand, the government clearly distinguishes TT exchange service providers from multilateral trading facilities²⁸⁸; elsewhere, the question of whether there is a service subject to registration is answered only on the basis of the service provided and not based on the “type of token” .²⁸⁹ Elsewhere, the government takes a more expansive view of the definition of a TT exchange service provider, including not only cryptocurrency exchanges, but also cryptocurrency trading venues — and thus multilateral systems as well.²⁹⁰ If one were to look only at the service, then multilateral systems for security tokens would also be included. However, in BuA 54/2019, the government clearly stated that TT exchange service providers are to be distinguished from multilateral trading facilities pursuant to the Banking Act (BankG) and MiFID II. These focus on financial instruments and are subject to the relevant financial market regulations.²⁹¹ In summary, multilateral systems as well as bilateral systems for non-security tokens are TT exchange service providers subject to registration. The financial market regulations take precedence and if financial market law imposes a corresponding licensing obligation, the registration obligation pursuant to the TVTG no longer applies.²⁹²
4.2.3 Transaction clearing
Trading (the conclusion of the contract) is followed by phase 2, the clearing²⁹³ of the transaction that has been concluded (determination of the payment obligations).²⁹⁴ The previously mentioned long post-trade phase lasting from several days to years for traditional financial market transactions²⁹⁵ provides substantial potential for efficiency improvements, especially when the amount of time is compared with the time required to clear and settle transactions on TT systems:
“The clearing and settlement of securities transactions on TT systems are considered […] to be one of the key areas of application for TT technologies.”²⁹⁶
Pursuant to Art. 2, №3 EMIR, clearing is the process of establishing positions, including the calculation of net obligations, and ensuring that financial instruments, cash, or both, are available to secure the exposures arising from those positions.²⁹⁷ Clearing occurs after the conclusion of the contract (undertaking) in phase 1 and before the fulfilment of the contract (conveyance) in phase 3, settlement, and includes all of the technical processes necessary for clearing. For example, the transaction details are transmitted and compared. A review is carried out to make sure the data for the transactions that have been executed match the orders and can be approved for fulfilment in phase 3 (settlement). Opposing delivery obligations and delivery authorisations are offset. This process (known as netting, see Fig 3) reduces the number and volume of transactions required for settlement, as only that which cannot be offset needs to be delivered. This not only leads to cost savings, but also reduces the settlement risk. Finally, any collateral obligations are identified. If a clearing house (central counterparty) has not be defined, clearing can take place as part of the post-transaction processing or upstream as part of the settlement.²⁹⁸ A definition of clearing houses can be found in Art. 6 of the Finality Act²⁹⁹, which implements the Finality Directive³⁰⁰ as amended by Directive 2009/44/EC³⁰¹. According to this directive, a clearing house is an entity responsible for the calculation of the net positions of institutions, a possible central counterparty and/or a possible settlement agent.
126.96.36.199 Central counterparty (CCP)
In practice, the clearing process is often carried out by central counterparties. Art. 2, №1 EMIR defines the central counterparty³⁰² as:
- a legal person
- that interposes itself between the counterparties
- to the contracts traded
- on one or more financial markets³⁰³
They therefore act as a buyer for every seller, and a seller for every buyer and minimise the counterparty risk.³⁰⁴
This definition becomes clearer if we keep the following key functions of CCPs in mind: With the involvement of a central counterparty, the (bilateral) contractual relationships between the parties are replaced with new individual contracts with the central counterparty on the same terms and conditions. From a legal perspective, this process is known as novation.³⁰⁵
The central counterparty interposes itself between the buyer and seller, becoming the seller for the buyer and the buyer for the seller.³⁰⁶ In particular, the interposition of the central counterparty has a risk-minimising function, as it assumes the counterparty risk of the transaction.³⁰⁷ Thus, in the event of the insolvency of one of the parties, the central counterparty must perform the agreed obligation to other party. The central counterparty assumes the insolvency risk.³⁰⁸ The interposition of the central counterparty also makes the participants involved in the trade anonymous, as only the central counterparty knows the contractual parties (buyer and seller) to the transaction.³⁰⁹
Because the interposition of a central counterparty results in the convergence centrally of the obligations of a number of involved intermediaries, multilateral netting is possible. A simplified example can be presented using Fig 3: A owes B 2 and D 5 and holds a claim for 9 against C. C owes A 9 and holds a claim for 4 against B and 3 against D. Without a central counterparty, A and C would have to meet their individual obligations and C would have to hope for fulfilment by B and D. In the second figure, the interposition of a CCP results in the netting of all of these positions. Thus, A receives a net of 2 from the CCP, and C pays a net of 2 to the CCP.
This not only simplifies matters, but it also minimises the costs and risks.³¹¹ Thus, it is not only the individual participants involved in the transaction, who gain a risk-minimising intermediary as a counterparty in the form of the central counterparty, who benefit, but the market as a whole because of the increase in efficiency.³¹² The central counterparty implements various safeguards to minimise the risks (especially the risk of insolvency) that it assumes because of its position. In addition to clearing collateral, the central counterparty requires the participants to meet strict membership criteria. In addition to an initial margin³¹³, participants are also required to provide a variation margin³¹⁴ in the form of cash or the corresponding securities so they can meet all of their obligations in the event of the insolvency of one of the participants.³¹⁵
When TT systems are used, smart contracts³¹⁶ can perform the clearing function, provided clearing in the true sense is even required.³¹⁷
The smart contract can carry out the clearing function upstream as part of the settlement. Because clearing and settlement take just a few seconds to a few minutes in the TT system multilateral netting is no longer required as well. The counterparty risk is mitigated through the use of smart contracts because the parties to the transaction must transfer sufficient collateral to the smart contract. Thematically, this function fits in better with settlement and will therefore be discussed in greater detail in phase 3.
Pursuant to Art. 35 MiFIR, central counterparties shall accept to clear financial instruments on a non-discriminatory and transparent basis, including as regards collateral requirements and fees relating to access, regardless of the trading venue on which a transaction is executed.³¹⁸ Access to central counterparties is also ensured for Liechtenstein Investment firms and market operators that operate an MTF.³¹⁹ The conditions for access to a central counterparty are governed in Art. 35 MiFIR, supplemented by Delegated Regulation 2017/581.³²⁰
188.8.131.52 Clearing obligations for derivatives
Art. 4, para. 1 EMIR imposes a clearing obligation for certain OTC derivatives³²¹. The European Securities and Markets Authority (ESMA) maintains a public register of the classes of OTC derivatives subject to the clearing obligation.³²² If a financial instrument is included in the register pursuant to Art. 6 EMIR, the clearing obligation only applies if the transaction is concluded between certain counterparties.³²³ For example, clearing obligations arise between two financial counterparties³²⁴ or between a financial and a non-financial counterparty if the clearing threshold is exceeded.³²⁵ The clearing obligations must be met by involving a CCP³²⁶.³²⁷
Art. 29 MiFIR expands the clearing obligations pursuant to EMIR and maintains a general³²⁸ clearing obligation for all derivatives that are traded on regulated markets.³²⁹
184.108.40.206 Clearing as a service subject to licensing
When using TT systems, a smart contract can carry out the clearing, as described above. A system subject to licensing pursuant to Art. 2, para. 1 in conjunction with para. 3 of the Finality Act is a:
- formal agreement on clearing […] or
- the execution of payment and transfer orders […] in accordance with common rules and uniform requirements that:
a. is concluded by […] at least three participants³³⁰;
b. at the choice of the participant subject to the laws of a contracting state of the EEA Agreement or Switzerland. […]; and
c. is reported to the ESMA following a review of admissibility by the contracting state of the EEA Agreement whose laws are authoritative pursuant to point b.³³¹
Depending on the structure, an agreement on the use of a smart contract between the participants could be viewed as a system pursuant to the above-cited law and thus be subject to licensing. However, the smart contract, as a decentralised application on a TT system, has no legal capacity and therefore cannot conclude formal agreements. Nor is it a participant; rather, the participants pursuant to Art. 7 of the Finality Act³³² use the smart contract with the knowledge of its functionality. Because of the lack of legal capacity, it also cannot be entered in a register. The derivative clearing obligations must also be observed. The TVTG does not apply to clearing that is not subject to a registration obligation.
220.127.116.11 Interim conclusion on clearing
TT systems are best suited for the automatic calculations required for the settlement of financial market transactions; therefore, they can assume the settlement function of clearing houses or this is no longer necessary. The interposition of central counterparties in central systems mainly serves to mitigate the counterparty risk. When using TT systems, smart contracts can assume the functions of the clearing house, which are performed directly before the settlement. Pursuant to the TVTG, clearing is not subject to registration.
4.2.4 Transaction settlement
Phase 3, settlement, is especially relevant for the secondary market for security tokens. During this phase, the transactions that were concluded in phase 1 and cleared in phase 2 are fulfilled (conveyance). In the secondary market, the actual delivery³³³ of the transactions is carried out through corresponding custody account rebookings. The involved custodian banks receive data from the CCP in the form of electronic lists of the transactions to be settled if this has not already been done as part of the clearing process. If the financial instruments were traded without the involvement of a CCP, the instruments are transmitted by the central securities depository. The custodian banks review the custody accounts for the corresponding cover and approve the transaction for fulfilment. The central securities depository carries out the necessary rebookings, and a current delivery report or settlement list is prepared.³³⁴ In addition to the central counterparties (CCPs), the central securities depositories also play a significant role during the post-trade phase.
18.104.22.168 Central securities depository pursuant to the Central Securities Depositories Regulation (CSDR)
Pursuant to the requirements of the Central Securities Depositories Regulation (CSDR³³⁵), central securities depositories, together with the central counterparties “contribute to a large degree in maintaining post-trade infrastructures that safeguard financial markets and give market participants confidence that securities transactions are executed properly and in a timely manner, including during periods of extreme stress.”.³³⁶ The securities settlement systems operated by them are of a systemic importance for the functioning of securities markets.³³⁷ The CSDR also aims to harmonise the heavily fragmented European central depository market and, in particular, to reduce risks and standardise the settlement cycle and discipline.³³⁸ In Liechtenstein the CSDR has been implemented via the EEA Central Securities Depository Implementation Act³³⁹ and included in the EEA Agreement via the resolution of 8 February 2019. The CSDR has been in effect in Liechtenstein since 1 January 2020. There are currently no central depositories in Liechtenstein.³⁴⁰
In Art. 2, para. 1 №1 in conjunction with Section A of the annex, the CSDR defines the central securities depository as a legal person that:
- operates a securities settlement system and provides at least one other core service listed in Section A of the Annex:
- Initial recording of securities in a book-entry system (‘notary service’);
- Providing and maintaining securities accounts at the top tier level (‘central maintenance service’).
Central securities depositories (CSD), together with the central counterparties (CCP) contribute to a large degree in maintaining post-trade infrastructures. They safeguard financial markets and give market participants confidence that securities transactions are executed properly and in a timely manner.³⁴¹ The securities settlement systems operated by central securities depositories occupy a key position in the settlement process.³⁴² They serve as an essential tool to control the integrity of an issue, hindering the undue creation or reduction of issued securities.³⁴³ Central securities depositories serve as a sort of custodian bank for custodian banks in that custodian banks maintain an omnibus account for their entire client holdings with the central securities depository. Many national central securities depositories have set up mutual account relationships with foreign CSDs (so-called CSD links).
Depending on the system selected and the participants involved, settlement can be carried out in different ways. Delivery is often carried out step-by-step versus payment of the consideration (usually a monetary payment). This method of settlement is known as “delivery versus payment” (DvP). The financial instruments can also be exchanged (known as “delivery versus delivery”, (DvD)). These two methods reduce the settlement risk of the involved parties. Less common is settlement in which the two previous step-by-step variants are followed and instead there is no payment (“free of payment”, or FoP).³⁴⁴
22.214.171.124 Obligation to book securities in a book-entry account pursuant to the CSDR
For the trading of transferable securities — and thus including security tokens — via regulated markets, MTFs or OTFs, the CSDR³⁴⁵ imposes an obligation on the issuers of these securities to ensure that the securities are booked in a book-entry account. From 1 January 2023, this obligation applies for transferable securities issued after 1 January 2023. From 1 January 2025, it then applies for all transferable securities, thus including those issued before 1 January 2023.³⁴⁶ The issuer must arrange for the securities to be booked in book-entry form through immobilisation or subsequent to a direct issuance in dematerialised form.³⁴⁷ Therefore, when transferable securities, including security tokens, are admitted to an exchange pursuant to MiFID II³⁴⁸ they must be registered with a central securities depository in dematerialised form.³⁴⁹
4.2.5 Settlement on decentralised trading exchanges
In contrast to central systems in the form of central securities depositories, decentralised systems provide technical (trustless) solutions in order to provide securities settlement systems in a functionally adequate manner, but without a central (regulated) operator. In particular, phase 3 is in most cases — even when the organisation is otherwise central³⁵⁰ — through the use of TT systems (on-chain).³⁵¹ With decentralised systems, clearing is carried out completely automatically prior to settlement using a smart contract. With TT systems, the custody is inherent; if anything at all, users only have custody of the TT keys.³⁵² Decentralised exchanges have therefore also been developed so that the settlement and custody of the tokens do not have to be entrusted to a centrally organised institution. For this reason, the settlement of transactions is carried out on-chain so that users can theoretically review the settlement themselves to make sure it was carried out in accordance with the agreed rules. As with trading involving on-chain order books, the choice of trustworthy technology is important for settlement. Depending on the configuration, there can, in turn, be compatibility problems that make it difficult or impossible to carry out the settlement function in a trustless manner with technology. As noted above, smart contracts are suitable for clearing transactions. However, the counterparty risk is mitigated by the type of settlement. Because of a lack of legal subjectivity, smart contracts cannot act as a central counterparty; instead, they provide a certain type of technical settlement. In this case,
users must provide their consideration (as collateral) to a smart contract. If a contract is concluded, the smart contract checks to make sure that both parties — i.e. that the counterparty has “deposited” its consideration as well — and then transfers the assets to the respective counterparty.
If there is no trade or if one of the parties has not “deposited” its consideration, the assets are returned to the user. This is quite simple as long as all considerations (tokens, purchase price) can be accessed by the smart contract. However, in the case of fiat³⁵³ currencies (legal tender) this has to date only been the case for some currencies (see Tether³⁵⁴, Central Bank Digital Currencies, CBDC³⁵⁵). Trustless settlement is much more difficult from a technical perspective if multiple TT systems are used.
When different TT systems are used interfaces must be defined so the systems can communicate with one another. This often leads to delays in settlement, increased (coordination) effort and higher implementation costs. It also — and this is the biggest problem — results in heightened counterparty risk, as such risk can no longer easily be reduced by using the same technical basis (only one blockchain) to almost zero.
An example involving cryptocurrencies shows the incompatibility problems as a result of media discontinuities³⁵⁶ very well³⁵⁷: A would like to buy 1.24³⁵⁸ ETH³⁵⁹ for 100 XTZ³⁶⁰ and B would like to sell his 1.24 ETH at the same price. However, as A is not aware of the offer by B, he turns to a crypto-exchange³⁶¹. Here, it is important to know that XTZ “runs” on the Tezos blockchain³⁶² and ETH on the Ethereum blockchain, meaning this transaction is to take place between two different TT systems and there will be a media discontinuity.³⁶³ The crypto-exchange must therefore provide the technical infrastructure or connection to the respective blockchain for both sides of the ETH/XTZ trading pair.³⁶⁴ The crypto-exchange used by A and B maintained an order book and matched both orders. Following the successful trade, the rebooking is then carried out in the system similar to a trade involving a regulated exchange and the crypto-currencies³⁶⁵ is debited or credited to the user accounts. The users can then transfer the crypto-currencies to their own TT identifiers and take care of custody themselves. The crypto-currency exchange maintains custody of the tokens until they are transferred to the user accounts on their own TT identifiers, which, as past experience has shown, can be extremely risky.³⁶⁶ Here, therefore, the central intermediary³⁶⁷ — which needs to be trusted accordingly — serves as the interface between the two systems.
If the parties have found one another and agreed to the trade (1.24 ETH for 100 XTZ) without a central intermediary³⁶⁸, the question is how to carry out settlement (without a central counterparty or central securities depository). Why don’t the parties simply transfer their tokens directly?
Transactions on TT systems are generally irrevocable. If, in the previous example, one party sends XTZ to the address of the other party, the former must trust that the other party will also send the agreed quantity of ETH to original sending party’s address. This results in the classic counterparty risk. The parties do not need to assume there is any ill will if one party receives the XTZ but never sends the ETH to the other party. It is possible that the sender of the XTZ sent it to the wrong address and no longer has sufficient assets to send the corresponding (replacement) quantity of XTZ to the right address. One solution to this problem is known as an “atomic swap”.
Atomic swaps are peer-to-peer transactions involving tokens with no interposed intermediary (such as a central counterparty or a crypto-exchange) in which the parties are able to manage their private keys themselves during the entire transaction.³⁶⁹
The key feature of an “atomic” transaction is its binary result. Either all of the transaction’s settlement orders are carried out or none are. Applying this concept to the above example in which the parties would like to exchange XTZ for ETH and need to use two different TT systems to do so, an “atomic” transaction would ensure that all necessary settlement orders, for both the Tezos and the Ethereum blockchain, would be carried out or none would be carried out all.³⁷⁰
We will come back to the example in which A would like to exchange 1.24 ETH for 100 XTZ.
An atomic swap is carried out, for example, as follows:³⁷¹
- A creates a private key (secret A) and calculates the hash³⁷² value of this key (hash A).
- A then sends:
- 100 XTZ,
- hash A,
- the blocking period A and
- the recipient address B³⁷³
to a smart contract on the Tezos blockchain, which blocks the 100 XTZ for the duration of blocking period A.
3. After the transaction is confirmed by A³⁷⁴, B sends:
- 1.24 ETH,
- hash A³⁷⁵,
- the blocking period B and
- the recipient address A³⁷⁶
to a smart contract on the Ethereum blockchain, which blocks the 1.24 ETH for the duration of blocking period B.³⁷⁷
4. After successful confirmation of the transaction by B and before the end of the blocking period B, A sends secret A to the smart contract on the Ethereum blockchain and receives the 1.24 ETH at recipient address A. Thus, B now knows secret A and can send secret A to the smart contract on the Tezos blockchain before the end of blocking period A and receives the 100 XTZ at recipient address B.³⁷⁸
The blocking periods ensure that, if a transaction is not completed, all settlement orders can be reversed. If in the above case:
- A does not collect the ETH from B, B can reclaim the ETH after the end of blocking period B by using hash A. Because B does not know secret A, he cannot collect the XTZ. After the end of blocking period A, A can reclaim her XTZ with secret A;
- B does not send the ETH, A will not, because of the missing transaction, attempt to collect the ETH by disclosing secret A, and instead will wait for blocking period A to end before reclaiming the XTZ.
Fig 4 shows how smart contracts, in conjunction with the blocking periods as well as the initially unknown secret A enable the secure reversal of the transaction (so-called hashed time lock contracts³⁷⁹).³⁸⁰ In addition to the relatively short blocking periods, the duration of an atomic swap depends largely on the transaction times of the TT systems that are involved. This sample transaction between Ethereum and Tezos takes about 8 minutes, which represents a substantial improvement in efficiency compared to a transaction on a regulated market, which can take several days.³⁸¹ Atomic swaps, however, also show how cumbersome it can be to carry out transactions on several TT systems without an intermediary. This is one of the main reasons why at present decentralised exchanges³⁸² mainly involve offers for tokens on Ethereum³⁸³ as trading pairs.³⁸⁴
One might think that the use of central securities depositories is a simpler solution than atomic swaps, and there is anyway the obligation to book securities in a book-entry account pursuant to the CSDR. However, it must be remembered that although the obligation to book securities in a book-entry account with a central securities depository can result in an improvement in efficiency at the European level compared to traditional securities trading, this may have a counterproductive effect on security tokens. The central securities depository would have to maintain its own interfaces for each TT system, and the question would arise as to which system would be the main one in the event of information asymmetries. Would the TT system for which the booking offers added value take precedence? If the register of the central securities depository takes precedence, then we’re back at the central system and the question is: What has been gained through the use of TT systems compared to uncertified rights in a uncertified rights register/ledger? In the first case, the central securities depository would have to ask whether, for liability reasons, it would even want to offer the corresponding services, as it would have no influence on TT systems. For example, it would be unable to correct “erroneous bookings”. How MTFs or OTFs would handle this if, of course, still not known.³⁸⁵
126.96.36.199 Settlement via decentralised systems as a service subject to licensing
The above makes clear that custody using TT systems is inherent in the system and decentralised settlement methods that do not require licensing and registration are conceivable. At present, there is no obligation to book securities in a book-entry account (yet). However, this obligation would, in addition to the question of whether central securities depositories are even permitted to making bookings, result in friction. Furthermore, it would also be necessary to review any obligation to register as a TT token custodian or TT key custodian pursuant to the TVTG.
188.8.131.52 Interim conclusion on settlement
The obligation to book securities in a book-entry account is probably the greatest challenge on the secondary market for security tokens.
There is currently no central securities custodian in the EEA that offers services for security tokens. The question is whether central securities custodians will offer these services in the near future for security tokens, or whether this central securities custodian function will be made obsolete or provided by TT systems themselves through the use of TT systems.
Furthermore, in contrast to the traditional world, the booking obligation does not result in an improvement in efficiency and might, in fact, even destroy the potential increase in efficiency.
4.3 Conclusion on trading, clearing and settlement
In practice, MTFs for equity instruments and OTFs for non-equity instruments appear suited as a secondary market for security tokens. Because trading on regulated markets is subject to public law, they will only become more relevant at a later date. For phase 1, trading, decentralised systems do not appear to offer any significant advantages and the current manifestations are not organised and regulated in a substantially different way than existing systems.
Because of the trend in Europe towards fully digital uncertified rights the requirement to certificate a right in the form of a physical document will likely soon be a relic of the past.³⁸⁶ In its report and proposal, the government states “that the clearing and settlement of securities transactions on TT systems is one of the most important areas of application for TT technologies.”³⁸⁷ Clearing might even become largely obsolete as a result of the use of TT systems. Because the post-trade phase could be organised in a substantially different way through the use of TT systems subjecting it to the current regime would be difficult and would, in part, be grossly disadvantageous. Here, the obligation to book securities in a book-entry account is probably the greatest challenge to the secondary market for security tokens.
5 On a new regulatory approach for the secondary market for security tokens
The current regulatory concept for financial instrument transactions — which developed, of course, before the advent of trustworthy technologies — focuses mainly on intermediaries, and the European legislative acts on capital market law are set against the background of the freedom of the movement of capital and services in the domestic market as well as the protection of investors through the provision of sufficient information.³⁸⁸ The (necessary) services for a functioning secondary market for security tokens (trading, clearing, settlement, custody) fall under current financial market laws and are provided by intermediaries subject to licensing (such as regulated markets, MTFs, CSD, CCPs and banks).
The systems of regulated intermediaries are no doubt shaped by the regulatory objectives of capital market law (function protection, investor protection and financial market stability)³⁸⁹. By contrast, unregulated crypto-exchanges have managed to develop technical solutions outside the box in order to enable efficient (or even more efficient) trading, settlement and custody. While regulated stock exchanges often have potential to improve efficiency on the basis of various regulatory requirements, crypto-exchanges are exposed to more or less hidden risks. The example of the Börse Stuttgart MTF for cryptocurrencies shows the challenges even the listing of non-security tokens based on trustworthy technologies on regulated institutions presents and the extent to which existing exchanges, especially MTF, are compatible with TT systems. This example also shows that the settlement phase, in particular, poses challenges to regulated institutions. In centrally organised systems, a central securities depository carries out the task of, among other things, reallocating and reconciling securities holdings without the need for the various custodian banks to maintain a technical connection to one another. Thus, central securities depositories are supposed to be able to, for example, prevent the unauthorised creation or reduction of securities.³⁹⁰ At the European level, there has been an attempt to increase efficiency with respect to (cross-border) settlement by booking securities in a book-entry account. These centrally organised intermediaries communicate and interact primarily in a bilateral manner, which is why coordinating information among them is extremely cumbersome. Each party maintains its own sets of data and keeps the information from the intermediaries in its own dataset.³⁹¹
Trustworthy technologies are based on the idea that the individual users, applying the same standards, receive direct access to the TT system (the same database).³⁹²
If all participants use the same system, a reconciliation in the true sense is no longer necessary. With TT systems, the functions of the clearing house, for example, are — if at all necessary — often provided together with settlement and the other functions — which would otherwise be carried out by the central securities depository — in part directly by the TT systems. However, there are already decentralised solutions for the order book and matching as well.
The question then is whether and which intermediaries will (or should) become obsolete as a result of the use of trustworthy technologies. This can be shown clearly by the example of the obligation to book securities in a book-entry account pursuant to the CSDR. Thus, the potential of security tokens to improve efficiency is at least levelled out by this obligation. There is a risk that the significant advantages of TT systems will be lost or go unused as a result of regulation. Looking at the individual functions and the purpose of existing regulations (ratio legis), some traditional intermediaries could soon disappear. By contrast, other intermediaries could assume new functions and, in turn, other service providers — such as those provided for in the TVTG — might now be needed.³⁹³
Although the TVTG was created with an awareness of the need to delineate it from other laws, in particular, from financial market law, its functional regulatory approach makes it possible to draw conclusions for financial market law.³⁹⁴ The TVTG regulates the key, critical functions of the token economy, including:³⁹⁵
- Token generation;
- Token issuance (public sale of tokens);
- Token custody (incl. custody of the TT key); and
- Token trading platforms
and creates new roles subject to registration³⁹⁶, such as:
- Token generator;
- Token issuer;
- TT key custodian;
- TT token custodian;
- TT protector;
- Physical validator;
- TT exchange service provider;
- TT auditor;
- TT price service provider; and
- TT identity service provider.
As part of a “Digital Asset Programme”, the Stock Exchange of Thailand (SET) asked how the Thai capital market might and must change as a result of the use of trustworthy technologies.³⁹⁷ In answering this question, it identified the following four drivers of the use of TT systems:
- The use of a shared decentralised ledger makes it possible to share information directly with all participants. This reduces data reconciliation costs considerably.
- The counterparty risk is “eliminated” as a result of the use of smart contracts.
- Unalterable records of the transactions are created (“immutable audit trail”), which simplifies the subsequent audit process. And
- Shared decentralised ledgers enable the digitalisation of processes and process automation.³⁹⁸
The SET hopes through its efforts to reduce settlement times, transaction costs and transaction risk.³⁹⁹ It also developed a blueprint that, like the Liechtenstein approach, defines and assigns rolls irrespective of the existing intermediaries.
The relevant conclusion for the secondary market as a sub-area of the capital market is that when using TT systems clearing is only required for derivatives and that exchanges by and large retain their function. In addition, settlement and custody roles will change.⁴⁰⁰
By comparing the results of the Digital Asset Programme of the Stock Exchange of Thailand (SET) with the TVTG⁴⁰¹, I will attempt to present a regulatory approach for the secondary market for tokens in the form of a role-based approach:
5.1 The necessary functions/roles of a secondary market based on TT systems
The following key functions are based on a comparison of the results of the SET⁴⁰² (marked with *) and the TVTG (marked with #):
- Token generation (token generator#, asset tokeniser*):
The technical provision (or generation) of tokens in the life cycle of a token; defines — usually irreversibly — the key features of the token;⁴⁰³
- Rights validation (physical validator#, digital asset registrar*):
Tokens represent rights digitally, but, depending on the law, they may need a connection to the physical world and, in some cases, an intermediary carries out or mediates the transfer and exercise of rights;⁴⁰⁴
- Token issuance (token issuer#, issuer*):
The public offering of proprietary or third-party shares is less expensive and more efficient when using TT systems.⁴⁰⁵
- Identity (TT identity service provider#, gatekeeper*):
When using TT systems that, because of their configuration, do not specify legal subjects by name there must be a connection between legal subjects and the TT system’s rights allocation system;
- Token trading/token exchange (TT exchange service provider#, exchange*):
Markets primarily serve as a means of exchange; this function can be carried out in a wide variety of forms, for example, by bringing together interests in a multilateral form or bilateral trading.
- Custody/registration⁴⁰⁶ (TT key custodian# or TT token custodian#, custodian*):
Certain functions, such as a new issuance following a declaration of the invalidity of a token or corporate action, are also necessary when using TT systems. Even when the custody and assignment of the token to an address is an inherent function of the TT system and no service providers per se are required, users must store their TT keys⁴⁰⁷ securely, which is why professional service providers are used in practice;⁴⁰⁸
- Fiat token⁴⁰⁹ (cash-on-ledger issuer* and cash tokeniser*):
Whether e-money or fiat currency issued in the form of tokens, every TT system needs to be able to access “money” directly.
Although the first three roles play a key role in the functioning of the capital market and in the life cycle of security tokens, they will not be discussed further in this paper as they are not relevant to the topic. Function/roles nos. 4 to 7 appear to be of particular interest, whereby token trading/exchange (no. 5) already appears to be properly regulated in the current legal framework (in particular, MTF, OTF and SI).
5.1.1 Fiat tokens
In order to take advantage of the potential for improved efficiency and risk minimisation through the use of TT systems fiat currencies (legal tender) in tokenised form are needed.
Only if the system is able to access fiat currencies directly as well with as few media discontinuities as possible, for example, during trading and settlement, are trading pairs with fiat currencies without the involvement of intermediaries and the preservation of value possible. This discussion often mentions step-by-step delivery versus payment of the consideration (usually a monetary payment (“delivery versus payment”, or DvP)⁴¹⁰. The financial instruments can also be exchanged (known as “delivery versus delivery”, (DvD). Here, it is important for these fiat tokens to be available to the key TT systems. For example, a CHF token on Ethereum and one on an Aeternity basis. Whether these fiat tokens are issued by central banks (CBDC)⁴¹¹ or an e-money institution plays a subordinate role for the function. This necessary function is already possible in the current legal framework, even if, in particular, the e-money regulation already resulted in interpretation problems.
Even if TT systems are publicly accessible and thus publicised⁴¹², the identity role is necessary for a functioning secondary market that safeguards the interests of participants. In international securities trading, the owner, for example, is not supposed to appear in registers personally (and thus be personally identifiable).⁴¹³ TT systems are (pseudo-)anonymous and therefore meet the requirements for publicity and anonymity in principle. With an additional function the connection of the legal subjects to the TT system’s rights allocation system⁴¹⁴ must be ensured. In other words, the TT system is used to create a connection between the TT identifier and the TT key. What is missing, however, is a function or role that assigns a natural or legal person (legal subject) to this TT identifier. The example of a share will make this clearer: The shareholder has a TT key that allows him to identify himself as the person authorised to dispose of the share (identification function). In the uncertified rights register/ledger, the TT identifier is connected with the shareholders by name. This function is currently also performed by CSDs as so-called shareholder identification. In addition, this assignment is a necessary function, in particular, for maintaining registers of beneficial owners⁴¹⁵. Thus, the identity role would carry out the assignment of parties to TT identifiers and enable both the prevention of money laundering and measures against terrorism financing, as all parties would have to identify themselves in advance, either directly or indirectly. Here, the debtor that maintains the uncertified rights register/ledger (usually the issuer) would also carry out the identity function, as it has to create the connection between the legal subjects and the securities anyway. In addition to the TT identifiers, the number of tokens⁴¹⁶ and the creditor⁴¹⁷, electronic proof of identification pursuant to the eIDAS Regulation⁴¹⁸ could also be maintained. This would also enable easier, digital identification and simplify register queries if the conditions are met.
One of the key roles in the current system, custody or registration — currently carried out by the central securities depository — could, from a functional perspective, continue to exist to some extent. However, other duties performed by the central securities depository could become obsolete and new ones could be added. This thesis is strengthened by the regulatory approach that Liechtenstein has chosen with the TVTG⁴¹⁹ as well as the newly created crypto custody service in Germany, which is subject to licensing/authorisation⁴²⁰.
Thus, it would be conceivable for central securities custodians to hold new special TT keys — let’s call them TSD TT keys⁴²¹ — for all security tokens that have been issued in order, for example, to carry out the following functions:
- Burning (destruction) of tokens;⁴²²
- Minting (creation) of new tokens;
- Trading halt (suspension of trading)
The custody of these special TSD TT keys entails a high amount of risk and being in central custody they are also attractive to cyber-criminals as a single point of failure; however, they also present substantial potential for misuse by operators, which is why corresponding regulations seem to be in order.⁴²³ In addition, it is not desirable from the investor’s perspective for these TSD TT keys to be held in custody by the issuer in order to prevent abuse here as well. It is more conceivable for custody to be carried out by custodian banks. In addition to custody, this role could also perform an important role by conducting an integrity control of issues⁴²⁴, in particular, by maintaining a register of:
- all (tradable) security tokens⁴²⁵, including a
- reference to the token smart contract or the provision of a clear identification of the token;⁴²⁶ and reference to
- the TT system used and
- the TT identifiers approved to trade these tokens (as a whitelist⁴²⁷).
This role would check the identity of the legal subject with the identity role (see 5.1.2) before inclusion of the TT identifiers in the whitelist. Thus, it would be possible to control transactions and assign them to legal subjects at any time by checking both the register and the identity role. This would ensure that, if the legal conditions⁴²⁸ are met, it would be possible to create a connection to the beneficial owners. Separating these roles could also better protect the privacy of market participants and users. Thus, investors could use their own TT identifiers for every financial instrument issued by an issuer. By querying the register, it would be possible to assign all securities to a TT identifier.
5.1.4 The new role of (Token-)CSDs, — provide custody/registration
Existing central securities depository could assume the role of custody/registration for the secondary market in security tokens.
Each regulated central securities custodian would be responsible for the security tokens registered with it and therefore could also book these security tokens for other central securities custodians (CSD links). In other words, a South African custodian bank could transfer and receive security tokens for its clients via its central securities custodian, which, in turn, is connected to a European central securities custodian for security tokens. Here, the CSD could, as the TSD (token securities depository), store, in addition to the TSD TT key, the TT key for the CSDs connected via TSD links and for its clients. Thus, trading could continue in a centralised and decentralised manner during a transitional phase. If the foreign banks use the same TT system, they could transfer, receive and store security tokens directly for their clients.
5.2 On the antithesis of the incompatibility of security tokens with the current regime
The antithesis would state that central securities depositories, on the basis of the current regulations alone, will not offer settlement services for security tokens for liability reasons⁴²⁹. This antithesis must be viewed in light of the fact that central securities depositories, by definition, have no control over trustworthy technologies. How, for example, would a central securities depository ensure that securities transactions involving security tokens on the Ethereum blockchain are carried out properly and in a timely manner? Or guarantee that security tokens are not generated or reduced in an unauthorised manner? However, this would mean that the EU/EEA would over the long term not be able to establish a functional and comprehensive secondary market for security tokens.
Bitcoin was created in response to the financial crisis with the aim of offering a global payment system with no intermediaries. Over time, the related technologies have shown potential and these technologies have been steadily developed and become increasingly interesting to the capital market. For the primary market, STOs have already shown that the use of trustworthy technologies can result in efficiency improvements and that they can comply with existing securities law. Under securities and civil law, the claims and membership rights that are relevant for the capital market may be issued and transferred in the form of uncertified rights maintained on TT systems — i.e. in the form of tokens. In practice, however, securities regulatory law already faces major challenge, especially the coming obligation to book securities in a book-entry account.
In addition to existing regulated stock exchanges, which are taking the first step towards listing cryptocurrencies and security tokens, there are unregulated exchanges for non-financial instruments and non-e-money (crypto-exchanges) that are seeking approval to offer security token trading.
Thus, regulated markets, MTFs and OTFs are currently able to offer security token trading. However, the obligation to hold new securities issues from 2023 and all securities from 2025 in a book-entry account with a central depositary as well as the clearing obligation for derivatives must be observed.
It remains to be seen whether phenomena such as fully decentralised exchanges with no operators are governed by de facto unenforceable regulations, or whether the normative force of the factual (see Jellinek) leads to the recognition of the innovative power and, in part, a departure from the regulatory model for intermediaries. The latter would be preferable, in my view, and Liechtenstein’s TVTG has clearly shown how to strike a balance between an openness to innovation and the various goods worthy of protection.
The example of the Börse Stuttgart MTF for cryptocurrencies shows the challenges even the listing of non-security tokens based on trustworthy technologies on regulated institutions presents, and whether and the extent to which existing forms of approval, especially MTF, are compatible with TT systems. In particular, the settlement phase poses challenges for regulated institutions. Whether the impending obligation to book securities in book-entry accounts and settlement via a central counterparty are ratio legis necessary, by contrast, shows the other side of the same reality. A technology appears to make the otherwise necessary trust in intermediaries obsolete and therefore much more efficient, more transparent and thus more secure. Key roles in the secondary market for security tokens would seem to be custody/registration, identity and fiat tokens. These roles “fit” in part with existing intermediaries and could be performed by them.
A decision must be made as to how the secondary market for security tokens will be organised and what role central securities custodians will have in future.
Custody of tokens seems to be diametrically opposed to the users of the new technology. Here, a centrally maintained register/ledger (like the register of a CSD) may be of benefit for the secondary market for security tokens as well. Should one risk relying too soon on technology that has not yet been designed for these applications and risk the stability of the European financial markets, which is precisely the purpose of the numerous regulations in this area, or risk missing an opportunity and incurring a competitive disadvantage that would be difficult to make up because the potential has gone unused as a result of excess regulation? At any rate, time is of the essence and these questions need to be addressed before the entry into force of the obligation to record securities in a book-entry account pursuant to the CSDR.
The present thesis was submitted to the University of Liechtenstein in German language under the original title “Sekundärmarkt für Security Token” as a Master’s thesis in order to obtain the Executive Master of Laws (LL.M.) in Banking and Finance.
The thesis refers to Liechtenstein law.
- Nägele/Xander, ICOs und STOs im liechtensteinischen Recht, in Piska/Völkel (eds.), Blockchain Rules (2019) 18.30.
- In most cases, it is not possible to clearly assign a token to one of the three main categories (utility, security, currency), as it usually takes a hybrid form.
- On utility tokens, see Nägele/Xander in Piska/Völkel (margin no. 18.15).
- Nägele/Xander in Piska/Völkel (margin no. 18.14).
- On ICOs, see Nägele/Xander in Piska/Völkel (margin no. 18.27).
- Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU Text with EEA relevance, OJ EC 2014/173, 349.
- The term “trustworthy technologies” was defined in the TVTG and is also used in this paper as an umbrella term for DLT and blockchain. See Art. 2, para. 1a of the Law of 3 October 2019 on Tokens and TT Service Providers (Token and TT Service Provider Act; TVTG), LLG 2019/301.
- DLT stands for distributed ledger technologies and is an umbrella term for technologies that use distributed ledgers. With such technologies, the ledger (or other information) is hosted by a number of parties and the data compared, whereby changes must be confirmed on the basis of the consensus mechanism; see Lin, Deconstructing Decentralized Exchanges, JBLP 2019, 58 (footnote 6).
- Primary market.
- For this reason, when such tokens are offered for public sale, for example, the prospectus requirements, in particular, must be reviewed. See Langer/Nägele, Blockchain- und tokenbasierte Unternehmen in Liechtenstein, IWB 2018, 1 (4).
- Liechtenstein Financial Market Authority, list of approved prospectuses through 20 July 2019 (FMA List of Prospectuses), register.fma-li.li/fileadmin/user_upload/dokumente/publikationen/Prospekte_nach_WPPG/Liste_geb_Prospekte_bis_20190720_6_20200103.pdf, 16.
- In particular, companies hope to gain efficiency improvements.
- Buck-Heeb, Kapitalmarktrecht10 (2019), margin no. 51.
- Schwarz, Globaler Effektenhandel (2016), 27.
- Anter (ed.), Die normative Kraft des Faktischen2 (2020), 53 f.
- See Art. 2, para. 1a) and b) TVTG.
- The 2008 white paper on Bitcoin does not refer to a “blockchain”, but rather a “chain of blocks”. See Nakamoto, (Pseudonym), Bitcoin: A Peer-to-Peer Electronic Cash System (Nakamoto 2008), https://bitcoin.org/bitcoin.pdf.
- Langer/Nägele, IWB 2018, 1 (1).
- In order to prevent a minority of users from manipulating the data.
- See also Government of the Principality of Liechtenstein, Report and Proposal Submitted by the Government to the Landtag of the Principality of Liechtenstein on the Creation of a Law on Tokens and TT Service Providers (Token and TT Service Provider Act; TVTG) and the Amendment of Other Laws (BuA 54/2019), 55.
- Measured in terms of trading volume; 24 Hour Volume Rankings (Currency) (coinmarketcap 24h volume), https://coinmarketcap.com/currencies/volume/24-hour/ (as of 14 April 2020).
- See Bitcoin: A Peer-to-Peer Electronic Cash System (2020), https://bitcoin.org/en/bitcoin-paper (as of 2 April 2020).
- See Ethereum is a global, open-source platform for decentralized applications (ethereum.org), https://ethereum.org/ (as of 14 April 2020).
- æternity, a Blockchain for scalable, secure, and decentralized æpps (æternity 2020), https://aeternity.com/ (as of 31 March 2020).
- Trustless: Also called trust-free, systems that use TT systems in order to create, through consensus, an immutable register of transactions that can be viewed publicly and that is managed by the entire system (all users) in order to address the lack of trustworthiness of central systems. In other words, the system is designed and can be checked by users themselves — at least in theory by those with knowledge of programming — to enable trust in the way the system works. See: Hawlitschek/Notheisen/Teubner, The limits of trust-free systems: A literature review on blockchain technology and trust in the sharing economy, Electronic Commerce Research and Applications 2018, 50 (57).
- See Prime Minister Adrian Hasler in the framework of the first reading of report and proposal no. 54/2014 on the TVTG in the Landtag of the Principality of Liechtenstein: Landtag of the Principality of Liechtenstein, minutes of the public meeting of the Landtag from 5 to 7 JUNE 2019, 1,071.
- For more on information, see BuA 54/2019, 62.
- See para. 2.1 on TT systems.
- TT identifier: Ensures the clear assignment of tokens. In the case of Ethereum and Bitcoin, these are referred to as “public keys”. The TVTG uses the identifier to create the connection/assignment between tokens and legal subjects (persons). See Art. 2, para. 1d) TVTG.
- BuA 54/2019, 60 ff.
- The best known examples are Bitcoin and Ether.
- Langer/Nägele, IWB 2018, 1 (3 f).
- See TVTG Section II. Civil basis, Art. 3 to 10.
- See Art. 7 TVTG.
- Or the establishment of a security or a right of usufruct to a token.
- The government ascribes finality to transactions on TT systems; see report and proposal no. 54/2019, 126; depending on the TT system used, from a technical standpoint finality is achieved at a later stage. In practice, a sufficient number of transactions (for example, seven to ten in the case of Bitcoin) is required to make subsequent changes uneconomical; on this point, see also “Why Is It Expensive to Manipulate the Blockchain”; Voshmgir, Token Economy, 1st ed. (2019), 59.
- Whereby a limited right in rem to a token can also be created without a transfer, provided this right is discernible to third parties and the date the right in rem is created is clearly defined.
- Thus, there must be a compulsory underlying transaction.
- Or that they want to establish a limited right in rem.
- Acquisitions in good faith pursuant to Art. 9 TVTG remain reserved.
- Art. 7, para. 1 TVTG.
- BuA 54/2019, 168.
- Art. 7, para. 1 TVTG must be read in conjunction with para. 2 of this law; this article discusses the steps that must be taken if the “legal effect pursuant to para. 1 does not come into force by law”.
- For a detailed discussion of this point, see Wild, Die zivilrechtlichen Bestimmungen des Token- und VT-Dienstleister-Gesetzes (TVTG) in Liechtenstein unter Berücksichtigung des Wertrechts gem § 81a SchlT PGR, 70.
- See also Wild, 60.
- The law is silent on the measures that are to be taken. Para. 2 requires the obliged person to ensure, through suitable measures, that the desired legal effects come into force and that there are no competing rights of disposal.
- But only if the uncertified rights register/ledger is maintained through the use of TT systems. See Art. 81a, para. 4 of the final section of the Liechtenstein Persons and Companies Act (SchlT PGR), LLG 1926/4.
- BuA Nr. 54/2019, 169.
- Art. 6, para. 3 TVTG; reversal of the transaction under the Unjust Enrichment Act in accordance with Art. 1431 ff of the Liechtenstein General Civil Code (Allgemeines bürgerliches Gesetzbuch, or ABGB), LLG Off. Comp.
- On this point, see report and proposal 54/2019, p. 191–192.
- Layr/Marxer, Rechtsnatur und Übertragung von «Token» aus liechtensteinischer Perspektive, LJZ 2019, 11 (14).
- As also stated by Layr/Marxer, LJZ 2019, 11 (pp. 14–15).
- See report and proposal 54/2019, 169.
- Legal persons.
- See Art. 149, para. 1 and 2 PGR.
- Like the creation of a limited right in rem.
- Since entry into force of the TVTG, any discussion of Liechtenstein law on securities is also understood to include uncertified rights as well; see report and proposal 54/2019, 111.
- Subject to other provisions, such as the right of first refusal, the duty to obtain the consent of corporate bodies or members in the company’s articles of incorporation.
- See Fig. 1 Comparison of the forms for transferring claims and membership rights, including in the form of securities, traditional book-entry securities and uncertified rights in the form of tokens.
- Sec. 73, para. 1 SchlT PGR.
- BuA Nr. 54/2019, 108.
- See Art. 75, para. 1 and 2 SchlT PGR.
- For example, savings books, bonds, debentures and convertible bonds.
- G. Leser/G. Leser/Habsburg-Lothringen, Finanzinstrumente — Aktien, Anleihen, Rohstoffe, Fonds und Derivate im Überblick2 (2019), 14.
- BuA Nr. 54/2019, 169.
- One option for meeting this condition, albeit an extremely outdated one, is the handover of the physical security; however, in modern global securities trading the handover of physical certificates is almost unimaginable given the transaction volume.
- Uncertified rights make the cumbersome process of handing over physical certificates unnecessary.
- Immobilisation refers to the phenomenon in which financial instruments that need to be registered are entered in the relevant register either under the name of the central securities depository or the nominee specified by the central securities depository instead of the actual investor’s name; consequently, it is no longer necessary when trades are conducted to change the entry in the register as the securities have been “withdrawn from circulation”; see Schwarz 2016, 31; not to be confused with the immobilisation of bearer shares to prevent money laundering; see Government of the Principality of Liechtenstein, Report and Proposal Submitted by the Government to the Landtag of the Principality of Liechtenstein on the Amendment of the Persons and Companies Act (Immobilisation of Bearer Shares and Introduction of a Sanction Mechanism for the Maintenance of the Share Register for Registered Shares) (Report and proposal 69/2012), 4.
- On this point, see Schwarz 2016, 44.
- Schwarz 2016, 29–44.
- Schwarz 2016, 45 ff.
- Schwarz 2016, 44 f.
- See Fig. 1.
- Schwarz 2016, 51 f.
- In Germany, uncertified rights (“Wertrechte”) are called “Schuldbuchforderungen”; Schwarz 2016, 52.
- BuA Nr. 54/2019, 108.
- On this point, see also BuA 54/2019, p. 108.
- BuA Nr. 54/2019, 110.
- BuA 54/2019, pp. 108–110.
- Art. 81a, para. 2 SchlT PGR.
- § 81a Abs 4 SchlT PGR.
- See BuA 54/2019, 116; Wild, 78 f.
- The documents related to the TVTG show that legislators therefore chose not to modify all of the laws; see BuA 54/2019, 111.
- See Art. 267 ff and 323 ff PGR.
- In practice, almost all equities are issued as securities; see BuA 54/2019, 117.
- Art. 259, para. 1 PGR.
- According to Art. 401, para. 3 PGR; this is in contrast to Swiss cooperatives, for which there is an express legal prohibition against ; see Meier-Hayoz/Crone, Wertpapierrecht3 (2018), margin no. 15.
- Art 380 Abs 3 PGR.
- Art 772 Abs 4 PGR.
- Art 540 Abs 5 PGR.
- Art. 409 has been repealed and Art. 391, para. 5 PGR amended; based on the materials, the reasons for this are likely the lack of relevance and the better suitability of joint stock companies; in view of the developments related to the TVTG it would, in my view, be worth considering a reintroduction of option to document securities as certificates in modified form; see Government of the Principality of Liechtenstein, Report and Proposal Submitted by the Government to the Landtag of the Principality of Liechtenstein on the Amendment of the Persons and Companies Act (PGR) (amendment of the LLC law) (BuA 68/2016), 26 and 40.
- And securities.
- BuA Nr. 54/2019, 116.
- And introduction of a sanction mechanism for the maintenance of the share register for registered shares by LLG 2013, №67.
- BuA Nr. 54/2019, 117.
- BuA Nr. 69/2012, 18.
- BuA Nr. 54/2019, 117.
- BuA Nr. 54/2019, 117.
- BuA Nr. 54/2019, 118.
- BuA Nr. 54/2019, 118.
- Property Law (PL) of 31 December 1922, LLG 1923/4.
- BuA Nr. 54/2019, 118.
- BuA Nr. 54/2019, 118.
- Or maintained as a joint register, which is made easier by the use of TT systems.
- BuA 54/2019, 117 ff.
- However, in its report and proposal, the government makes it clear that there can be empty containers, such as Bitcoin, that do not represent any rights. See BuA Nr. 54/2019, 61.
- At least in the case of uncertified rights represented by tokens; see: BuA 54/2019, 110.
- For more on the specified functions, see BuA 54/2019, 110.
- See also para. 184.108.40.206.
- BuA Nr. 54/2019, 111.
- BuA 54/2019, 141; see also Langer/Nägele, IWB 2018, 1 (6); see also para. 2.1 Schopper/Raschner, Die aufsichtsrechtliche Einordnung von Krypto-Börsen in Österreich, ÖBA 2019, 249.
- BuA Nr. 54/2019, 142.
- Langer/Nägele, IWB 2018, 1 (6).
- For example, the International Token Classification model of the ITSA in International Token Standardization Association e.V., International Token Classification (ITC) (International Token Standardization Association e.V. 2020) (as of 11 April 2020, https://itsa.global/what-we-do/#ITC).
- See also Schopper/Raschner, ÖBA 2019, 249 (3.3.1.).
- FMA, communication 2019/1. Supplementary obligations when issuing/redeeming and maintaining a share register for fund share tokens (FMA, communication 2019/1), https://www.fma-li.li/files/list/fma-mitteilung-2019-01.pdf (as of 3 September 2019), 2.
- FMA, Mitteilung 2019/2. Obligations for issuers of securities and security tokens (FMA, communication 2019/2), https://www.fma-li.li/files/list/fma-mittteilung-2019-2-emittenten-wp-st.pdf (as of 15 October 2019), 4.
- FMA, communication 2019/2, 5.
- The technology-neutral approach corresponds to the practice of the US regulatory authority, the US Securities and Exchange Commission (SEC); on this point see: “A change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed. Said another way, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance”: Clayton, Statement on Cryptocurrencies and Initial Coin Offerings (Clayton 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11 (as of 11 December 2017).
- For example, shareholder rights, in particular, dividend payment and voting rights, as a traditional equity instrument.
- See also BuA 54/2019, 44.
- Act of 21 October 1992 on Banks and Investment Firms (Banking Act; BankG), LLG 1992/108.
- See Art. 4, para. 1(48) on payment instruments pursuant to the Payment Services Act (Zahlungsdienstegesetz, or ZDG) of 6 June 2019, LLG 213.
- For another view (“exhaustive list”) Schopper/Raschner, ÖBA 2019, 249 (sec. 3.1).
- Government of the Principality of Liechtenstein, Report and Proposal Submitted by the Government to the Landtag of the Principality of Liechtenstein on the Amendment of the Law on Banks and Investment Firms, of the Law on Asset Management, and of Other Laws (BuA 14/2017), 42.
- The transferable securities specified in Regulation (EU) 2017/1129 are financial instruments pursuant to Art. 4, para. 1(15) in conjunction with Annex I, Section C MiFID II.
- FMA — Mitteilung 2019/2, 5.
- FMA, communication 2019/2.
- Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC (text with EEA relevance) (Prospectus Regulation), OJ EC 2017/168, 12.
- See FMA, list of approved prospectuses.
- FMA — Mitteilung 2019/2, 5.
- A virtual marketplace alone is sufficient for tradability on a capital market; see Paulmayer, Initial Coin Offerings (ICOs) und Initial Token Offerings (ITOs) als prospektpflichtiges Angebot nach KMG? ZFR 2017, 530 (533) with other ref.
- The operators appear to include the listing of blockchain-based financial instruments here.
- Multilateral trading facility (MTF).
- On this point, see also the article dated 29 April 2020 by three Austrian FMA staff members who were unable to locate any trading platform in the EEA that purposely and openly listed DLT-based transferable securities; Pekler/Rirsch/Tomanek, Kapitalmarktrechtliche Hindernisse für den Handel von Security Token, ZFR 2020, 172 (172); see the press release of the advising law firm Ashurst; as of the date this paper was submitted, the MTF was still not entered in the register maintained by the FMA. Last reviewed on 26 April 2020; see in Ashurst LLP “Ashurst advises Nomisma on Europe’s first MiFID II license for a blockchain-based MTF” (Ashurst LLP 2020), https://www.ashurst.com/en/news-and-insights/news-deals-and-awards/ashurst-advises-nomisma-on-europes-first-mifid-ii-license-for-a-blockchain-based-mtf/ As of 26 April 2020.
- Transfer restrictions such as whitelisting that are not in the standard are planned for security tokens.
- Tokens pursuant to the ERC 20 standard are generally fungible and easy to generate in large numbers.
- In addition to the three criteria, the Austrian Financial Market Authority (AFMA) also reviews whether the right is “embodied”. Here, the AFMA views the connection between the claim and holding the security as relevant. The overwhelming view is that the use of trustworthy technologies can affirm embodiment (representation), as tokens have an identification function; Schopper/Raschner, ÖBA 2019, 249 (para. 3.1.1) with other ref.; the TVTG assumes that the rights will be represented and not embodied; see BuA 54/2019, 142.
- See with other ref. Patz, Handelsplattformen für Kryptowährungen und Kryptoassets, BKR 2019, 435 (436).
- FMA — Mitteilung 2019/2, 4.
- FMA, communication 2019/2, 5–6.
- In order to account for Bitcoin Germany, in Art. 1, para. 11, clause 1, no. 10 of the German Banking Act (Kreditwesengesetz, or KWG), created a catch-all clause in order to take account of all of the various forms of “cryptoassets” that, in particular, do not already fall under another category of financial instrument; see Federal Financial Supervisory Authority, information sheet: Guidance notice on the crypto custody business (BaFin on the crypto custody business), https://www.bafin.de/EN/Aufsicht/BankenFinanzdienstleister/Zulassung/Kryptoverwahrgeschaeft/kryptoverwahrgeschaeft_node_en.html.
- FMA — Mitteilung 2019/2, 6.
- Buck-Heeb 2019, margin no. 72.
- Such as shares.
- Buck-Heeb 2019, Rz 74.
- The German word “Börse”, or “stock exchange”, meaning a place where traders met to conduct business is derived from the name van der Beurse, the surname of a family of Belgian traders; G. Leser/G. Leser/Habsburg-Lothringen 2019, 6.
- Buck-Heeb 2019, Rz 74.
- See the definition of financial instruments in Annex 2, Section C BankG; examples include shares, debentures (bonds), money market instruments, futures and options.
- G. Leser/G. Leser/Habsburg-Lothringen 2019, 7.
- In Germany, by contrast, holding cryptocurrencies in safekeeping requires authorisation; see BaFin crypto custody business.
- Also called cryptocurrency exchanges. Examples include Binance, Bitfinex, Coinbase, Kraken, Bittrex.
- E-money: any monetary value stored electronically — including magnetically — in the form of a claim against the issuer that is issued against payment of a monetary amount in order to carry out payment processes and that is accepted by natural persons or legal entities other than the e-money issuer; Art. 2 no. 2 Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC (Text with EEA relevance) (Electronic Money Directive), OJ EC 2009/267, 7.
- People in the industry refer to “fiat money”.
- “Off-chain” means no blockchain is used or the transaction is conducted outside of the blockchain, in contrast to “on-chain”, which is the case when a blockchain is used.
- On crypto-exchanges, see in, particular, Schopper/Raschner, ÖBA 2019, 249.
- Abbreviation of “decentralised exchange”.
- Lin, JBLP 2019, 58 (59).
- Or several decentralised systems if tokens are to be listed on different TT systems.
- For example, a central order book and decentralised settlement.
- Kumpan in Schwark/Zimmer, Kapitalmarktrechts-Kommentar. Börsengesetz mit Börsenzulassungsverordnung, Wertpapierprospektgesetz, Wertpapierhandelsgesetz, Wertpapiererwerbs- und Übernahmegesetz (KMRK)5 (2019) Art. 21 BörsG, margin no. 3.
- Stegeman/Berket, Derivatives: Trading, Clearing, STP, Indirect Clearing and Portfolio Compression, in Busch/Ferrarini (eds.), Regulation of the EU Financial Markets (2017) 15.35.
- It does not include the subsequent custody and management of the securities.
- See also Schwarz 2016, 90.
- Investors held the certificates representing the rights themselves or gave it to their bank for safekeeping. Thus, there was a direct connection between the investor and the issuer. See Schwarz 2016, 27.
- Schwarz 2016, 29 f.
- The agent is the party that carries out a transaction with another counterparty for a fee in its own name and for the client’s account; see Annex 3 of Art. 24b No 37, para. 14 of the Ordinance of 22 February 1994 on Banks and Investment Firms (Banking Ordinance; Bankenverordnung or BankV).
- This example does not go into further detail on clearing; for more on clearing, see Section 220.127.116.11.
- See Patz, BKR 2019, 435 (441).
- Even though in practice there are often hybrid forms with decentralised and centralised elements.
- See ethereum.org.
- Decentralised exchange application.
- A decentralised application (DApp) is a decentralised application that is not operated by an individual provider, but rather on a blockchain and thus meets additional criteria; see Schiller, Was ist eine DApp (dezentralisierte App)? (Schiller 2018), https://blockchainwelt.de/dapp-dezentralisierte-app-dapps/ (as of 21 April 2018).
- “On-chain” refers to on the blockchain, i.e. using a TT system, in contrast to “off-chain”: outside of a TT system.
- In the form of websites.
- Lin, JBLP 2019, 58 (59 f).
- See, however, also without GUI and in some cases with other names Lin, JBLP 2019, 58 (60).
- Especially in respect of crypto-exchanges, which hold clients’ tokens in safekeeping and were and are increasingly the target of hacker attacks; see Biggs/Nelson, Upbit Is the Seventh Major Crypto Exchange Hack of 2019 — CoinDesk (Biggs et al. 2019), https://www.coindesk.com/upbit-is-the-sixth-major-crypto-exchange-hack-of-2019 (as of 2 December 2019).
- DEX are available 24/7 and trading is generally not suspended; by comparison, the MTF of Baden-Württembergische Wertpapierbörse GmbH suspends trading for Bitcoin everyday for 30 minutes; see Baden-Württembergische Wertpapierbörse GmbH, Art. 1 of the Baden-Württembergische Wertpapierbörse GmbH Market Regulations for the Digital Exchange (BSDEX Market Regulations), https://www.bsdex.de/documents/legal/AGB_BWWB_Digital_Exchange.pdf (as of 11 September 2019).
- See the listing conditions of Bittrex International GmbH, which requires a legal opinion from a Liechtenstein law firm for every token team as well as information about the technical integration of the tokens. Bittrex Global, HOW TO LIST ON BITTREX GLOBAL (BITTREX Listing), https://medium.com/bittrexglobal/how-to-list-on-bittrex-global-3535f05683d0.
- Lin, JBLP 2019, 58 (58 ff).
- Based on Buck-Heeb 2019, margin no. 125.
- Trading venue: Umbrella term for exchanges, multilateral trading facilities and organised trading systems (which in turn include all multilateral systems); however, it should not be used synonymously with multilateral system, as there are multilateral systems that are not trading venues; see Kumpan in Schwark/Zimmer, Kapitalmarktrechts-Kommentar. Börsengesetz mit Börsenzulassungsverordnung, Wertpapierprospektgesetz, Wertpapierhandelsgesetz, Wertpapiererwerbs- und Übernahmegesetz (KMRK)5 (2019) § 2 BörsG, Rz 32.
- Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories, OJ EC 2012/201, 1.
- Here, “trading” is always viewed as an economic activity between the market participants/investors, as even when a central counterparty is involved and it therefore serves both parties as contractual partner, the investors are, from an economic standpoint, acting between themselves; on multilateral and bilateral, see, in particular, Kumpan in Schwark/Zimmer, Kapitalmarktrechts-Kommentar. Börsengesetz mit Börsenzulassungsverordnung, Wertpapierprospektgesetz, Wertpapierhandelsgesetz, Wertpapiererwerbs- und Übernahmegesetz (KMRK)5 (2019) § 2 WpHG, margin no. 142.
- Kumpan in KMRK5 § 2 WpHG, margin no. 142.
- Title III: Regulated markets.
- See Art. 55d BankV.
- Art. 55d, para. 1b) sec. 3 and 4 BankV.
- Art. 44, para. 4 MiFID II.
- BuA Nr. 14/2017, 138.
- See Recital 121 MiFID II.
- BankG (see Art. 3a, para. 1(6b)).
- MTFs and OTFs must have at least three active members or users who are able to communicate with one another for the purpose of pricing; see Art. 55l, para. 5 BankV.
- The operators have no scope for discretion.
- Titel II: Authorisation of investment firms and conditions for carrying out activities.
- Kumpan in KMRK5 § 2 WpHG, Rz 137.
- Kumpan in KMRK5 § 2 WpHG, margin no. 137; on transparency and reporting obligations, see also Schopper/Raschner, ÖBA 2019, 249 (262).
- See with other ref. Kumpan in KMRK5 § 2 WpHG, margin no. 137.
- Kumpan in KMRK5 § 2 WpHG, Rz 138.
- Quotes can be both binding and non-binding declarations. See Kumpan in KMRK5 § 2 WpHG, margin no. 139.
- Kumpan in KMRK5 § 2 WpHG, Rz 139.
- Bring the orders or interests together must be done with a certain amount of continuity; occasional auctions of financial instruments is not sufficient; see Kumpan in KMRK5 § 2 WpHG, margin no. 138.
- Or quotes.
- Kumpan in KMRK5 § 2 WpHG, Rz 138.
- Kumpan in KMRK5 § 2 WpHG, Rz 140.
- These include the processes contained in the software.
- Kumpan in KMRK5 § 2 WpHG, Rz 138.
- Kumpan in KMRK5 § 2 WpHG, Rz 141.
- Art. 55m, para. 5 BankV.
- See Art. 55b, para. 1e) sec. 3 BankV.
- Art. 55m, para. 2 in conjunction with Art. 55d, para. 1 BankV.
- Sec. 4.1.3 Schopper/Raschner, ÖBA 2019, 249.
- ICONOMI AG participation certificates; see FMA, list of approved prospectuses, 3.
- The home authorities are the supervisory authorities in the home country of the applicant; in Liechtenstein, this is the FMA.
- The establishment of branches is also permitted.
- BaFin: Bundesanstalt für Finanzdienstleistungsaufsicht (Federal Financial Supervisory Authority), the German equivalent of the Liechtenstein Financial Market Authority (FMA).
- However, any additional national laws in the relevant jurisdiction (e.g. stricter must be reviewed prior to commencement of the activities.
- Scholz-Fröhlin, FinTechs und die bankaufsichtsrechtlichen Lizenzpflichten, BKR 2017, 133 (137 f).
- BWWB is a wholly-owned subsidiary of Vereinigung Baden-Würtenbergische Wertpapierbörse eV, which is, in turn, called the Börse Stuttgart Group; at Börse Stuttgart Group, About us (Börse Stuttgart GmbH 2020) (as of 19 April 2020, https://www.boerse-stuttgart.de/en/about-us/company-structure/our-companies/).
- BaFin granted BWWB approval to operate a multilateral trading facility on 23 September 2019 (Art. 1, para. 1a, clause 2 №1b KWG), in Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin),BaFin company database, entry for Baden-Württembergische Wertpapierbörse GmbH (Bundesanstalt für Finanzdienstleistungsaufsicht 2020) (as of 19 April 2020, https://portal.mvp.bafin.de/database/InstInfo/institutDetails.do?cmd=loadInstitutAction&institutId=156958&locale=en_GB).
- Currently, only Bitcoin trading is offered; other cryptocurrencies will follow.
- BSDEX is a joint venture of the Börse Stuttgart Group, Axel Springer and finanzen.net; in Baden-Württembergische Wertpapierbörse GmbH, BSDEX | Frequently Asked Questions (Baden-Württembergische Wertpapierbörse GmbH 2020) (as of 19 April 2020, https://www.bsdex.de/de/faq/).
- See para. 9.3. blocknox GmbH, General Terms and Conditions of blocknox GmbH for private clients (blocknox GTC), https://www.bsdex.de/documents/legal/AGB_blocknox_Digital_Exchange.pdf (as of 5 December 2019).
- On 1 January 2020, Germany included, and thus regulated, crypto custody business in the Banking Act (KGW) as a new financial service; companies that want to provide these services need authorisation from BaFin; BaFin crypto custody business.
- The functionality of the account is limited to deposits, the settling of the participant’s balance in connection with trading on the MTF, and the repayment of the balance to the user’s reference account; see para. 8.1.1. solarisbank AG, Special Terms and Conditions of solarisBank AG for Payment Processing in Connection with Trading on the Digital Exchange (solaris STC), https://www.bsdex.de/documents/legal/AGB_Sonderbedingungen_solarisBank_Digital_Exchange.pdf (as of 29 August 2019).
- GUI: Abbreviation of graphical user interface.
- See Sec. 1 Definitions in conjunction with Sec. 4 Trading cryptocurrencies, Baden-Württembergische Wertpapierbörse GmbH, General Terms and Conditions of Baden-Württembergischen Wertpapierbörse GmbH for Private Clients Engaging in Trade on the Digital Exchange (BSDEX GTC for Private Clients), https://www.bsdex.de/documents/legal/AGB_BWWB_Digital_Exchange.pdf (as of 11 September 2019).
- Art. 3, para. 2 of the BSDEX market regulations.
- See Art. 4, para. 1 of the annex to the BSDEX market regulations.
- See the price-time priority in Art. 2, para. 2 of the BSDEX market regulations.
- See Art. 4, para. 2 of the BSDEX market regulations.
- Blocknox GmbH does not hold the cryptocurrencies in custody separately from other client holdings, but instead holds them in collective custody, but separate from its own holdings. It is to be assumed that “rebookings” are carried out off-chain, i.e. in a central account maintenance system and that only when the payouts are made to clients are they on-chain. See Sec. 4.1. ff blocknox GTC.
- Art. 12, para. 1 of the BSDEX market regulations, 10.
- Sec. 4.3. blocknox GTC.
- Art. 12, para. 2 of the BSDEX market regulations.
- In the case of BSDEX, the fees due the MTF were assigned to BSDEX and the account-holding bank is informed by the users, in line with the GTC, to transfer them directly to BSDEX. See Sec. 9.1.2. solaris GTC.
- Sec. 9.1.2. AGB solaris.
- Ziff 9.1.4. AGB solaris.
- Implemented in national law in Art. 3a, para. 1(6c).
- Compared to the regulated market or an MTF, which does not operate in accordance with discretionary rules.
- See Recital 8 of Regulation (EU) №600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) №648/2012 Text with EEA relevance, OJ EC 2014/173, 84.
- See 4.1.4. Organisiertes Handelssystem in Schopper/Raschner, ÖBA 2019, 249.
- See Art. 20, para. 1 to 3 MiFID II.
- See, for example, Crowdlitoken; FMA, list of approved prospectuses, 1.
- See with other ref. Buck-Heeb 2019, margin no. 157.
- Recital 17 MiFID II.
- Buck-Heeb 2019, margin no. 156–158.
- Xetra for short, in Deutsche Börse AG, Xetra Best (Deutsche Börse AG 2007) (as of May 2007, https://www.deutsche-boerse-cash-market.com/resource/blob/311770/6ea3a86bf128cbe7dc79b9f4b8a47534/data/FAQs-zu-Xetra-BEST.pdf).
- Buck-Heeb 2019, Rz 157.
- Deutsche Börse AG 2007.
- The post-trade phase includes clearing and settlement.
- On 16 April 2020, there were 256,108 ERC-20 token contracts listed on etherscan.io; see Etherscan.io, Token Tracker | Etherscan (Etherscan.io 2020), https://etherscan.io/tokens (as of 16 April 2020).
- Depending on the exchange, these may be participants, clients or users as with DEX. The term “users” is used here for the sake of simplicity.
- OasisDEX is one of the few DEX projects that operates an on-chain order book, displaying open orders in it and not performing any matching. Takers must find suitable orders on their own. On the OasisDEX order book, see OasisDEX (2017), https://github.com/OasisDEX/oasis/wiki (as of 10 April 2017).
- The tokens usually following a uniform standard, such as ERC-20 in the case of Ethereum.
- Through so-called mining fees.
- Depending on the consensus, procedure and other features, transactions may be conducted faster or slower.
- On 13 April 2020, a transaction on the Ethereum blockchain cost about $0.02; see ETH Gas Station (2020), https://ethgasstation.info/ (as of 13 April 2020).
- See Lin, JBLP 2019, 58 (62).
- As is also the case for every order that is to be removed from the order book.
- Consensus algorithm: In order to be able to ensure the agreement of all participants regarding the information recorded on the TT system all new transaction requests are first gathered and then a decision on them is made in accordance with the algorithm rules for accepting information; see also Völkel, Grundlagen der Blockchain-Technologie und virtueller Währungen, in Piska/Völkel (eds.), Blockchain rules (2019) 1.46.
- By up to several minutes.
- See Lin, JBLP 2019, 58 (62 f).
- “Off-chain” order books: Traditional order books that are also operated by centralised exchanges.
- Even though a server is usually not sufficient.
- The operator can change, filter, hide or arrange the information in the order book any way it wishes; manipulations of the orders that are displayed cannot always be detected (completeness, authenticity, etc.).
- Lin, JBLP 2019, 58 (67).
- See Kumpan in KMRK5 § 2 WpHG, Rz 138.
- Which are also used by exchanges.
- Takers: Takers are the parties who place orders that can immediately be matched with one or more orders in the order book; see Lin, JBLP 2019, 58 (62).
- Makers: The parties who place orders for later execution; on this point, see also the term market making strategy pursuant to Art. 17, para. 4 MiFID II and Baden-Württembergische Wertpapierbörse GmbH, Börse Stuttgart Digital Exchange (Baden-Württembergische Wertpapierbörse GmbH 2020), https://www.bsdex.de/de/ (as of 19 April 2020).
- Lin, JBLP 2019, 58 (72).
- It is worth noting that there are additional software solutions that display automated systems to users, enabling them to look for suitable orders in the order books according to predefined criteria.
- Resting order: An order for a certain volume at a certain price that is placed in the order book for later execution. In the case of central order books, such as the one maintained by Baden-Württembergische Wertpapierbörse GmbH, a certain amount of time, such as 360 calendar days, is set; see Art. 2, para. 7 of the BSDEX market regulations.
- Lin, JBLP 2019, 58 (70).
- See Lin, JBLP 2019, 58 (62 and 70–71).
- Pursuant to Art. 4, para. 1 №19, 21 to 23 MiFID-II on the basis of in Autorité des marches financiers (AMF),Review and analysis of the application of financial regulations to security tokens (AMF Security Tokens), https://www.amf-france.org/sites/default/files/2020-03/legal-analysis-security-tokens-amf-en_1.pdf As of 27 February 2020, 16.
- Whether the decentralised provision of this service makes the service provider an operator is another question.
- At least, that is the view of the Autorité des marchés financiers (AMF), the French regulatory authority; but what if it is not the system itself, but rather a user interface provided by a third party or locally installed software that looks through the on-chain order books, finds a suitable order, fills it and “takes care” of the settlement? This question is not answered; in this case, the bulletin board would not be subject to approval and the locally installed software would be operated by the user him/herself; of course, this does not include primary market systems where only the issuer acts as the seller; see AMF (ed.) 27 February 2020 — Review and analysis, 17; also confirmed by three employees of the Austrian FMA, with other ref.; Pekler/Rirsch/Tomanek, ZFR 2020, 172 (173).
- Also in the form of websites, which, in turn, access order books.
- BuA 54/2019, 30 and 160.
- BuA Nr. 54/2019, 160.
- See Recital 8 MiFIR and the affirmative position of the AMF, the French regulatory authority, with other ref. AMF (ed.) 27 February 2020 — Review and analysis, 16 f.
- “This interpretation leaves little room for the development of hybrid security token trading platforms outside of the MiFID regulations”; AMF (ed.) 27 February 2020 — Review and analysis, 17.
- BuA Nr. 54/2019, 82.
- See Art. 2, para. 1s) TVTG.
- BuA Nr. 54/2019, 161.
- Government of the Principality of Liechtenstein, Statement by the Government to the Landtag of the Principality of Liechtenstein on the first reading on the Creation of a Law on Tokens and TT Service Providers (Token and TT Service Provider Act; TVTG) and the Amendment of Other Laws (BuA 93/2019), 9.
- See BuA Nr. 93/2019, 9.
- BuA Nr. 54/2019, 161.
- BuA Nr. 54/2019, 161.
- Neither MiFIR nor MiFID II define clearing; see Stegeman/Berket in Busch/Ferrarini (15.36).
- Kumpan in KMRK5 § 21 BörsG, 4.
- BuA 93/2019.
- BuA Nr. 54/2019, 120.
- See Art. 2, №3 EMIR.
- Kumpan in KMRK5 § 21 BörsG, 4–5.Act of 23 October 2002 on Settlement Finality in Payment and Securities Settlement Systems (Finality Act), LLG 2002/159.
- Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment and securities settlement systems, OJ EC 1998/166, 45.
- Directive 2009/44/EC of the European Parliament and of the Council of 6 May 2009 amending Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2002/47/EC on financial collateral arrangements as regards linked systems and credit claims (Text with EEA relevance) OJ EC 2009/146, 37.
- The term CCP is not defined directly in Art. 2, para. 1 №31 MiFIR; instead, this directive refers to the definition in Art. 2, para. 1 EMIR.
- Contracts traded are contracts concluded for financial instruments (purchase contracts), as well as other transfer transactions, such as securities lending or securities repurchase agreements; See Kumpan in KMRK5 § 21 BörsG, margin no. 7.
- Kumpan in KMRK5 § 21 BörsG, margin no. 7.
- See Stegeman/Berket in Busch/Ferrarini (15.37).
- In some cases, the central counterparty is involved in the trading system during the matching process (open offer) and thus interposed between the participants involved in the transaction; see Kumpan in KMRK5 § 21 BörsG, margin no. 7.
- Kumpan in KMRK5 § 21 BörsG, Rz 8.
- Stegeman/Berket in Busch/Ferrarini (15.37).
- Kumpan in KMRK5 § 21 BörsG, Rz 8.
- See Fig. 1.52 in margin no. 15.38 Stegeman/Berket in Busch/Ferrarini (15.38).
- Kumpan in KMRK5 § 21 BörsG, Rz 8.
- See footnote 74 in Stegeman/Berket in Busch/Ferrarini (15.38).
- The initial margin should cover the costs of a replacement purchase (forward looking).
- The variation margin should cover fluctuations in the price of the positions (backward looking).
- Stegeman/Berket in Busch/Ferrarini (15.39).
- Smart contract: Refers to computer programs or program code that imposes conditions for the performance of subsequent activities; this results in an automated progression of steps (that can be) carried out and stored on a decentralised network; whether smart contracts are contracts in the legal sense is disputed. See also Mofidian/Smets, Smart Contracts im Zivil- und Gesellschaftsrecht, in Piska/Völkel (eds.), Blockchain rules (2019) 5.1; they are also referred to as self-enforcing agreements; see Voshmgir 2019, 88.
- For example, smart contracts could always settle the individual positions immediately, and CCP would therefore only remain relevant for derivatives; see also SET, Digital Asset Programme. 3rd Digital Asset Industry Forum (SET Digital Asset Programme), https://www.set.or.th/contactcenter/files/20191220_3rd_SET_IndustryForum_PUBLIC.pdf (as of 20 December 2019), 16.
- See Art. 35MiFIR.
- See also Art. 38, para. 1 and 2 MiFID II.
- See Kumpan in KMRK5 § 21 BörsG, margin no. 1.
- Also called OTC derivatives contracts; these are derivatives contracts that are not executed on a regulated market; see Art. 2, №7 EMIR.
- See Art. 6 EMIR.
- German Federal Financial Supervisory Authority, Clearingpflicht bei Derivaten (BaFin on clearing obligations for derivatives), https://www.bafin.de/DE/Aufsicht/BoersenMaerkte/Derivate/EMIR/ZentralesClearing/pflichten_zum_zentralen_clearing_node.html.
- For example, authorised securities firms, credit institutions, insurance companies, etc. pursuant to Art. 2 No. EMIR.
- Austrian Financial Market Authority, Clearing obligation (Austrian Financial Market Authority 2020), https://www.fma.gv.at/kapitalmaerkte/emir/clearingpflicht/ (as of 5 April 2020).
- In practice, only CCPs that have either been authorised by a national regulatory authority in the EU/EEA in accordance with EMIR to settle derivatives subject to clearing obligations or, in the case of third countries, that have been recognised by the EMSA are used. See Pankoke, Zinsderivate, bj 2015, 27 (31).
- Either through a clearing membership or through an indirect connection to a CCP; see BaFin 17 October 2019 — derivatives clearing obligation.
- General here means irrespective of the type of derivative that is traded.
- See Stegeman/Berket in Busch/Ferrarini (15.32).
- Not including the system operator, any settlement agent, central counterparty or clearing house or any possible indirect participant.
- Systems that are subject to Swiss law and whose head office is in Switzerland are exempt from the reporting and admissibility review requirements.
- Participants include institutions, central counterparties, settlement agents, clearing houses and system operators; see Art. 7, para. 1 of the Finality Act.
- On the development of a booking-supported securities system, see Schwarz 2016, 27ff.
- Kumpan in KMRK5 § 21 BörsG, Rz 6.
- Regulation (EU) №909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012 Text with EEA relevance, OJ EC 2014/257, 1.
- Recital 1 CSDR.
- See Recital 2 CSDR.
- See Government of the Principality of Liechtenstein, Report and Proposal Submitted by the Government to the Landtag of the Principality of Liechtenstein on the Promulgation of a Law Implementing Regulation (EU) №909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories; EEA CSDA) and amending other laws (BuA 37/2017), 5.
- Act of 10 November 2017 on the implementation of Regulation (EU) №909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories (EEA Central Securities Depository Implementation Act; EEA CSDI Act), LLG 2017/426.
- In particular, market participants in Liechtenstein use Switzerland’s SIX SIS AG as a central securities depository; see BuA 37/2017, 16; Germany’s Clearstream Banking AG also offers its services in Liechtenstein; see ESMA, CSD Register. Art. 21 and 58 of Regulation (EU) №909/2014 (CSDR) (ESMA CSD Register), https://www.esma.europa.eu/sites/default/files/library/esma70-151-889_csd_register.pdf (as of 9 March 2020), 38.
- Consid 1 CSDR.
- Consid 2 CSDR.
- See Consid 2 CSDR.
- For example, on the basis of a gift or inheritance; see Kumpan in KMRK5 § 21 BörsG, margin no. 6.
- See Patz, BKR 2019, 435 (440).
- See Art. 3, para. 1 in conjunction with Art. 76, para. 2 CSDR.
- See Art. 3, para. 1 CSDR.
- Regulated market, MTF or OTF.
- See Patz, BKR 2019, 435 (440).
- On this point, see also the MTF of Börse Stuttgart in Section 18.104.22.168.
- See “Off-chain relay, on-chain settlement” 0x, Core Concepts (0x 2020), https://0x.org/docs/core-concepts#digital-signature (as of 27 March 2020).
- With central systems, the central securities depository assumes custody of the securities.
- Fiat or fiat currencies or fiat money refers legal currencies that have neither an intrinsic value nor a payment guarantee; examples of fiat currencies include the euro, the Swiss franc and the US dollar; see with other ref. footnote 9: Müller/Ong, Aktuelles zum Recht der Kryptowährungen, Aktuelle juristische Praxis, 198.
- Tether is a token — and thus can be accessed directly by smart contracts — whereby 1 token is supposed to correspond to USD 1; see Tether is a cryptocurrency token claimed by its creators to supposedly be backed by one USD for each token issued; Chohan, Tethering Cryptocurrencies to Fiat Currencies Without Transparency: A Case Study, SSRN Journal 2018 (2).
- CBDC: Abbreviation for central bank digital currencies; central banks can issue fiat currency in the form of tokens, which can, in turn, be accessed by smart contracts; see Central bank group to assess potential cases for central bank digital currencies (BIS 2020) (6 April 2020).
- Because two different TT systems are used.
- From a technical perspective, the processes are the same for cryptocurrencies and security tokens; however, there are already central exchanges (crypto-exchanges) and decentralised exchanges (DEX) for cryptocurrencies, which is why cryptocurrencies are better suited as an example.
- The price for ETH/XTZ on 17 April 2020 = 0.01242069; Bittrex Global, The Next Generation Crypto-Currency Exchange (Bittrex Global 2020), https://global.bittrex.com/home/markets (as of 17 April 2020).
- ETH is the symbol on the Ethereum blockchain used for Ether.
- XTZ is the symbol used for the cryptocurrency Tezos; Tezos is its own blockchain like Ethereum, which is the best known blockchain aside from Bitcoin; see Tezos.com (2020), https://tezos.com/ (as of 24 March 2020).
- For this example, it is assumed for the sake of simplicity that, as is standard on crypto-exchanges, both the matching as well as the clearing and settlement and, in particular, custody are offered together.
- Thus, in order to have XTZ it is necessary to adhere to the rules of the Tezos blockchain.
- Smart contracts on the Ethereum blockchain cannot access XTZ directly, and smart contracts on the Tezos blockchain cannot access ETH directly.
- In practice, omnibus wallets are maintained for each listed cryptocurrency.
- Depending on the trading pair, fiat as well.
- See the various hacks of crypto-exchanges; Biggs et al. 2019.
- For cryptocurrencies, this may, in some cases, be possible without approval and simply via registration pursuant to the TVTG; for security tokens, this service is subject to approval, as described above.
- A so-called OTC trade. Similar problems arise when trading cryptocurrencies against fiat money, as here, too, there is a media discontinuity.
- Uczciwek, What Are Atomic Swaps? (Uczciwek 2020), https://blockgeeks.com/guides/atomic-swaps/ (as of 18 April 2020).
- Lin, JBLP 2019, 58 (footnote 13).
- In addition to this example, which describes the process on Atomex, there are other technologies as well, such as PolkaDot and Cosmos, that are intended to enable transactions between two different blockchains.
- Hash value: When a quantity of data is entered, a hash value always provides the same result, but much shorter (hash value); if the quantity of data (entered) changes, a “good” hash function provides a different result. Thus, the hash value can be used to check whether the quantity of data has been changed without always having to compare the entire quantity of data. But the hash function only works in one direction; it is not possible to use the hash to “restore” the data entered.
- The address of B on the Tezos blockchain (recipient address B) for the receipt of XTZ.
- B is therefore sure that the 100 XTZ are in the smart contract and blocked.
- The same hash that A sent to the smart contracts on the Tezos blockchain.
- The address of A on the Ethereum blockchain (recipient address A) for the receipt of ETH.
- The blocking period prevents A from initiating a reimbursement of the 100 XTZ and from releasing B’s 1.24 ETH from the smart contract. The prerequisite is blocking period B<blocking period A.
- Bad, (Pseudonym), Cross-chain atomic swaps on practice (Atomex, Atomic Swaps), https://medium.com/coinmonks/atomex-cross-chain-atomic-swaps-on-practice-8139571f0ee5 (as of 25 September 2019).
- See Uczciwek 2020.
- Atomex, Atomic Swaps.
- Atomex, Atomic Swaps.
- Examples of such DEX include: Ox, ForkDelta, AirSwap.
- For example, the 0x ecosystem is compatible with ERC-20 and ERC-721-based tokens; see 0x, Protocol Specification (v3) (0x 2020), https://0x.org/docs/guides/v3-specification (as of 27 March 2020).
- Lin, JBLP 2019, 58 (60 f).
- See also Patz, BKR 2019, 435 (margin no. 441).
- BuA Nr. 54/2019, 108.
- BuA Nr. 54/2019, 109.
- Buck-Heeb 2019, Rz 34.
- Buck-Heeb 2019, f7 ff.
- See Consid 2 CSDR.
- See the comparison of the current infrastructure to the proposed infrastructure on the basis of DLT; SET 20 December 2019 Digital Asset Programme, 13.
- SET 20 December 2019 — Digital Asset Programme, 13.
- This is also the conclusion of the Digital Asset Programme of the Stock Exchange of Thailand SET; see Sandner, DLT in the Thai Capital Market (Sandner 2020), https://medium.com/@philippsandner/dlt-in-the-thai-capital-market-how-old-roles-change-and-new-roles-emerge-5805da07e36c (as of 30 April 2020).
- BuA Nr. 54/2019, 36 und 46.
- BuA Nr. 54/2019, 38 und 46.
- Art. 2, para. 1k) to t) TVTG.
- SET 20 December 2019 — Digital Asset Programme.
- SET 20.12.2019 — Digital Asset Programme, 9.
- SET 20.12.2019 — Digital Asset Programme, 10.
- SET 20.12.2019 — Digital Asset Programme, 16 f.
- During the Digital Asset Programme of the Stock Exchange of Thailand (SET) the author was able to present the TVTG to interested participants of the Thai financial market; see: Panumarch, When the Stock Exchange of Thailand Set Out to Disrupt Itself with Digital Asset Technology (Panumarch 2020), https://medium.com/flipay/when-the-stock-exchange-of-thailand-decided-to-disrupt-itself-with-the-digital-asset-299563c0f16a (as of 3 March 2020).
- See Sandner 2020.
- This does not involve the regulation of the technical service provider, but rather of the service provider that puts the token “into circulation”. Comparable to the creation of the certificate for securities, but with the difference that this role is not critical.
- In the traditional world, CSD enable the exercise of rights in some cases (such as corporate actions). This might include, for example, the “tokenisation” of physical assets without the involvement of a special purpose vehicle (SPV) in the form of a stock corporation, whose shares would then be issued in token form and the rights would have to be exercised through the company.
- However, it is also easier for issuers to contact their shareholders directly and enable them, for example, to exercise their voting right.
- Based on the role of the CSD, this role could be called the security token depository, or STD.
- With most technological implementations, these are referred to as “private keys”.
- In order to be able to comply with the requirements of the secondary market professional custodian services are needed; however, this role goes far beyond pure custody; in the traditional world, this function is assumed by central securities depositories.
- In the form of e-money or legal currencies, such as CHF, USD and EUR, issued as tokens.
- See the “Cash-on-Ledger Issuer” and “Cash Tokenizer” roles, Sandner 2020.
- 6 April 2020.
- The aim of the CSDR is also to create publicity; see Pekler/Rirsch/Tomanek, ZFR 2020, 172 (174).
- Subhash/Stadler, Die Emission von Wertrechten auf Basis verteilter elektronischer Register — Distributed Ledger Technology, wbl 2020, 181 (184).
- Das TVTG bspw spricht hier vom VT-Schlüssel, VT-Identifikator — Paar.
- See the Act of 6 December 2018 on the Register of Beneficial Owners of Liechtenstein Legal Entities (Gesestz über das Verzeichnis der wirtschaftlichen Eigentümer inländischer Rechtsträger, or VwEG), which implements Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) №648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC (Text with EEA relevance) (AMLD 4), OJ EC 2015/141/73.
- And, depending on the type of token, the token ID in the case of non-fungible tokens (NFTs).
- See Art. 81a, para. 2 and para. 4 SchlT PGR.
- OJ EC 2014/257, 73.
- Registration obligation for custodians of TT keys and TT tokens; in particular, see also the safeguarding requirements in Art. 25 TVTG.
- BaFin crypto custody business.
- TSD TT key: TSD stands for “token securities depository”.
- For example, after implementation of proceedings to declare a token invalid pursuant to Art. 10 TVTG; on the need to reissue or the functional incapacity of tokens, see also report and proposal 54/2019, 188 f.
- Someone who breaks into the intermediary’s central IT system could potentially access all of the TT keys it holds in custody.
- In addition, it must also be determined which role the custodian might play in terms of corporate actions and proxy voting by shareholders and proxies.
- For example, it would be possible to determine how many security tokens are available for trading; this, in turn, would be interesting for short sales.
- The ITIN, for example, might be helpful here; see International Token Standardization Association e.V. 2020.
- A list of approved TT identifiers that are queried by the token smart contracts before the transfer and that enables the transfer only to approved addresses.
- Similar to the conditions under which banks must now provide courts and the administrative authorities with information about their client relationships.
- On liability risk, see also Pekler/Rirsch/Tomanek, ZFR 2020, 172 (176).
0x, Core Concepts, https://0x.org/docs/core-concepts#digital-signature (18.04.2020).
0x, Protocol Specification (v3), https://0x.org/docs/guides/v3-specification (18.04.2020).
24 Hour Volume Rankings (Currency), https://coinmarketcap.com/currencies/volume/24-hour/ (14.04.2020).
æternity, a blockchain for scalable, secure and decentralized æpps, https://aeternity.com/ (16.04.2020).
Ashurst LLP, Ashurst advises Nomisma on Europes first MiFID II license for a blockchain-based MTF, https://www.ashurst.com/en/news-and-insights/news-deals-and-awards/ashurst-advises-nomisma-on-europes-first-mifid-ii-license-for-a-blockchain-based-mtf/ (26.04.2020).
Autorité des marches financiers (AMF), Review and analysis of the application of financial regulations to security tokens, https://www.amf-france.org/sites/default/files/2020-03/legal-analysis-security-tokens-amf-en_1.pdf (27.02.2020).
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