A new direction for German Token Regulation?

Germany cannot be considered the most welcoming jurisdiction in terms of token regulation. A recent report might spell a change of direction though. Here is why.

Monday afternoon I received a gentle notification that the new BaFin Journal was out. For those of you who are now asking themselves what we are talking about, let me explain: BaFin is short for Bundesanstalt für Finanzdienstleistungsaufsicht and it is the German financial regulator as you may already have known. The BaFin Journal on the other hand is the regulator’s monthly specialist magazine and main news bulletin. It consists of interviews, reports and in-depth articles by experts on key national and international supervisory issues as well as official. You can find it each month (in German on the BaFin website but only a few articles are translated into English. BaFin generally does a pretty decent job publishing all relevant news in English, too (though with a bit of delay), but unfortunately some of these reports are only available to those that have mastered the German language.

What then happened in the BaFin Journal this month that makes such an explanation necessary (unless you have discovered your taste for German regulatory news for another reason)? Well, one of the three key subjects is Tokenisatoin and its regulatory application, a matter we have regularly reported about on PlanetCompliance and in particular the German approach to it. The question whether tokens are securities or not has been the on our focus for years and in respect of our German friends as recently as onlya few weeks ago. The bottom line is that Germany has not exactly been the most embracing of jurisdictions when it comes to Blockchain and Cryptocurrencies. Not only did it seem not to be very fond of the idea, but slightly behind the curve in particular with regard to repeated warnings about the risks of ICOs. Having said that the question of whether tokens are securities or not was somewhat answered early on (sort of) by the BaFin stating that in accordance with German Banking Act cryptocurrency tokens constitute financial instruments (units of account). At the same time, the regulator did not grow tired of reminding stakeholders of other potential regulatory application and obligations that stem from token related activities. For instance, in a recent statement the BaFin emphasized that “undertakings and persons that arrange the acquisition of tokens, sell or purchase tokens on a commercial basis, or operate secondary market platforms on which tokens are traded are generally required to obtain authorisation from BaFin in advance”. BaFin also stated that “based on the specific formulation of the contract for each ICO, BaFin decides on a case-by-case basis whether the offeror is required to obtain authorization pursuant to the German Banking Act (Kreditwesengesetz – KWG), Investment Code (Kapitalanlagegesetzbuch – KAGB), Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG) or Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) and whether they must fulfil prospectus requirements”.

The latest report in the BaFin Journal instead picks up the question whether the growing trend of tokenisation should be interpreted as a tendency towards tokens as investments or securities and the blurring of the lines in the case of Blockchain technology. Security Token Offerings in that sense appear to be straight forward and BaFin confirms that even if a financial instrument should be considered an investment in the sense of article 1 of the German Law on Investment Products (Vermögensanlagengesetz), its tokenisation, i.e. the transformation into a transferable and tradable token, would mean it is a security in the sense of the German Securities Trading Act.

A new sun rises

This is in line with recent ESMA interpretations on the subject, but the BaFin considers it necessary to highlight the essentials. For a token that represents an investment as outlined above to be considered a security it needs to tick three boxes:

1) It needs to be transferable, which usually in the case of tokens isn’t an issue but one of its key advantages;

2) The token must be tradable, i.e. its fungibility must result in the equal rights of each token (BaFin has also clarified in this context that crypto trading platforms should be considered financial markets in the sense of current EU regulations); and

3) the existence of rights that are comparable to those of traditional securities such as voting rights or a claim to an underlying asset.

The regulator also stresses that the issuer needs to comply with any other legal and regulatory obligations that result from this categorisation, in particular obligations with regard to treasury, clearing and settlement.

It’s a paradigm shift for security law, but also for the regulator itself, too. While BaFin already approved the first prospectus of an STO in Germany in January (with more in the pipeline and currently under review by BaFin), it could also mark a change in the perception of an important development on the hands of the German watchdog. Even though these clarification might not constitute a revelation, it is the frequency and visibility that the subject receives in the regulatory practice that is fairly astonishing.