Welcome to the first edition of our Legal Digest, where we dissect the intricacies of asset tokenization regulations.
Throughout this series, we aim to navigate the complexities of transformative legislation, shedding light on its impact on the tokenization of assets and exploring the implications for investors, financial entities, and the broader market. Join us as we uncover the nuances of this evolving regulatory framework and unravel its implications in the ever-evolving world of asset tokenization.
The draft bill for the Financial Market Digitalisation
The draft bill for the Financial Market Digitalisation Act was published by the Federal Ministry of Finance on 23rd October 2023 It aims to implement and enforce the MiCA Regulation (Markets in Crypto Assets), the EU Transfer of Funds Regulation and the Dora Package and is intended to summarise these in the Financial Market Digitalisation Act (“FinmadiG”).
The draft bill contains provisions for the implementation of EU regulations such as the MiCAR (Markets in Crypto-Assets Regulation), the Transfer of Funds Regulation and the DORA package. New laws such as the Crypto Markets Supervision Act (KMAG) are to be introduced and existing laws such as the German Banking Act (KWG) are to be amended.
The Financial Market Digitalization Act (“FinmadiG”) Act is expected to come into force on the 30th December 2024; however, the regulations on e-money tokens and asset-backed tokens will already apply from 1 July 2024.
The draft defines and differentiates between crypto assets and cryptographic instruments by harmonizing the German concept of crypto assets with the European MiCAR concept and redefining financial instruments. It also differentiates between security tokens, crypto securities and crypto fund units and creates new categories such as qualified crypto custody business.
The main aim of the draft bill is to resolve current demarcation difficulties between MICAR and MiFID II by harmonizing the definitions of crypto-assets as defined in the draft KWG and MICAR and removing all crypto-assets as defined in MICAR from the scope of the “cryptographic instrument” as defined in the draft KWG. This would ensure that the strict alternative between MiCAR and MiFID II is maintained.
As a result, the scope of application of MICAR will in the future be open to currency tokens, stablecoins and utility tokens with and without an investment purpose. The KWG, on the other hand, is to cover security tokens as a cryptographic element, for example.
The law also expands the money laundering regulations for crypto asset service providers, who must now assess the money laundering risk for transfers with self-hosted addresses, among other things (Section 15a GWG draft). However, this should not be a novelty for German service providers.
The draft KWG also renames the crypto custody business as “qualified crypto custody business”. The new qualified crypto custody business includes digital assets that previously fell under the crypto custody business but will no longer be covered by MiCAR crypto custody in the future (security tokens and NFTs with an investment purpose that are not a series or collection).
Previously, the custody of currency tokens, stablecoins and utility tokens with an investment purpose also fell under the KWG. In the future, only the MiCAR will regulate the custody of these digital assets. This means that companies wishing to hold all types of digital assets in custody will have to obtain two separate licenses: one under the draft KWG and one under MiCAR.
In the future, crypto-asset service providers that already have a German license will be able to undergo a simplified licensing procedure in accordance with Article 143(6) MiCAR. However, it is unclear when exactly these applications can be submitted or will be processed.
The FinmadiG is an important step towards the harmonization and implementation of European regulations in the area of digital assets but also brings with it some challenges and discussions regarding definitions and implementation.
Indirect investments in special funds: BaFin draws attention to risky transactions
Indirect investments in special AIFs are not normally accessible to retail investors, as these funds are usually reserved for professional and semi-professional investors who invest considerable sums, often starting at 200,000 euros. However, a trend has been emerging for some time that allows small investors to invest indirectly by not investing directly in these funds, but via other financial investment issuers, who in turn hold shares in the special AIFs.
This diversion basically circumvents the applicable laws, in particular Sections 295 and 277 of the KAGB, which regulate such direct investments. However, these constructions, which formally comply with the legal framework, often lead to a lack of transparency, as not all conditions and risks are publicized in the information for retail investors.
One mistake that is often made is the assumption that indirect investments are less risky than direct investments. In reality, however, the risk of loss is higher, as success depends not only on the investment itself but also on the underlying investment project. This makes this type of investment complex and riskier compared to direct investments in specialized AIFs.
Draft bill of the Federal Ministry of Finance Draft Act on the Digitisation of the Financial Market (Financial Market Digitisation Act – FinmadiG): link
Heuking/ Kühn/ Lüer/ Wojtek: Financial Market Digitalisation Act – the German answer to MiCAR, DORA and Co.: link
A good overview of the supervisory regime for digital assets under previous and new law can be found here
Mittelbare Investitionen in Spezialfonds: BaFin hat Anlegerschutzbedenken bei Umgehungskonstruktionen: link.