Draft Electronic Securities Act paves the way for DLT based securities in Germany

The German government has recently published a draft Electronic Securities Act. This provides a legal framework for the issuing of electronic securities (bearer bonds) and finally opens German securities law to innovative technologies such as distributed ledger technologies (DLT).The draft law explicitly addresses the possibility of issuing bearer bonds on DLT, introduces a new licence requirement for maintaining the DLT, foresees more technical requirements for the use of blockchains and addresses the most important civil law issues around tokenised securities. This key legal development is seen as a first step towards further modernisation of other forms of securities and opens the door for other future DLT based securities in Germany.

Market impact

Even though the draft law aims to be technology neutral, it is expected that once implemented, DLT and blockchain technology will receive a boost and become more established in capital markets. The new regime would also allow new business models to be introduced (e.g. a crypto securities register) and should enhance the digitalisation and speed-to-market for products in relevant financial markets.

We have created an English translation of the draft law which covers not only the draft provisions but also the legislative reasoning behind them.

Part of the broader German blockchain stage to modernise the finance industry

The draft law is embedded in the blockchain strategy of the German government announced on 18 September 2019, which confirmed that German would be opened to address electronic securities. It builds on the previous introduction of a definition of crypto assets as financial instruments as well as a new licence requirement for crypto custody business.

As other countries already permit the electronic issuance and use of blockchain technology in relation to financial instruments (e.g. Switzerland), this modernisation of the German securities law is vital for Germany to compete in digital assets markets. The German law requirement for a physical document to certificate any bond issuance has been a particular impediment being directly at odds with the digitalisation of the capital markets.

Key aspects of the new electronic securities regime
  1. The draft law only addresses bearer bonds (Inhaberschuldverschreibungen) where there is a significant practical need for modernisation of these instruments to allow for digitalisation. The regulation of electronic shares as well as electronic investment fund units will take place at a later stage.
  2. Two new forms of issuing bearer bonds electronically: (1) by way of an electronic register which is to be maintained by a central securities depositary (CSD), and (2) via a decentralised crypto securities register (Kryptowertpapierregister). The registrar maintaining such a crypto securities register will require a new financial services licence under the German Banking Act (KWG).
  3. Bearer bond issuers will have a choice between using the existing paper form or to switch to one of two electronic forms.
  4. Further changes to the German civil law will also be introduced, ensuring the treatment of electronic securities as a “moveable” (Sache) and allowing for a good faith acquisition which is crucial for safe and secure capital markets.
  5. The draft law requires a description of the security’s underlying technology in the so-called Wertpapierinformationsblatt (a German key information document required for issuances from EUR 100,000 to EUR 1 Million for financial products where no “European” PRIIPs-KID is legally necessary).
  6. The draft law gives the German Federal Ministry of Finance - in cooperation with the Federal Ministry of Justice and Consumer Protection - wide reaching potential to issue decrees to specify technological requirements for the underlying technology.
  7. As the legal nature of a security is not to be changed, the custody of an electronic security might still require a custody licence. Custody of the private key for DLT- based electronic securities will trigger a crypto asset custody licence requirement.
Legal impact

The draft law particularly affects the following areas of law:

  • maintenance of an electronic or crypto securities register;
  • classification of electronic securities as a “moveable” under the German Civil Code;
  • ownership, transfer and entitlement of the registered security;
  • modification of financial services according to the KWG; and
  • adjustment of other securities-related legislation (e.g. German Prospectus Act (WpPG) and Safe Custody Act (DepotG).

The following three examples provide a deeper illustration of the extent to which service providers can provide new services, as well as the extent to which certain requirements are linked to them.

Example 1 - Maintenance of an electronic or crypto security register
  • The most important feature of the draft law is the ability to carry out an issue of a bearer bond directly as an electronic registration (Eintragung) in addition to the previous issuing of a bearer bond and keeping it in custody.
  • In this respect, the only difference between an electronic security and other securities is the form of issue chosen.
  • For both the electronic security depositories and the decentralised crypto security register, the draft law sets out specific information which is to be included, such as: the identity of the issuer and the volume of the issuance, further technical requirements for maintaining the register, data storage, changing the form of securitisation and mapping the legal situation are also introduced. Both types of electronic securities are treated equally: the new options are thought to enable issuers to utilise the advantages of modern technology without introducing significant obstacles or costs.
  • It is important to note that not all DLT based crypto assets will be crypto securities. The relevant categorisation will still be based on applicable law.
  • As there is no CSD responsible for the registry of crypto securities, crypto securities will need to be published in the German Federal Gazette (Bundesanzeiger) as well as notified to BaFin, without such requirements being constitutive. Notably, both entities responsible for the register need to ensure that the registers are state of the art.
Example 2 - Classification of electronic securities as a “moveable” (Sache) under the German Civil Code
  • The draft law determines that an electronic security is deemed to be a “moveable” (Sache) within the meaning of Sec. 90 of the German Civil Code. Such a legal fiction is necessary in order to extend the link with property law applicable to securities to electronically issued securities.
  • The draft law also addresses many uncertainties in connection with digital securities under German civil law. For example, the draft law introduces rules on the acquisition in good faith (gutgläubiger Erwerb), according to which the registration of a legal transaction in the securities register creates the legal title (Rechtsschein). In general, these new rules contain specific provisions regarding the disposal (Verfügung) of electronic securities under property law and requires an update of the register upon disposal.
Example 3 - Modification of financial services under the KWG
  • Maintaining a crypto security register will fall under the KWG and will require a financial service licence. Although the KWG provides for far-reaching exemptions from the scope of application of the KWG, no exemption applies from organisational obligations, money laundering regulations and capital adequacy requirements.
  • The capital adequacy requirement for the provider of a crypto security register is considerable, requiring that an initial capital of EUR 730,000 be available (whereas the initial capital required in respect of crypto custody services is only EUR 125,000).
  • Here, the risk for a crypto security register is deemed to be similar to that of the provision of a limited custody business under the KWG. However, the service will not be required to be maintained by a CSD. In addition, and consequently, the crypto custody service will now also capture the custody of private cryptographic keys for others.
Next steps

The draft law is expected to be adopted by the German parliament after the consultation period and, subject to any possible amendments, by the end of the year 2020 - without any transition periods.

Our German Fintech team, and key contacts listed, are available to discuss any aspect of the proposed new electronic security regimes and the opportunities it presents.