The MFSA as the competent authority dealing with Virtual Financial Assets recently published a consultation document (the “Consultation Document”) as part of its capital markets strategy in order to provide further legal certainty and enhance investor protection. The proposed issues strive to complement the resilient FinTech Framework devised by legislators in relation to ICOs and VFAs.
The salient features that the MFSA is proposing:
Where the outcome of the Financial Instrument Test (‘FIT’) determines that a DLT Assets upholds characteristics of a financial instrument under MiFID II, it is expected to adhere to existing regulations. Thus, the authority is suggesting that a comprehensive definition of STOs is drawn up. This will provide differentiation between traditional security offerings (TSTOs) as opposed to other STOs (OSTOs) which refer to all those ‘tokens the storage and/or transaction execution of which is intrinsically dependent on, or utilises Distributed Ledger Technology (‘DLT’).
It is also suggesting that further clarification is given in relation to the application process including the approval of prospectus and/ or admission to trading. The MFSA acknowledges the importance of giving due consideration to the legal nature of the issuing entity. In this respect, the MFSA is open to introducing alternative business set-ups including but not limited to the possibility of trusts, foundations and securitisation cell companies. This possibility is however still in its embryonic stage and thus further assessments are envisaged in order to determine the impact of such structures vis-à-vis regulatory requirements. Consequently, the MFSA is considering the possibility of amending Art 123 of the Companies Act (Chapter 386, of the Laws of Malta), to enable companies which are duty bound to keep a register of members and adhere to the requirements of keeping securities in a dematerialised form, from utilising DLT. Other possible amendments to the above quoted law are also being proposed. The outcome of any such changes will continue to build on Malta’s reputation as a ‘Blockchain island’.
Furthermore, upon receipt of application, the MFSA will carry out a ‘Three Pillar Assessment’. The MFSA is proposing that issuers of STOs draw up a Financial Due Diligence report (‘FDDR’) in order to determine the Applicants Financial Soundness, as well as adhere to rules of Corporate Governance and Compliance with Transparency Requirement. These steps will ensure that any pertinent risks attributed to these innovations are acknowledged and backed up with appropriate safeguards which will ensure optimal investor protection
The Authority devises an extensive explanation of centralised (‘CEX’) and decentralised (‘DEX’) exchanges which act as a platform on which STO can be bought and traded upon. On a CEX, all transactions are supervised by a central authority and is similar to conventional trading venues. Conversely, a DEX is made up of various ‘nodes’ connected to each other holding a universal copy of the ledger which is updated every time a transaction occurs. Transactions in a decentralised exchange occurs peer-to-peer (P2P) as opposed to the intermediation that occurs on a CEX. The MFSA also distinguishes between permissioned and permission-less DEXs. The challenge lies in the fact that MiFID II requires that all investment firms executing transactions of financial instruments and operators of a trading venue ‘shall report complete and accurate details of transactions in financial instruments to the competent authority as quickly as possible, and not later than the close of the following working day’. In view of the build of permission-less DEX, which execute transactions on chain without any intervention certain hurdles are met in ensuring proper adherence to MiFID/ MiFIR.
The MFSA factors in on the Regulation 596/2014 on Market Abuse (‘MAR’), which is a fundamental piece of legislation that ensures an efficient and transparent market. MAR is applicable to TSTOs which are duty bound to have in place effective arrangements to combat the occurrence of any of the prohibited acts (insider dealing, unlawful disclosure of inside information, market manipulation), as well as report to the competent authority of all transactions carried out. In view of these obligations, there are still minor obstacles which must be overcome in relation to platforms operating in a decentralised manner.
The final issue discussed in the consultation document relates to Post-trade settlement. This comes by way of recognition that ‘issues or has issued transferable securities which are admitted to trading or traded on trading venues, shall arrange for such securities to be represented in book-entry form as immobilisation or subsequent to a direct issuance in dematerialised form’.