The Maltese regulator is currently working on three draft bills that shall set out a regulatory framework for the certification of Distributed Ledger Technology Platforms, ICOs, Virtual Currencies, Virtual Currency Exchanges and related service providers. With the promulgation of these draft bills, Malta would offer legal certainty in an area that is currently unregulated and establish itself as one of the top jurisdictions for businesses seeking to utilise distributed ledger technology.
DLT – Revolution in the Financial Services Industry
Distributed ledger technology (“DLT”) takes the concept of a database to the next step. Simplistically, it refers to a database which is not owned by a single entity, but which is spread across different regions and is held by different participants who all have the same copy of the database and no change can be affected to verified records, which makes it a highly transparent and auditable database of records.
The applications of DLT are far-reaching and are reshaping several industries, however the Financial Services industry has proven to be particularly amenable to the utilisation of DLT, particularly in the field of asset management using innovative instruments such as smart bonds and smart contracts. Now, parties to the transaction (including the broker, custodian and the clearer) will no longer have to keep their own records, thus reducing the inefficiency, reducing the chance of human error since records are encrypted, and simplifing the entire process by removing the need for intermediaries.
Three main types of DLT can been identified on the onset, namely:
- A private consumption distributed ledger which can be used by financial institutions, companies seeking to store data regarding employees and can also be used for payroll purposes.
- A private platform for businesses who provide services to clients
- A totally public distributed ledger which may be accessed by anyone.
The MDIA Bill: A proposed framework for the Malta Digital Innovation Authority ("MDIA")
The consultation paper set out to create a framework for the MDIA, a national competent authority which will be in charge of the certification of technology arrangements, as well as the registration of Technology Service Providers (“TSPs”). The MDIA will be established in virtue of the Malta Digital Innovation Bill which is currently being drafted along with two other draft bills (the TAS bill and the Virtual Currencies Bill).
Throughout its operation, the MDIA will seek to implement governmental policies that promote Malta’s development as a hub for such innovative technologies while at the same time ensuring consumer protection and the public interest. The MDIA will thus serve to foster the balance needed between promoting innovation and safeguarding sound principles of transparency and auditability while at the same time maintaining the sterling reputation which Malta has earned as an established European financial services hub. In support of this aim, the MDIA will also provide education on the ethical standards and the legitimate exploitation of DLT.
The TAS Bill: A proposed framework for Technology Arrangements and Technology Service Providers
The TAS bill will set out the framework applicable to:
- Technology arrangements – defined in the consultation document as DLT Platforms and related smart contracts.
- Auditors of Technology Arrangements related to Smart Contracts; and
- Administrators of Technology Arrangements;
and will also specify various Private Law issues relating to Technology Arrangements.
The TAS bill will therefore limit the definition of Technology Arrangements to DLT platforms and smart contracts only, however, there are plans to extend this definition in the future to include other platforms and arrangements such as Artificial Intelligence.
The Bill proposes a system whereby a person will be able to request MDIA to certify a technology arrangement on a voluntary basis. To consider this request, the MDIA will require, among other requirements, that the Technology Arrangement has an administrator that is registered with the MDIA. It is envisaged that a principles-based review will be undertaken with respect to the proposed Technology Arrangements, and it will assess compliance with applicable laws, as well as their integrity and security. The Technology Arrangement seeking certification will need to possess certain qualities which will be clarified once the certification process has been formulated by the MDIA once this is constituted.
A degree of legal certainty to smart contracts
A smart contract can be defined as a self-executing contract which does not need additional third-party intervention. The use of DLT makes it possible to integrate such contracts when contracting. While the proposed legislative framework does not contemplate the creation of a contract in a ‘smart’ form, it does not wholly exclude the possibility of the existence of a smart contract and therefore is provides a degree of legal certainty to smart contracts. It is envisioned that a provision similar to Article 9 of the Electronic Commerce Act (Chapter 426 of the laws of Malta) which provides that a contract shall not be invalid simply because it is in ‘electronic’ form, will be introduced to ensure that a contract is not invalidated simply because of its ‘smart’ format.
Defining Technology Service Providers
The key service providers to a Technology Arrangement shall be:
- Auditors of Technology Arrangements, in charge of reviewing and assessing the Technology Arrangements against a number of pre-determined criteria.
- Administrators of Technology Arrangements, who assumes responsibility to manage or otherwise control the operation of the whole or part of any Technology Arrangement.
Any Technology Service Provider who provides a service in relation to any DLT Platform which is certified by the MDIA in or from Malta, or through Maltese legal persons, or in such other cases as the Minister responsible for the Digital Economy may prescribe may seek registration with the MDIA.
To become eligible for registration as a Technology service provider, the Consultation Document proposes that a person will need to be a:
- body corporate, unincorporated body or association formed in accordance with or existing under the laws of Malta
- body corporate, unincorporated body or association formed in accordance with or existing under the laws of another EEA Member State to the extent that it provides services in Malta.
The Virtual Currencies Bill: A proposed Framework applicable to Initial Coin Offerings (“ICOs”) and the provision of certain services in relation to Virtual Currencies (“VCs”)
In November 2017, the Malta Financial Services Authority (“MFSA”) had issued a consultation document in relation to ICOs and the provision of certain services in relation to VCs which drew positive feedback from the industry. Under the proposed framework, a ‘Financial Instruments Test’ would be applicable to issuers and/or persons offering ICOs, conducted in or from Malta, and will be divided into two stages. During the
1. first stage, the test would determine whether a VC qualifies as a financial instrument in terms of existing legislation.
2. second stage, the test would determine whether a VC qualifies as an asset under the proposed VC Bill.
Should the person satisfy the first stage, they would not need to proceed to the second stage. The results of the test would need to be verified by an external independent reviewer.
The Proposed VC Bill seeks to create a framework in the field of ICOs as well as a regulatory framework application to service providers offering certain services in relation to VCs falling outside the scope of the current legislative and regulatory regime, when such activity is carried out in or from Malta.
The proposed VC Bill provides for the following:
ICOs which relate to those VCs which do not qualify as financial instruments under the European and national investment services legislation.
The minimum transparency requirements applicable to such offerings as well as the obligations of the relevant parties involved shall be set out in the VC Bill. More specifically, the proposed VC Bill is set to integrate the high-level principles of the legislation applicable to initial public offerings, that must be adhered to by an issuer of VCs. In particular, it shall cover the information that needs to be communicated to the investors in the whitepaper and the additional transparency requirements applicable where the issuer intends to have a VC admitted to trading on an exchange.
Persons providing the services mentioned in the Discussion Paper in relation to the aforementioned ICOs and VCs.
The VC Bill shall set out inter alia the licensing requirements, procedure and ongoing obligations applicable to such persons, which shall reflect the high-level principles enshrined in the existing EU financial services legislation in relation to the provision of investment services, financial markets and market abuse.
The functions and powers of the MFSA as the regulator responsible for this field of financial services.
The VC Bill will empower the MFSA with the necessary regulatory and investigatory powers largely reflecting those under other national financial services laws, including the powers to issue directives, to adopt and publish rules, to require information, to introduce the ‘Financial Instruments Test’, to suspend either an ICO or the trading of a VC on an exchange, and to require the determination of a ‘Financial Instruments Test’ to be audited by an external independent professional reviewer. Furthermore, the proposed VC Bill sets the parameters for the European and international cooperation between the MFSA and other overseas regulatory authorities in line with Malta’s European and International commitments.
Additionally, one should note that the government is currently discussing with the MFSA to establish a decision-making mechanism within the aforementioned authority which will focus on Digital Financial Services which would fully coordinate with the MDIA once this is established.
The exact categories of VCs and services which fall under the proposed VC Bill will be determined in the near future following an evaluation following an evaluation of the industry’s feedback. The MFSA has noted its preference towards excluding utility tokens, in their purest form, as well as certain services from the proposed framework’s sphere. Definitions and the classifications of VCs as set in the discussion paper shall be revisited to avoid any misconceptions as highlighted by the industry specialists in their feedback. The Government has also expressed the importance of providing a peaceful transition for existing operators in the field which would be regulated by the proposed VC bill. A transitory period of six months is proposed to enable such persons to become fully compliant with all the requirements set out in the proposed bill.
Author: Dr Priscilla Mifsud Parker is a private client lawyer heading our Corporate, Trusts & Fintech areas of the firm. Having participated in Malta’s Fintech Legislative Framework she is able to provide guidance to clients seeking to venture into the Fintech Industry. Moreover, she also provides assistance to individuals with regards to corporate and trusts matters.
Dr Priscilla Mifsud Parker can be contacted at [email protected] and on +356 2205 6603.