Following the issue of the Malta Financial Services Authority’s (“MFSA”) consultation document on Security Token Offerings on 19th July 2019 which aimed to pave the way to legal certainty for Security Token Offerings (“STOs”) in the Maltese financial markets, the authority has today issued a feedback statement summarising the responses which the MFSA received and setting out the authority’s response and position thereto.
This article shall summarise the authority’s position on the feedback provided.
The authority is of the opinion that the definition of transferable securities in Article 4(1) (44) of MiFID is loosely defined at EU level and is not harmonised within the laws of the Member States. Therefore, the MFSA highlighted the need to give guidance on the interpretation of what constitutes transferable securities by delving into the three formal requirements that are needed for an instrument to qualify as such, namely;
Limitation of the issuance of STOs to companies
The MFSA’s approach to limit traditional STOs to companies remains unchanged after not having received any viable arguments to the contrary.
Amendments to the Companies Act
The feedback received from the industry has pushed the MFSA to collaborate with the Malta Business Registry to explore whether any provisions of the Companies Act require any amendments in order to clarify whether the registers of members and debenture-holders can be kept in dematerialised form, using DLT, although the authority is of the view that this is already possible and that no amendments are necessary.
Financial Due Diligence Report (FDDR)
The MFSA agrees that the requirement of a FDDR should be the same for the same type of securities, regardless of whether these are tokenised or not.
Corporate Governance Requirements
The additional corporate governance requirements proposed in the Consultation Document, including the requirement of a systems audit have been confirmed with most respondents agreeing to such requirements.
Prospectus Regulation Requirements
The authority confirms that the Prospectus Regulation and the relevant Annexes are sufficient in the case of STOs.
The MFSA had initially proposed that where the company itself operates the underlying DLT, the company is required to annually prepare a ‘Systems Audit Role’. In clarifying its new position, the authority holds that:
1. If the Issuer has an innovative technology arrangement (“ITA”) in place, or if the Issuer operates a technological infrastructure which interacts with an ITA in some way or form (such as a wallet), then a System Auditor must be appointed.
2. Where a company will be operating an ITA which underpins the storage and transactions in securities, a Systems Auditor will need to be appointed to prepare a Systems Audit Report in line with the MDIA’s Guidelines.
Furthermore, the authority initially proposed that in cases where the company also operates an underlying DLT, the company is required to prepare annually a Type 2 Systems Audit. The MFSA has now reconsidered its proposal in relation to the requirement of a Type 2 Systems Audit where the company operates its own native ITA. Instead, a requirement to appoint and have in place a Systems Auditor at all times shall apply where the Issuer has an ITA in place, or if the Issuer operates a technological infrastructure which interacts with an ITA in some way or form.
Companies operating DLT
The Authority does not intend to limit offers to the public made by Issuers operating their own DLT from attaining the necessary authorisation from the Listing Authority to list their securities on a secondary market.
Permission-less Decentralised Exchanges
Although the majority of respondents were of the opinion that permissionless decentralised exchanges could create difficulties in ensuring compliance with the transaction reporting requirements contained in MiFIR, the Authority does not intend to impose an outright prohibition on decentralised exchanges.
Trading of Traditional STOs
The authority holds that full disintermediation would not be an ideal solution and that some level of intermediation is needed. This is in line with the majority of responses which were in agreement with the MFSA’s proposal that traditional STOs should be traded on either a centralised exchange via investment firms or on a decentralised exchange with investment firms granting DEA.
Centralised or Decentralised but Permission-based Trading Platforms
In agreement with the feedback received, the MFSA believes that both centralised as well as decentralised but permission-based trading platforms (hybrid platforms) could provide a workable solution. In view of the fact that the industry remains undecided on the approach related to centralised vs decentralised exchanges, the Authority stands by its position expressed in relation to the MIFID framework and concludes that a case-by-case analysis based on the proposed business model will be needed.
Transparency/ Transaction Reporting
The majority of respondents agreed that by its nature, the prevention of financial market abuse is reliant on transaction reporting. The Authority will examine the best way to exploit the use of blockchain in its market oversight function in order to prevent and detect market abuse.
Applicability of the Central Securities Depositary Regulation (“CSDR”)
A number of respondents believe that the legal requirements set out in the CSDR are too cumbersome and will halt the application of DLT. They believe that a number of challenges related to the CSDR must be addressed or that the current legislation is altered in order to embrace the use of DLT within the settlement process.
Whilst a settlement internaliser may provide a solution in theory, it appears that the CSD cannot be totally removed from the ecosystem of a traded STO. Nevertheless, the authority are currently exploring this issue in order to understand the risks which would develop and how these can be reduced if a settlement internaliser is opted for.
In conclusion, the authority holds that the use of DLT within the context of secondary markets will be hindered by the lack of institutions which are capable of providing settlement for tokenised transferable securities. Therefore, unless the European legislator amends certain provisions of the CSDR, there seems to be agreement that some advantages of DLT cannot be availed of due to the need to comply with the current regulation.
This article was written by Dr Luke Mizzi and Mr Gigi Gatt
For more information on STO Regulation please contact Dr Ian Gauci on firstname.lastname@example.org Dr Terence Cassar on email@example.com and Dr Luke Mizzi on firstname.lastname@example.org