In a context of growing interest in the issuance of financial instruments on a blockchain, the Financial Markets Authority examined legal obstacles to the development of security tokens. Among the advanced avenues, a European digital lab would allow national authorities to lift certain regulatory requirements in return for appropriate safeguards.

Beyond the Initial Coin Offerings (ICO), offers to the public of tokens framed by the Covenant Act, the actors of the blockchain ecosystem and traditional players have shown a strong interest in Security Token Offerings (STO) and more generally the inclusion of financial instruments on the blockchain. The FMA considers that the “tokenization” of financial assets could be a long-term trend in the automation of the post-market chain.

The FMA’s legal analysis focused on both the issuance and exchange of security tokens and their inclusion in investment funds. With regard to the issue, the Prospectus regulation appears to be compatible with the STO’s. In the field of asset management, European and national regulations do not prevent the development of security tokens. Management companies that would like to develop this activity should apply to the FMA for approval or update their business schedule.

On the other hand, the exchange of security tokens faces major legal obstacles, due to the decentralized nature of blockchain technology.

Regulatory changes are expected to allow the tokenisation of the securities processing

The negotiation of security tokens could be applied the current financial regulations without too many difficulties. Platforms could provide certain investment services in security tokens (receiving, transmitting orders on behalf of third parties, executing orders on behalf of third parties) by requesting approval from an investment services provider (ISP) or Financial Investment Advisor (FIA), subject that they get an identified manager, which excludes decentralized platforms.

In order to offer a real secondary market for security tokens and to exploit a trading platform within the frame of the Directive MIF 2, an approval as a multilateral trading system (MTS) or an organised trading system (OTS) would be required, which also excludes decentralized platforms.

On the other hand, the FMA just published a position specifying to what extent certain token security interfaces allowing the display of buyer and seller interests, without confrontation of orders, would not require approval as trading platform within the frame of the MIF 2.

As for the delivery of securities against payment (the settlement-delivery), if it is already possible for unlisted financial securities thanks to the blockchain order of December 8, 2017, it poses significant difficulties for other security tokens. The current regulations (European regulation on central custodians of CSDR securities, Finality directive, account-keeping and retention obligations) do not allow the payment-delivery entirely on the blockchain. Therefore, a platform that reports security tokens should either go through an intermediary licensed as a central custodian or be itself accredited as such.

An adjustment of the CSDR regulation thus appears necessary to allow the settlement-delivery in cryptocurrency.

A European exemption scheme to create a secure environment

Among the advanced options, the FMA proposes that an exemption scheme be created at European level, which could be described as a “digital lab”, which would allow the relevant national authorities to lift, in return for guarantees, certain requirements imposed by European regulations and identified as incompatible with the blockchain environment. This exemption would be granted providing that the entity benefiting from it complies with the key principles of the regulations and that it is subject to increased oversight.

Such a scheme would allow the emergence of security tokens market infrastructure projects that could develop in a secure legal environment. It would be framed by a precise monitoring mechanism at European level (ESMA).

This experimentation in the context of a “digital laboratory” would allow, after a three-year review clause, to envisage the necessary adjustments to European financial regulation, drawing on the expertise acquired by the national authorities and ESMA.