Alexander Vogel Reto Luthiger Lukas Lezzi December 6 2019 New DLT/blockchain regulatory framework ready for parliamentary deliberations MLL Meyerlustenberger Lachenal Froriep Ltd | Banking & Financial Services - Switzerland Alexander Vogel, Reto Luthiger, Lukas Lezzi Banking & Financial Services Executive summaryBrief overviewWhat are DLT and blockchain?Notable amendmentsTimelineExecutive summaryDuring its meeting on 27 November 2019, the Federal Council adopted a dispatch on the further improvement of the framework conditions for distributed ledger technology (DLT) and blockchain. The proposal aims to increase legal certainty, remove barriers for applications based on DLT and reduce the risk of abuse. The Federal Council assumes that Parliament will start its deliberations in Spring 2020.Brief overviewIn December 2018 the Federal Council published a report on the legal framework for blockchain and DLT in the financial sector. It emphasised that it wanted to create the best possible conditions for Switzerland to establish itself and evolve as a leading, innovative and sustainable location for fintech and DLT companies. Moreover, the Federal Council wanted to combat abuse and ensure the integrity and good reputation of Switzerland as a financial centre and business location.Among other things, the report showed that Switzerland's legal framework was already well suited to dealing with new technologies, including DLT. Nevertheless, it also pointed out the need for action in certain areas, which is why the Federal Council submitted a series of amendments to existing legislation for consultation in March 2019. However, it refrained from drafting a completely new act specifically regulating DLT and blockchain technology. Eighty responses were received during the consultation process. All of the participants welcomed the Federal Council's proposal in principle.The Federal Council has now adopted a dispatch to adapt federal law to developments in DLT. The proposal has been revised and refined in a number of areas as a result of suggestions received during the consultation process. This federal legislation, which is designed as framework legislation, proposes specific amendments to nine existing federal acts, covering both civil and financial market law.What are DLT and blockchain?DLT allows shared data management and, in particular, shared accounting among participants that neither know nor trust each other's identity. Essentially, it is a system for shared data management based on distributed ledgers. Blockchain represents a possible way in which data can be stored in such a system. DLT permits the direct electronic transfer of value between a network's participants without the need for a central account management entity. The development of DLT is predicted to generate significant potential for innovation and efficiency gains in the financial sector as well as other sectors of the economy. In recent years, a notable ecosystem has been developed among innovative fintech and blockchain companies in Switzerland, especially in the financial sector.DLT-based applications can have numerous points of contact with civil, criminal and financial market law, specifically banking and financial market infrastructure law, collective investment scheme law, insurance law and anti-money laundering regulations, as well as the impending Swiss Financial Services Act (FinSA) and Swiss Financial Institutions Act (FinIA). The objectives of financial market law – such as the protection of the functioning of financial markets and customers – are as relevant to the activities of DLT companies in the financial sector as they are to all other financial players.The Federal Council currently sees no fundamental problem with financial market law that specifically affects DLT-based applications which requires large-scale adjustments. Financial market law in Switzerland is fundamentally technology neutral and principle based and therefore able to deal with new technologies.Notable amendmentsMost notably, the proposed amendments will introduce so-called 'register-uncertificated security' to the Code of Obligations, which can be transferred solely according to the rules of the respective register. The wording of these articles has been amended in order to be technology neutral.In individual areas, further targeted adjustments are planned. In particular, the draft law will create a new category of financial market infrastructure in the DLT area (the DLT trading facility) with the aim of creating more flexibility to better meet the requirements of DLT applications. This new financial market infrastructure will be a multilateral trading facility on which so-called 'DLT securities' can be traded and settled. Further, a DLT trading facility can not only provide trade execution services (matching), but also clearing, settlement and custody of DLT securities. Most likely, a DLT trading facility will refer to the asset token as qualified by the Swiss Financial Market Supervisory Authority (FINMA) in its initial coin offering guidelines of 16 February 2018. However, the most fundamental change is the possibility for retail clients to trade directly on such a trading facility. Under current law, only institutional clients may participate in a multilateral trading facility or stock exchange.In addition, an adaptation of the new FinIA will provide complementary flexibility for securities firms doing proprietary trading (ie, securities dealers). Namely, it will be possible for this kind of licensee to operate an organised trading system. However, this also means that an organised trading system can be operated by a securities firm, only when it conducts proprietary trading activities. Further, organised trading systems can continue to be operated by banks, multilateral trading facilities or stock exchanges.The proposed amendment of the Debt Collection and Bankruptcy Act clarifies that on a technical level, unsegregated crypto-based assets are bankruptcy remote with regard to their custodian as long as they can be individually allocated to their owners. In contrast to the initial draft amendments, individual allocation no longer needs to be directly traceable in a distributed ledger itself. Therefore, crypto-based assets can be removed from a bankruptcy estate if they are held within a collective deposit and the individual claim to the assets can be allocated at any time. However, holding collective deposits will require a fintech licence.The proposed amendment to the Banking Act overshoots the mark somewhat by stating that a bank licence is not only required when public deposits of a minimum of Sfr100 million are collected, but that accepting crypto-based assets (designated by the Federal Council) in any amount and holding them in a collective deposit requires a fintech licence. If this proposal makes it into the final version of the Banking Act, it will mean a further intensifying of Switzerland's regulatory requirements.Moreover, the draft provides that FINMA should be authorised to set a maximum amount of crypto-based assets that banks can hold in collective custody accounts in individual cases if it is advisable due to the risks associated with the transaction.The Federal Council also proposes changes to the anti-money laundering ordinance. One of the most notable amendments is the proposed qualification of the transfer of assets through smart contracts on a decentralised trading system as an activity that falls within the scope of anti-money laundering laws by qualifying it as supporting transaction services.In summary, the draft for the proposed amendments to crypto-assets is (with a few exceptions) generally well thought through and will bring much-needed legal certainty in the field – namely, with regard to trading platforms. However, it remains to be seen what changes Parliament will make.TimelineThe proposed amendments to the various laws required to prepare Swiss law for new DLT-related technologies are expected to be discussed in Parliament in Spring 2020. They are not expected to enter into force before 1 January 2021.For further information on this topic please contact Alexander Vogel, Reto Luthiger or Lukas Lezzi Meyerlustenberger Lachenal by telephone (+41 44 396 91 91) or email ([email protected], [email protected] or [email protected]). The Meyerlustenberger Lachenal website can be accessed at www.mll-legal.com.