On the 7th of December 2018, the Federal Council of Switzerland released a report on the legal framework for blockchain and distributed ledger technology (DLT) in the financial sector. While the report shows that Switzerland's legal framework is well suited for dealing with blockchain, it also determines a need for selective adjustments.
MME has analysed the report in order to provide a summary for those who do not wish to dedicate their Christmas break to work through the 170 page strong document.
Clear Political Statement
Most importantly, the report is a clear political message with a very positive signal sent to the blockchain community and other governments globally.
The Federal Council acknowledges the high potential of distributed ledger and blockchain technology for innovation and enhanced efficiency both in the financial sector and in other sectors of the economy. Moreover, the government confirms its determination to create the best possible framework conditions in order to allow Switzerland to position itself as and a leading, innovative and sustainable location for fintech and blockchain companies. In order to achieve this goal, it wants to effectively combat abuses in the marketand ensure the integrity and good reputation of Switzerland as a financial centre and business location.
The report provides an overview of the existing legal framework and proposes selective adjustments in order to enhance legal certainty in the marketspace. It takes clear positions on various legal issues; including some that are highly controversial among Swiss scholars. Sincethe Federal Council is the executive body of the Swiss government, its legal analysis has no binding effect and is an opinion only. Accordingly, the final decision on these issues will need to be clarified bySwiss court. Until then, we expect the debate among scholars to continue.
Clear Token Classification Framework
The report draws a very clear line between different token categories, based on the functional approach proposed by MME’s Token Classification Framework (BCP).
It acknowledges that Native Tokens (BCP 1) which have a mere technical functionality in a decentralized, open-source and cybernetic network and are not synchronized with any relative or absolute rights (such as protocol tokens, e.g.BTC, ETH, or XTZ, but also - in our view - tokens of decentralized applications such as MLN or GNT), are neither securities nor subject to any civil law requirements for their transfer. The report proposes that they get qualified as “factual intangible assets” sui generis and are freely transferable with no restrictions. This is the first time in history that a government acknowledges that Native Tokens form a new kind of property based on cybernetically formed networks, which will also have (positive) consequences from regulatory, tax and VAT perspectives.
On the other hand, tokens which are synchronized with relative rights against a counterparty (BCP 2) or with absolute rights (BCP 3) need to follow the respective formal requirements for their creation and transfer imposed by civil law, including securities law, where applicable.
For security tokens, the Federal Council is proposing an amendment to securities law to increase legal certainty in this area. The planned legislative amendment should enable the legally secure transfer of uncertificated securities by means of entries in decentralised registers and be designed as technology-neutral as possible. Unfortunately, digital vouchers and e-money based on blockchain technology, but with a (centralized) counterparty, are not discussed in the report.
Clear Legislatory Path: No need for Blockchain Legislation
According to its interpretation of Swiss law, the Federal Council is of the opinion, that there is no need for fundamental adjustments to the Swiss legal framework or the release of new “blockchain” legislation. Thus, following the Federal Council’s interpretation of Swiss law, together with the amendments submitted, Swiss law provides a sound and reliable legal framework for all kind of blockchain projects. Accordingly, Switzerland will not follow the path which other jurisdictions , e.g.Liechtenstein, Malta or Gibraltar have taken.
Summary of the Report by Legal Topics
Below is our summary of the opinions provided by the Federal Council as well as the topics the Federal Council has instructed the Federal Department of Finance (FDF) and the Federal Department of Justice and Police (FDJP) to draw up a consultation draft in the first quarter of 2019.
The Federal Council analyses the need for legislative actions based on an extensive description of the implications of DLT-transactions on civil law. For this purpose, it distinguishes between tokens, which primarily represent a value within the blockchain context (BCP 1, e.g. protocol tokens like BTC, ETH, or XTZ, but - in our opinion - also tokens of decentralized applications, e.g.MLN or GNT) and tokens, which intent to map and represent a right existing outside the blockchain (BCP 2 & 3). Whereas the first category of tokens itself may have a value, the tokens of the second category represent an indirect value because they are (a) linked toa value outside the blockchain, (b) represent such a value, or (c) provide access to such a value.
Transfer of Native Token (BCP 1): The Federal Council classifies tokens in the form of Native Tokens (e.g. protocol tokens such as BTC, ETH, or XTZ, but - in our opinion - also tokens of decentralized applications. e.g.MLN or GNT) as intangible assets. Since they therefore cannot be classified as absolute or as relative rights (and are therefore no securities), the transfer rules provided for those categories do not apply. Accordingly, Swiss law neither imposes requirements nor any restrictions on Native Token transactions. Therefore,, the transfer of “cryptocurrencies” and “decentralized utilities” are legally valid and the Federal Council recognizes no need for any legislative adjustments.
Transfer of Non-Native Token (which represent a relative or absolute right, i.e. BCP 2 & 3), e.g. Asset / Security Token: Here te Federal Council does not delve in to the controversial legal discussion of whether tokens may be subject toproperty rights under Swiss law. The report rather highlights the similarities between the functionality of asset tokens and traditional securities. In addition, the report also acknowledges the risk that there is no established legal basis for asset tokens to be qualified as "electronic securities" under Swiss law, and that there remains a substantial legal uncertainty relating to tokenized securities. However, the Federal Council does acknowledge that under Swiss law tokens can be linked to the legal concept of uncertificated rights. But in order to guarantee the full legal functionality of negotiable securities (proof of entitlement, transfer, protection of transactions), the legal setup must be solid.
In this regard, different approaches are discussed in the report. One of these approaches is to structure uncertificated securities as intermediated securities. Intermediated securities may be transferred by instruction of the account holder to the custodian and subsequent crediting to the securities account of the acquirer. There areno form requirements for such instructions. However, it is stipulated that the entry must be performed by a custodian referred to in Article 4 FISA. This requirement of a central custodian according to the report, is not easily reconciled with the blockchain as a decentralised register. However, if the requirements of the Federal Intermediated Securities Act are not met, classification of tokens as intermediated securities is not possible. This means that transfer under the Federal Intermediated Securities Act without formal requirements is also not possible.
Even though asset tokens can be legally framed under the existing Swiss regulations, in order to facilitate the transfer of the associated rights together with the transfer of the token on the blockchain, and in order to increase legal certainty, the Federal Council suggest an adjustment of the Swiss securities regulations. It calls for an amendment to Art. 4 FSA, with the aim that postings in decentralised registers would also be able to effect the transfer of uncertificated securities. As a consequence, uncertified securities would be upgraded to a new, fully-fledged category of securities law. However, this approach is of limited value for other issues where a right cannot be framed into a security, such as most rights in rem (ownership of chattel) and most forms of membership under company law. The Federal Council does not see a need for action under civil law in these constellations, even though it acknowledges that not all related legal questions are clarified in Swiss legal doctrine.
It would be a big move forward if Art. 4 FSA would be amended to establish an acknowledged decentralised register on the blockchain. However, there are further questions whether the legal framework for DLT-based transactions could be similarly facilitated, such as the electronic signature on the blockchain, the formal requirements for assignments, or the ownership and the possession of tokens.
Smart Contracts: Regarding the legal framework for Smart Contracts, the Federal Council states that a party cannot enter into a legal relationship with the computer system as a counterparty, since such a system lacks any legal personality within the meaning of the Civil Code. The concept of smart contracts raises issues with respect to the automated and immutable nature of contract execution technology. Even though not all legal questions are yet clarified, the Federal Council sees no need for further legislation, since the this technology is still at an t embryonic stage and further experience is required
According to the Federal Council, further clarification is required with regard to the segregation of crypto-based assets in the event of a bankruptcy, and further examination is required with respect to the segregation of data with no asset value. However, the Federal Council also considers it to be important to restrict the legislative design of such a segregation right to assets that can unambiguously be assigned to the trustor (e.g. to the client of a wallet provider). This corresponds withthe rule for ownership under current property law. In contrast, segregation claims should not be extended to cases where it is not possible to unambiguously assign the assets to the trustor.
The Federal Council also proposes a provision setting out a right to the surrender of non-physical data in the event of insolvency, which would cover crypto assets and other data to which the beneficiary is able to demonstrate a special entitlement. Thereby, according to the report, not only the treatment of crypto assets in insolvency proceedings could be solved, but the approach would also avoid the introduction of a new category of ownership position for data.
Financial Market Infrastructure Regulations
The terms “securities” and “derivatives” are of utmost importance to financial market infrastructure regulation, as they trigger itsapplication: Financial market infrastructures havebeen uniformly regulated by FMIA, which governs the operation of financial market infrastructures and any obligations related to the trading of securities and derivatives. The report explains that tokens are not considered to be certificated securities, but may be classified as uncertificated securities, derivatives or intermediated securities. The report acknowledges that the categorization of the tokens is difficult and ambiguous, but rejects the creation of a new legal definition tailored towards securities in the form of Tokens.
- Trading: As of today, trading platforms such as stock exchanges and MTFs need an authorisation from FINMA. No authorisation is required to operate an OTF (trading system). However, the operator of an OTF itself requires a license (as a bank, securities dealer or trading venue). As a consequence, an exchange or an MTF operating an organised trading platform for tokens qualified as securities requires FMIA approval. . Stock exchanges and MTFs are typically designed in a way that they allow multilateral trading based on non-discretionary rules. Discretionary multilateral and bilateral trading in tokens classified as securities can be conducted through the operation of an OTF without specific authorisation.
- Clearing and Settlement: Central Counterparties and central securities depositories require an authorisation as a financial market infrastructure. A central counterparty assumes the counterparty default risks which are inherent in securities and derivatives trading. The report acknowledges that this function does not exist in a blockchain environment, since instant settlements occur continually on a large scale.. Related to settlement, it seemsunclear to what extent the settlement activity of blockchain-based platforms is in line with the applicable provisions in FMIA. The report acknowledges that any requirements for authorisation as a CSD (e.g. for a token-based securities settlement system) would present a high barrier to market entry and therefore suggests the introduction of a minimum volume for the authorisation requirement for CSDs with respect to blockchain and DLT Systems.
- New authorisation category for blockchain / DLT financial market infrastructure: In addition to the above, the report suggests the introduction of a new authorisation category by amending FMIA (and its ordinance) which would entail a combination of trading and post trading functions (e.g. securities settlement). A novelty with this concept of FMIA is that both, retail and regulated participants will be admitted to participate in the new financial market infrastructure. Trading should be facilitated multilaterally based on non-discretionary rules and should encompass both, security tokens and non-security tokens. According to the report, regulations should take place based on a holistic approach: As in the area of blockchain / DLT trading and settlement of transactions can take place simultaneously, the new financial market infrastructure category should comprise one single authorisation holder, encompassing not only trading but also post-trading activities of Tokens.
- Operation of an OTF: In addition to the above, the report suggests to introduce an authorisation for the (sole) purpose of operating an OTF. Further, it recommends analyzing whether the operation of an OTF should be permitted for the persons specified in Article 1b BankA (fintech authorisation which enters into force on 1 January 2019).
Financial Institutions Act (FinIA)
FinIA sets out the requirements applicable to portfolio managers, managers of collective investments, fund management companies and securities firms. The report analyses whether FinIA is sufficient respectively appropriate for blockchain- and DLT-based business models. The report concludes that there is no need for regulatory action.
Financial Services Act (FinSA)
FinSA aims to guarantee client protection in the financial services sector. Similar as withe FinIA, the report concludes that the current legal basis is sufficient for blockchain- and DLT-based business models and hence, there is no need for regulatory action. However, the report explicitly mentions that due to the novel and complex nature of the various financial instruments in the blockchain area,the prospectus requirements are justified in order to provide clients with appropriate protection. It finds no reasons to change the prospectus requirements for blockchain.
Collective Investment Schemes Act (CISA)
According to the report, the use of blockchain technology in the area of CISA is currently at a very early stage. Therefore, it is not yet possible to draw any conclusions on potential impacts. The report deems it essential to follow further developments and to propose regulatory measures as needed. The report mentions in particular the legal classification of DAOs (Decentralized Autonomous Organization) and questions whether the requirement of “third-party management” is fulfilled. The report concluded that any amendment of CISA - in particular with regards to DAO -must be in line with financial market regulation in its entirety.
Deposits: Many fintech business models are based on the acceptance of third-party assets. According to Swiss regulations, the only parties authorised for the professional acceptance of public deposits are banks and, starting January 2019, the persons indicated in the context of the new fintech authorisation (see below).
Accordingly, blockchain- and DLT-based business models may in many cases be within the scope of banking regulations, e.g. the provision of account-like services that enable clients to hold Crypot-Assets, provided that the service provider is obliged to make repayment. Such services are supplied, for example, by providers that offer safekeeping of tokens or more extensive services based on token safekeeping.
The Federal Council acknowledges that the broad scope of the term "deposit" may lead to unsatisfactory results and that clarification of the term is required for use in practice. . In particular, as the authorisation requirement for the acceptance of public deposits is intended to protect clients from the risk of the counterparty becoming insolvent, there is no justification for the application of banking regulations if (e.g. tokens) are not included in the bankruptcy assets of the custodian or they can be segregated from the bankruptcy assets. The Federal Council therefore suggests to amend the insolvency regulations in order to further increase legal certainty with regard to third-party custody of tokens in insolvency law (see below), which is relevant in the context of the term "deposit" under banking law.
Beyond that, the Federal Council confirms in the report that there are various exception which may allow a blockchain- and DLT-based business to be setup without triggering the application of Swiss banking regulations:
- Consideration for the acquisition of property or the use of services: The acceptance of tokens as a contractual consideration, such as the consideration in a contract of sale or exchange or payment for a service is not subject to banking regulations.
- Bonds (and comparable debt securities): If the creditors are informed through a properly issued prospectus.
- Settlement accounts: Client assets booked in settlement accounts for the settlement of client business are not considered deposits if no interest is paid and the settlement takes place within 60 days. However, according as currency dealers today cannot benefit from the settlement account exemption, cryptocurrency dealers in accordance with FINMA practice, to the extent that their activity is comparable to that of a currency dealer, will need to seek for an exemption approved by FINMA.
- Money entered into a means of payment or payment system: Monies and functionally comparable tokens that are entered into a means of payment or payment system (e.g. payment cards) in small amounts (max. CHF 3’000 per user), are intended solely for the future acquisition of goods or services and do not earn interest.
- Money with a default guarantee from a bank: Fintech service providers can offer custody services for tokens that are functionally comparable to money without bank authorisation, provided that a Swiss bank provides a guarantee in case of default.
- Innovation area in banking law (sandbox): To use this innovation area, the accepted public deposits must not amount to more than CHF 1 million in total, and there must be no interest operations. Furthermore, depositors must be notified before they make a deposit that the company in question is not subject to FINMA supervision and that the deposit is not covered by deposit insurance.
- New authorisation category in banking law (fintech authorisation) starting 1 January 2019: The Fintech authorisation gives companies the right to accept public deposits of up to CHF 100 million ( FINMA may raise the threshold on a case-by-case basis) on a professional basis. This encompasses both traditional currencies (e.g. CHF) and the acceptance of cryptocurrencies (e.g. Bitcoin, Ether). Nonetheless, if cryptocurrencies are accepted for safekeeping and these assets are held on the blockchain and can be attributed to individual clients at all times, these assets are not considered to be deposits and can therefore be accepted by a company with fintech authorisation without regard for the maximum amount of CHF 100 million. Furthermore, companies with fintech authorisation may also hold tokens classified as securities in custody for clients, without needing additional authorisation as a securities dealer or securities firm solely for the safekeeping of such securities tokens.
Bank Insolvency Law: If an institution subject to bank insolvency law holds tokens in custody for a client, the question arises as to how such tokens are to be handled under insolvency law. Thereby, Bank insolvency law distinguishes between deposits and custody assets:
- Token as deposits: If the accepted tokens (e.g. payment tokens such as Bitcoin and Ether) can be classified as deposits, the same bank insolvency rules about the proportionate satisfaction of creditors apply as for the acceptance of deposits in traditional currencies.
- Token as custody assets: To the extent that tokens can be classified as securities, the report states that the same bank insolvency provisions apply as for traditional securities in the current legal situation. However, the Federal Council points out that uncertainties may arise if it is not clear whether particular tokens should be classified as (segregable) securities and/or as (non-segregable) claims and that even in cases in which tokens are classified as custody assets, uncertainties about their segregation under banking law in practice currently remain.
Anti-Money Laundering Regulations
Regarding the Anti-Money Laundering regulations, the Federal Council confirmed that Swiss AML Regulations are sufficiently neutral with respect to technology at present to be able to apply to activities related to Crypto assets to a large extent. Consequently, activities that constitute financial intermediary activities in the analogue world basically also constitute financial intermediary activities in the virtual world. Accordingly, many activities related to Crypto assets are classified as financial intermediary activities and are thus subject to the AML regulations why the Federal Council identified little need for action.To summarize:
- Wallet Provision: To the extent that a wallet providers hold clients’ private keys in safekeeping and enable clients to send and receive cryptocurrencies. Insuch setups, the provider has power of disposal over third-party assets and therefore qualifies as a financial intermediary and is subject to AML regulations. Notably, the Federal Council does currently not see a need to start regulating “non-custodian wallet providers”, i.e. provider of wallet software which do not keep or have access to the user’s private keys.
- Trading Platforms: To the extent the trading platform operator has access to clients’ private keys and therefore also the power of disposal over third-party assets, they act as an intermediary between clients in a trilateral relationship. Accordingly, the application of AML regulations is likely to be triggered and the Federal Council intend to clarify this position in the AML regulations.However, and importantly, the Federal Council also acknowledges the fact that a trading platform may be set up in a fully decentralised manner. If properly designed, such decentralised exchange is not subject to AML regulations. Thereby, the Federal Council seems similarly to move on a similar path as the SEC in its Etherdelta decision. However, the Federal Council also identified money-laundering risks with regard to such platforms and announced to continue to observe the risks arising from the various technical forms of trading platforms and promote uniform standards for a possible regulation in the relevant international committees.
- Exchange Services: The professional purchase and sale of Cryptoassets in return for FIAT (e.g. CHF) or for other Crypto assets constitute exchange activities subject to AML Regulations. The report does not discuss if this only applies to Payment Tokens, or also applies to Utility or other Tokens models.
- Crypto Funds: Crypto funds understood as collective investment schemes that invest their assets primarily or exclusively in Crypto assets are treated the same as other collective investment schemes under anti-money laundering Legislation.
- Mining: Principally a service compensation and not subject to AML regulations.
- Token Issuance: The Federal Council states - in line with the FINMA ICO Guidelines - that the issuance of Payment Token, and in certain cases also of Utility Token, which are designed to be used in applications related to financial services, may be subject to AML regulations depending on the circumstances.
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