The German Federal Ministry of Justice and Consumer Protection (Bundesministerium für Justiz und für Verbraucherschutz (BMJV)) and the German Federal Ministry of Finance (Bundesministerium für Finanzen (BMF)) have proposed a ministerial draft law for the introduction of securities in electronic form in Germany. The draft is based on the concept paper published by the BMF and BMJV on 7 March 2019.
The draft provides for the implementation of a new law on securities in electronic form (Gesetz über elektronische Wertpapiere (eWpG)) and is intended to provide the option to issue German-law governed “electronic securities” and “crypto securities” which are not represented by a physical certificate.
What is new and which securities are covered?
Under current German law, securities need to be represented by a physical certificate (Urkunde). This certificate forms the basis for the protection of ownership in the security and its transfer pursuant to German property law.
The draft aims to provide the option to issue securities under German securities law without issuing a certificate representing these securities. Beyond this technical option, the draft would not change the legal framework for securities in Germany. Ultimately, the goal is to provide an additional way to issue securities. Conversely, it is not intended that all virtual assets generated via distributed ledger technology (DLT) or similar technologies shall be electronic securities under civil and supervisory law. To ensure this, the draft provides for the entry of securities in electronic form into specific registers and disclosure obligations.
Securities in electronic form shall in principle have the same legal implications as securities represented by a certificate. Securities in electronic form include but are not limited to “crypto securities”. That is, such assets are a sub-set of the securities in electronic form governed by the eWpG. The term crypto security is intended to be technology-neutral and is defined by reference to the requirements applicable to the securities register.
How is this to be implemented?
In the first step, the eWpG is limited to bearer bonds.
The regulation of shares and fund shares in electronic form is intended to be implemented at a later date, due to the related corporate law implications.
Entry in an electronic securities register as an alternative to a certificate
Pursuant to the draft, the option to issue a bearer bond in electronic form is introduced in addition to the existing issuance via certificate. The issuance of the certificate is replaced by the entry into an electronic securities register.
For “traditional” securities in electronic form (electronic securities), a central register is envisaged which has to be managed by a central securities depository (CSD) within the meaning of Article 16 of Regulation (EU) No. 909/2014 (in Germany, Clearstream Banking AG).
Crypto securities, on the other hand, are to be entered into decentralized crypto securities registers, which in each case have to be maintained in a decentralized, forgery-proof digital storage system, in which data is stored sequentially and protected against unauthorized deletion and subsequent modification. According to the draft, at the current state of technology, this would mainly comprise DLT-based storage systems. However, no limitation to DLT is intended. The crypto securities register may also be managed by the issuer itself. The management of a crypto securities register is designated as the provision of financial services which requires a license, but shall not be safekeeping within the meaning of the German Law on Deposits of Securities.
The management of the registers is supervised by the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht).
Recording (Niederlegung) of the terms of the securities
Prior to the entry of a security in electronic form in the register, the terms of the security (Emissionsbedingungen) have to be provided – in the form of data – via the entity managing the register in a way that ensures access. Changes to the terms also require Niederlegung in order to be valid.
Consistent legal implications – equal status of securities represented by certificates and securities in electronic form
The draft states that a security in electronic form has, in principle, the same legal implications as a security represented by a certificate.
Accordingly, it provides that a security represented by a global certificate can be replaced by an electronic security with identical terms unless this is prohibited by the terms of the security. The same applies to the replacement of an electronic security by a security represented by a certificate. On the other hand, replacing a security represented by a certificate with a crypto security requires the express consent of the beneficiary. There is no right to require representation by individual certificates, unless expressly provided by the terms of the security.
To this end, the draft also provides for changes to other German laws, specifically the Stock Exchange Admission Regulation, the Securities Prospectus Act and the Law on Safe Custody of Securities.
Ownership and transfer
The draft contains the legal stipulation that electronic securities are movable assets (Sachen) for the purposes of German property law. From a German law perspective, this is one of the focal issues: Under German law, the transfer and ownership of securities are governed by the legal principles applicable to movable assets. Therefore, this legal stipulation is essential in order to ensure the equal legal treatment of securities in electronic form and securities represented by a certificate.
For electronic securities, the draft provides for collective entry in the register, with the securities registered in the name of a securities depository bank. The beneficiaries are treated as co-owners according to their fractional share. Individual entry in the register is provided only for crypto securities. The draft envisions that the transfer of electronic securities and crypto securities registered by collective entry shall be effected – in the same way as for securities represented by a global certificate in collective deposit – via bookings in the individual securities accounts of the beneficiaries.
The transfer of individually registered crypto securities shall be effected by a change in registration, where the transferring holder is signed out of the register and the new holder is registered. It remains to be seen how this will be implemented practically in the context of technologies already available, and where innovation will be required. We have advised multiple platforms globally on transfer procedures and related documentation and there will be a need to continue to bear such formalities in mind when designing solutions to take advantage of this new regime.
A small step or a giant leap? (It is both)
The draft is an important step that we expect to have a material impact on securities issuance and the attractiveness of the German market to large global institutions and innovators alike.
In a way, the changes are modest. That is, the changes do not primarily focus on crypto securities, but aim to remove the current requirement of representation by a physical certificate while maintaining the property law-foundation of German securities law. Since the vast majority of securities governed by German law have for some time been settled via clearing systems (with only a global certificate representing the securities held in collective deposit), replacing the certificate by a digital system is arguably a small step. Securities not incorporated in a certificate have been used in certain other jurisdictions for some time, and are not a complete novum in Germany: German “Bunds” (federal sovereign bonds) are already issued without a paper certificate and the provisions in the eWpG may have been modelled on the provisions of the German law on Federal Obligations. The system proposed by the draft is structured in a way that should ease implementation into the existing clearing system without dramatic changes.
However, the leap lies in the confluence of this change with the technologies now available to leverage it. Novel is the attempt to provide a legally sound framework for the issuance of crypto securities that protects the assets and trust of investors. Whether the securities markets are prepared to use these new technologies to a significant extent remains to be seen.
It is also important to remember that a number of jurisdictions still struggle with comprehensive electronic transactions and contracts legislation, as paper-based processes remain part of essential procedures (such as stamp duty) and certification requirements. Demonstrating that this friction can be reduced will not only boost Germany’s competitiveness, but also signal to others that this can be done.
We expect that over the course of the legislative process, changes will be made to the ministerial draft. The provisions regarding holders (Inhaber) and beneficiaries (Berechtigte) would benefit from further clarification. The provisions regarding the terms of securities in electronic form and their Niederlegung leave some questions: According to the explanatory memorandum, the terms comprise all provisions of the subscription agreement. The subscription agreement, however, typically also contains provisions relating solely to the initial purchaser and/or the underwriters and not to investors acquiring the securities subsequently or in the secondary market.
In this context, it will also be interesting to see how the European legal framework for crypto assets will develop. Should the European Union implement an EU Regulation for crypto assets, it would be directly applicable in Germany. We do, however, think it unlikely that an eventual EU Regulation would focus on the technical details of the issuance of securities, but would rather expect it to deal with questions of how the existing EU framework should be applied to crypto assets, or to provide supplementary or new regulations for crypto assets.
“Staying local” – impacts on choice of jurisdiction?
Finally, it should be noted that an issuer planning a placement in Germany is ultimately free in its choice of the law that governs its securities. The choice of New York law typical for high yield bonds or the choice of English law frequently used for international placements remain available to German issuers. The same is true for the laws of Switzerland or Liechtenstein, which are generally viewed as “crypto-friendly.” The draft aims to ensure that issuing mechanics which the market perceives as outdated are no longer a reason for issuers to turn their backs on German law.
Globally, we have a significant team working on a number of virtual asset projects, including digital bonds, crypto funds, stablecoins, central bank digital currencies and multiple other assets.