As recently reported, the Swiss parliament has passed the new DLT Act (Federal Act on the Adaptation of Federal Law to Developments in Distributed Ledger Technology) in its autumn session 2020. Yesterday the corresponding blanket ordinance was published and submitted for consultation. The consultation process with cantons, political parties and other interested parties will last until 2 February 2021. The entry into force of the amendments to the laws and regulations is expected to take place on 1 August 2021.
The new DLT Act, together with the blanket ordinance, entails various improvements to the Swiss legal framework in connection with the use of decentralised technologies and blockchain. The introduction of so-called ledger-based securities, which enable the digitization of shares and other rights, is certainly central to this. An overview of the innovations can be found here.
For many market participants, the most important innovation which the DLT Act brings is the introduction of the DLT / Security Token Exchange, a new form of licence for trading venues for digital assets. We are happy to provide details on the new licence category and explain why this licence will be central for many FinTech companies.
DLT Trading Facility as Trading Venue 2.0
The Swiss DLT trading facility is the trading venue of the future. Similar to existing trading venues, it enables multilateral trading, i.e. the simultaneous exchange of offers among several participants and the conclusion of contracts according to non-discretionary rules. However, instead of the assets of the old world, the DLT trading facility focuses on trading DLT securities. DLT securities include the ledger-based securities (Security Token) introduced by the DLT Act and their foreign equivalents. In addition to DLT securities, other digital assets, such as payment tokens (e.g. BTC, BCH, LTC, ETH) and utility tokens (e.g. ADA, WINGS, FIL) may also be used in DLT trading facilities.
DLT trading facilities differ from traditional trading venues in that they:
- Allow retail customers as participants;
- Hold DLT securities in safe custody; and/or
- Clear and settle transactions with DLT securities.
DLT trading facilities also differ from traditional token exchanges in that they
- Allow trading with security tokens
- Allow safekeeping of tokens and DLT securities
- Allow safekeeping of payment tokens and thus the keeping of accounts
By offering the trading of DLT securities – instead of conventional securities – the new licence type allows for a larger group of participants to be admitted. This extension of potential participants to retail customers is expected to lead to a partial disintermediation of banks, as customers can trade DLT securities themselves and, unlike in the current system, are no longer obligated to trade shares and other financial instruments exclusively via their bank or broker.
In terms of the activities covered by the new licence, the DLT trading facility is very different from current trading venues. In addition to trading, DLT trading facilities may offer the custody of DLT securities, a service which under current law required a licence as a central securities depository. DLT trading facilities may further provide the settlement and clearing of transactions in DLT securities. This is also a service which, under current law, requires an additional licence, namely as a central securities depository respectively as a payment system. However, the licence as a trading facility does not cover the clearing of transactions. The concentration of counterparty risks resulting from this may also in the future be assumed only by central counterparties. It should be noted, however, that clearing can be waived if the settlement takes place at the same time as the trading and not, as is the case on today's trading venues, two days later.
In summary, the new DLT trading facility is a one-stop-shop for the trading, custody and settlement of digitized assets (e.g. tokenised shares or other security / asset token that qualify as DLT securities), which is open not only to banks or brokers but also to retail customers.
Advantage over other Jurisdictions
With the entry into force of the DLT Act and the regulation of the DLT trading facility provided for therein, Switzerland will have a clear legal basis for the offering of trading and post-trading services by the same company. This innovation, together with the i) introduction of ledger-based securities, ii) easing of requirements for custodians of digital assets and iii) introduction of clear rules on the issuing of digital assets in the event of bankruptcy, also provided for in the DLT Act, will give Switzerland one of the most innovation-friendly legal basis for the safe custody, trading and settlement of security token like digital shares and other digitized assets.
The recently published draft of the Markets in Crypto-Assets (MiCA) Regulation, which is intended to ensure uniform rules for the handling of digital currencies and crypto-assets in the European Union, does not – unlike the DLT Act – cover tokens that represent financial instruments. The latter are to be regulated in the Markets in Financial Instruments Directive (MiFID). It is however not yet possible to make a definite statement with regard to both, the precise content and the date of entry into force of the MiCA or the adapted MiFID. Consequently, the legal certainty that the DLT Act provides will, at least until the entry into force of the MiCA and the adaptation of the MiFID, be unique in Europe.
In principle, the requirements for financial market infrastructures associated with licensing and prudential supervision, such as those relating to organization, guarantors, ancillary services, business continuity, etc. also apply to DLT trading facilities.
Furthermore, the requirements applicable to trading venues also apply to DLT trading facilities. These include requirements for self-regulation, organisation of trading, ensuring pre- and posttrade transparency, guarantee of orderly trading, supervision and suspension of trading etc.
In addition, DLT trading facilities providing custody settlement and/or clearing services are also subject to the requirements applicable to central securities depositories. These include, for example, requirements for the custody, booking and transfer of securities, as well as requirements relating to collateral, capital adequacy, liquidity, procedures in the event of participant’s default and segregation.
Segregation of assets does not necessarily have take place on the underlying blockchain but may be conducted via the (central) system of the DLT trading facility. Omnibus custody solutions are thus possible under the new law.
Among other things, the Federal Council has specifically regulated the admission of DLT securities. As mentioned above, the DLT trading facility may also admit to trading assets other than DLT securities. However, derivatives structured as DLT securities, DLT securities and assets, which could significantly impede the implementation of the requirements of the Money Laundering Act or which could impair the stability and integrity of the financial system, may not be admitted. The latter category includes in particular so-called privacy coins, which specifically make transaction monitoring considerably more difficult (e.g. Monero or Zcash).
Lower Requirements for small DLT Trading Facilities
In contrast to the Financial Market Infrastructures currently established in Switzerland, the new authorization category of the DLT trading facility has the clear aim to be suitable for smaller market players. For reasons of proportionality and in consideration of the protective purpose of the Financial Market Infrastructure Act, the Federal Council was given the power to provide for relief from certain legal requirements for DLT trading facilities.
According to the blanket ordinance submitted for consultation by the Federal Council, a DLT trading facility is considered small if it meets the following criteria:
a. its trading volume is less than CHF 250 million per year;
b. its custody volume is less than CHF 100 million; and
c. its settlement volume includes transactions worth less than 250 million Swiss francs per year.
d. No credits are granted to participants
The lighter regulatory regime for small DLT trading facilities as porposed by the Federal Council's draft regulation in particular relate to the organisational / governance structure of the trading facility as well a to lower capital requirements:
The Federal Council's draft regulation provides in particular for the following easing of requirements for small DLT trading facilities:
a. A reduced minimum capital requirement for small DLT trading facilities of i) CHF 500,000 if no custody, clearing and settlement services are provided and ii) 5 per cent of the DLT securities held in safe custody, but at least CHF 500,000 if custody, clearing and settlement services are provided.
b. The capital adequacy and liquidity requirements for central securities depositories that apply to other DLT trading facilities do not apply to small DLT trading facilities.
c. The business management does not have to be strictly separated in terms of personnel from the overall management, supervision and control. Only a majority of the members of the management, supervision and control may not be members of the business management.
d. The requirements for business continuity can also be met by the fact that, in the occurrence of damaging events, the operation of the DLT trading facility is taken over by another licensee (Art. 13 para. 1 FinMIA).
e. Self-regulation can also be carried out by a non-independent body (Art. 27 para. 2 FinMIA).
f. An independent appeal body is not required (Art. 37 FinMIA).
g. An internal audit is not required (Art. 8 para. 1 let. c FMIO).
The draft regulation provides for a reduced minimum capital requirement for small DLT trading facilities of i) CHF 500,000 if no custody, clearing and settlement services are provided and ii) 5 per cent of the DLT securities held in safe custody, but at least CHF 500,000 if custody, clearing and settlement services are provided. The capital adequacy and liquidity requirements for central securities depositories that apply to other DLT trading facilities do not apply to small DLT trading facilities.