Post BlockFinance Malta Security Token Offerings Event Reflections
Firstly I want to point out that I really enjoyed listening to the different points of views from some High level Maltese key market players had to say, especially the regulators.
While attentively listening to all presentations and panel discussions I jotted down quite a few of my own thoughts about certain matters. I also scribbled some questions down which I hoped to pose during Q&A session which unfortunately did not happen (probably due to time). Instead I will post my feedback and questions here.
What I understood from these discussions is that market players agree that if a security token has 3 main characteristics; negotiable, profit sharing and certain rights attached to it, then these assets would be classified as securities.
Where security token offerings concern primary markets, so far it seems that application of traditional rules namely the prospectus directive are not problematic. One can just embed the rights and obligations on token form, whereby such rights (eg dividend or interest payments) will be automated by smart contracts and all recorded on a blockchain or DLT. In fact as Hagen Weiss (Senior Bafin Advisor) stated that Germany has successfully issued its first STO (Bitbond) and there are more to come.
What happens however when these prospectuses offer future promises regarding listing the securities on secondary market platforms?
STO primary market issuance discussions led to some discussions about secondary market platforms and about the manner and form that these players could be shifting to DLT.
A couple of speakers expressed the view that they did not really believe in disintermediation or if STOs will transform capital markets. I believe that such comments may stem from not fully understanding the technology or full potential and different types of the technology as they seem to have missed the point. Capital Market participants are exploring the shift and use of DLT because this new type of database is a great way to organise and shorten the security value chain and also re define roles in the security value chain (which at the moment consists of multiple players from brokers, to custodians, to depositaries, exchanges and clearing houses).
We can move from a multi-tier holding system where investors only have access to the next intermediary in line to a system which merges all these hubs of information to a single master record whereby players (nodes) can plug in and play.
Panelists spoke about the importance of CSDs and post trade settlements. It would have been good if perhaps the conversation focused a bit more on the technology and how it can be leveraged to perform such roles instead of speaking about the important of the roles themselves. ESMA has produced some material stating that it favors the idea of permissioned DLT (DLT and Blockchain technology are different). A permissioned DLT platform will allow intermediaries such as CSDs to plug in as a node in order to execute the same functions but on DLT technology. In my opinion technological systems may be built to perform and execute the same functions as CSDs therefore giving permission and access to a licenced CSD to plug in may not be necessary, however since current regulation dictates that CSDs need to be licenced players, for now the realistic approach taken by regulators is that permissioned DLT should be used in secondary markets. Due to certain oracle problems such as off chain events and governance issues (which may require human input) it is more ideal for certain players (even for example the regulator itself) be given access via node participation to supervise or control certain aspects of the security value chain.
Lorraine Vella (the MFSA deputy head of the Securities and Supervision Unit) gave a great overview of some key capital markets challenges and also commented about some feedback received from the STO consultation paper. Her presentation indicated that it seems that permissioned blockchains were also favoured and regarding the role of the CSD intermediary there was a dual response: one stating we need CSDs and others stating that their functions can be automated. I would suggest that perhaps it would be a good idea to also get input and discuss certain aspects of the DLT vis a vis secondary markets infrastructures further with developers who have knowledge and experience with the technology in order to see what is possible and what is not possible.
Another participant stated how revolutionary the MDIA is and how good it is to be testing and auditing the technology. As much as I think it is good to test the technology, I think that some of the costs are a bit too high and that not all projects should be subject to the same treatment. I agree with Dr.Jonathan Galea who stated that EU IT security standards are needed. One of the questions I had scribbled with the intention of raising is what will happen when it comes to passporting of certain activities – will these MDIA audits and certification still apply? How will this work?
While on the topic of passporting I think as Hansen Weiss (senior advisor at BAFIN) also stated it is important for regulators to work together. Since many laws are transposed from EU directives and many activities may be passported around the EU I think it is imperative for similar standards and DLT application to be applied in order not to run into problems or halt processes in the future. For STO primary markets issuance I think we are safe however when it comes to decisions and legal certainty for how capital markets infrastructure and players should make such shift there is still a lot of work to be done. I sincerely believe that although many persons advocating in this space are true experts in the world of finance and capital markets they have not grasped or understood some of the revolutionary aspects DLT and Blockchain will bring to the table.
We are seeing many players shift to DLT / Blockchain in various jurisdictions (EGs: French CSD, Swiss Stock Exchange and MSE). I think that until legal certainty and more clear regulation (or better yet harmonisation of legislation) occurs if such players want to remain in existence, they must ensure that the technology they are operating on are interoperable (i.e can co-exist with other systems) and must also take the current traditional rules into consideration. Although as Dr.Jonathan Galea also stated over time there will be only a few main tech leaders of DLT/Blockchain which will become used and adopted - survival of the fittest.
Another aspect I thought I would perhaps hear a bit more about (but of course it is hard to touch up on everything in just one morning) was the money aspect of post trade settlements. We are also seeing an emergence of Stablecoins and CBDCs which essentially could satisfy another important part of the security value chain in post trade settlements. The reason this topic was not discusses could also be that given that central banks currently satisfy this role this may be a bit of sensitive topic and therefore persons may not want to suggest or promote the use of alternate stablecoins (maybe also not backed by fiat).
In conclusion I would like to positively remark and commend all those persons who spoke, participated and gave their thoughts on the above matters as it is not easy to merge these two very technical worlds together. Making certain decisions and coming up with such revolutionary break throughs is not easy however more of these sessions, consultation papers and workshops will slowly mould the right regulation needed for this ecosystem to flourish and infrastructure to develop. I would however once again like to emphasize on the importance of not underestimating the technology and delving deeper into its potential and technicalities; or if persons are 'too old schooled' then to consult with developers to see what is possible instead of making assumptions.
As a final note I also think that it would also be beneficial if a Malta or better yet the EU would foster sandbox environments to actually put these doubts and scenarios into practice and to the test. We are seeing many projects in the pipelines, not only for primary issuance platforms but also exchange platforms, CSDs etc. I think that if there are serious market players who want to test their systems or see how different aspects of the infrastructure would work on a DLT based platform sandbox test environments would be the best playground and could produce the best outcomes. Notably the FCA has approved over 20 applications for their Sandbox environment, and incidentally the London Stock Exchange was one of them. Switzerland also did a test run on how DLT settlements would run on their DLT based platform and it proved to be successful. It would be good if Malta also vetted and accepted applications and hosted such sandbox environments.
With over 1 billion invested in DLT capital markets projects last year it is inevitable that we are heading in that direction however I think that key players and drivers of such shift need to get better acquainted and educated with the tech side and potential of things.
I am currently writing a research paper on how and why Capital Market players are leveraging DLT. After publications I would be happy to discuss certain aspects of it further with any persons interested in brainstorming ! Best solutions and revelations come from brainstorming with different bright minds!
About the author- This piece is written by Dr. Justine Scerri Herrera — a warranted Maltese Lawyer (LL.B, LL.D, LL.M) with a background in banking and finance and who is currently specialising in licencing and advisory in the crypto space. The author is an academic at heart and also a true believer of the crypto movement. She regularly publishes papers and speaks at international events about how and why crypto and blockchain intertwines and is being leveraged by players from the financial industries and capital markets.
She works at a top tier international firm Michael Kyprianou (https://www.kyprianou.com/en/index.html) and is a Director of MK VFA Agents entity (part of Michael Kyprianou group).
Stay tuned for Justine's next article titled: "How and Why are Capital Market players leveraging DLT?"
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