A Fast-developing Sector

In 2018, Malta made international headlines by giving force of law to a legal virtual financial asset (VFA) framework for the launch of new virtual financial assets, provision of services to virtual currencies, those who operate them and the technology on which they are built.

The country's obligations under the various anti-money laundering regimes that it forms part of, such as AML4D, were clearly given a very high level of importance. The legislator chose to implement considerable requirements and safeguards to enter the market by way of licensing fees, minimum share capital requirements and governance structure. These were all seen as necessary means to filter out the undesirable market players in an industry that unfortunately has had a large incidence of fraudulent fundraises and successful cyber-attacks that wiped out millions of dollars of investor value.

The Impact of the Maltese VFA Framework

Following in Malta's steps, France has also recently enacted a legislative framework for VFAs, while Italy has a draft bill pending parliamentary approval to regulate crypto exchanges. Estonia, which currently attracts those seeking minimal regulation, have recently announced an overhaul and beefing up of its virtual currency framework, while the UK has issued a consultation paper on the use of blockchain and smart contracts with a view to revising existing laws if deemed necessary.

We believe that a widespread, international move towards regulation is beneficial to all stakeholders. With operators and market makers subject to a stringent level of regulatory oversight and compliance, investors and consumers alike benefit from increased levels of safeguarding and protection.

The EU and VFAs

With so many EU member states actively regulating this space, it is believed to be only a matter of time until some form of harmonised laws promulgated at the EU level. This should be viewed positively as it would bring any national license issued by an EU member state authority to permit activity surrounding Virtual Financial Assets in line with the legislation governing for other areas such as financial services. This would offer market participants a known quality, ensure a level playing field across the Union, and permit the benefit of passporting services into other EU member states.

However, there remains the possibility of non-harmonisation, as remains the case with remote gaming that Malta has certainly turned to its advantage. In either scenario, the key for Malta to make a success in this area is for market operators, guided by the licensed VFA Agents, to ensure that only high-quality applications, backed by promoters of integrity and probity are submitted for regulatory approval.

VFA Framework: Service Providers

Malta's regulatory framework provides clarity to operators wishing to issue digital tokens on a blockchain platform in or from Malta. The law also covers businesses offering any of a wide range of services to or around VFAs, with the Second Schedule of the Virtual Financial Assets Act (Cap. 837) permitting the following activities, closely modelled on those found in traditional financial markets:
i) Reception and Transmission of Orders
ii) Execution of orders on behalf of other persons
iii) Dealing on own account
iv) Portfolio Management
v) Custodian or Nominee Services
vi) Investment Advice
vii) Placing of virtual financial assets
viii) The operation of a VFA exchange

Launching Security Token Offerings (STO)

The industry has, over the latter part of 2018 and into 2019, shown a preference for launching Security Token Offerings (STO) whereby a token represents ownership of equity or entitlement to rights akin to rights of equity. Such tokens may be issued in Malta subject to the issuing and approval of a prospectus under the Prospectus Directive, and indeed Malta has done very well to attract several serious industry players to seek STO approval in Malta. In practice, while processing such applications, the MFSA has identified some challenges in matching the tokenisation element to traditional financial instruments - not least because some proposed tokens offer a benefit that is not uniquely captured under the MiFID II definitions (for instance, a potential right to a profit share that would typically be governed by a private agreement and not form part of a public offering document.)

The MFSA is working hard to propose a policy to facilitate the structure and approval process of security tokens. This is critical to Malta's success in this field as a financial instrument launched in Malta may benefit from passporting to any other EU member state and thus provide operators access to the entire EU capital market.

Another challenge in launching STOs is finding a market in which these may be issued for the first time and subsequently traded in a secondary market. It is of utmost importance to provide fora where brokers and investors of all sizes may meet and trade, since a key advantage of tokenisation is facilitating liquidity to hitherto highly illiquid markets, such as real estate or infrastructure investment. The Malta Stock Exchange (MSE) has taken the bold step of entering into joint ventures, through an MSE subsidiary, with key industry players in this sphere, particularly the Berlin-based Neufund to create a Security Token Exchange.
Malta has pushed the envelope in terms of giving force of law to a comprehensive legal regime in an innovative area, and continues to drive forward with ongoing work to add further guidelines where required, as well as planning a regulatory sandbox to facilitate access to smaller market entrants or provide a testbed and launchpad for new ideas.

Summary: During 2018, the VFA Framework was implemented in Maltese Law. Since then, various other jurisdictions have taken initiatives to implement their own VFA framework. Moreover, movements in the European Union to harmonise this industry have also been anticipated.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.