Germany – New regulation (KryptoFAV) enables issuance of digital fund shares on the blockchain | Dechert LLP
At a glance:
- The new German Ordinance on Crypto Fund Shares (Verordnung über Kryptofondsanteile – KryptoFAV) introduces the possibility to issue shares in German investment funds digitally as so-called crypto fund shares.
- The issuance of Crypto Fund Units is processed via a decentralized Crypto Securities Register based on distributed ledger technology (DLT) or on a blockchain.
- The fund’s custodian keeps the respective crypto securities register, but they can also delegate this to a third-party company, which is authorized to keep crypto securities registers.
- KryptoFAV applies to German investment funds in the form of a contractual mutual fund (Sondervermögen), but not to investment funds in a company structure.
- The KryptoFAV will enter into force on 18 June 2022.
Background: Introduction of electronic securities by the German Electronic Securities Act (Gesetz über elektronische Wertpapiere – eWpG)
KryptoFAV is a complement to the law on the introduction of electronic securities1, which entered into force in June last year. The core of this omnibus action (Artikelgesetz) was the Electronic Securities Act (Gesetz über electronic Wertpapiere – eWPG), which applies to bearer bonds. (For further background: Read our OnPoint “An overview of German legislative initiatives affecting asset managers and financial service providers in Germany and abroad”) Section 95 of the German Capital Investment Code (Capital investment – KAGB), which was amended when the eWPG entered into force, has already enabled German investment funds in legal form as mutual funds (Sondervermögen) to issue digital fund units. On this basis, the requirement to issue a physical certificate (Urgent customer) (eg a global certificate, or Gobalur customer) no longer applies because, in accordance with amended § 95 (1) of the KAGB, the certificate can be replaced by registration in a centralized electronic securities register when fund shares are issued to the holder.
However, so far no legal prerequisites have been established for issuing crypto fund shares, i.e. electronic fund shares that are not registered in a central register, but in a (decentralised) crypto securities register. The German legislator initially postponed the introduction of crypto fund shares in order to properly assess the special characteristics of investment fund shares compared to securities when considering registration in decentralized crypto securities registries. In particular, it was intended to reflect the depositary’s special position with corresponding regulations. For this reason, the legislature authorized the Federal Ministry of Finance, together with the Federal Ministry of Justice and Consumer Affairs, to fine-tune the more specific regulations for crypto fund shares by authorizing them to issue a corresponding regulation2after taking these special features into account.
Provisions in KryptoFAV
The two ministries have now provided for this missing regulation by issuing a joint regulation, KryptoFAV, and thus created the legal basis that enables the issuance of crypto fund shares in Germany. In essence, the regulation stipulates that the relevant provisions of the eWPG on crypto-securities generally also apply to crypto-fund shares. This is intended to establish some synchronization between crypto securities and crypto fund shares. As discussed in more detail below, however, there is a significant discrepancy in the provisions for maintenance of the crypto securities register.
This means that German investment fund shares in the legal form of a mutual fund (Sondervermögen) can now also be issued as crypto fund shares that are not registered in a central securities register as electronic securities or electronic fund shares, but in a so-called crypto securities register. Since, according to the current regulations, crypto-securities registries must be kept on a tamper-proof registration system where data is logged in chronological order and stored in a way that protects them from unauthorized deletion and subsequent modifications as DLT or blockchain is usually used for this crypto-securities registry.
Consequently, fund management companies can now process fund shares “on the blockchain”. for the investment funds they manage.
Electronic fund shares and crypto fund shares can only be issued for mutual funds (Sondervermögen), i.e. investment funds in contract form, and exclusively as bearer share certificates. Registered shares as well as shares in investment joint stock companies and limited shares in investment limited companies do not fall within the scope of application and must therefore continue to issue a physical certificate (e.g. a global certificate, or Global watch customer).
The regulation contains a clarification that a joint fund (Sondervermögen) including its individual share classes can be issued in both forms, as crypto fund shares and as physical share certificates, simultaneously. This should give fund management companies maximum flexibility.
When it comes to the provisions on keeping the register, however, the regulation deviates from the further provisions in the eWPG. For crypto fund shares, the only persons authorized to act as registrars are the custodian and companies commissioned by the custodian and authorized to maintain crypto securities registries. In the draft regulation, the original intention was for the depositories to be the only ones authorized to maintain crypto-securities registries.3 This limitation was justified by the fact that the depositary must be put in a position to fulfill its duties according to §§ 68 et seq. and 80 et seq. KAGB in relation to investors4 but was criticized in the consultation phase of the regulation. In response to this, legislators provided for the change described above and gave the depositary the option to outsource the registrar function to a third party holding the relevant license. However, the custodian must ensure that it can fulfill its legal duties and obligations even where such a delegation is in place.
KryptoFAV provides operational advantages for the German fund industry
The advantages of crypto fund shares are obvious, especially when issuing and redeeming fund shares (so-called fund share transactions, or Anteilscheingeschäfte). Due to the elimination of the global certificate (Global watch customer), there is no need for further interaction with the central securities depository for the settlement of fund unit transactions. The same applies to the sale and transfer of fund shares in the secondary market. This opens up significant simplifications, since investors can in principle come into direct contact with each other to carry out the legal transaction. However, the custodian remains involved in the settlement of the transactions. In this regard, there may be further benefits as the value date (currently often T+2) of the settlement to transfer ownership of fund units can be significantly reduced, which will facilitate the settlement of fund units on the trade date.
All in all, the adoption of the regulation has been met with a positive response in the fund industry; the possibility of issuing crypto fund shares is seen as a sensible and necessary step for the future viability and competitiveness of German fund products.5
The near future will show how intensively the German fund industry will make use of the new opportunities to issue crypto fund shares. It will probably also depend on the fund and investor structure as well as on the processes that have been established in individual cases with regard to fund share transactions. This is because the investors must also be able to map the crypto fund units in their systems and manage them outside the established custodian system (eg within a self-managed “wallet”).
Footnotes
1) Full title of the German law: Gesetz zur Einführung von elektronische Wertpapieren v. 3.6.2021 (BGBl. I S. 1423).
2) Section 95 (5) KAGB includes a corresponding decision-making authority.
3) The license to maintain crypto securities registries (Perlaubnis zur Kryptowertpapierregisterführung) in accordance with § 1 (1a) Satz 2 No. 8 in connection with § 32 (1) sentence 1 German Banking Act (Kreditwesengesetz – KWG).
4) Cf. see rationale for the bill: Federal Ministry of Finance
5) Cf. see BVI statement on draft regulations for shares in crypto funds (KryptoFAV): The Federal Ministry of Finance
6) Cf. Frank Dornseifer’s (CEO of BAI) statement in the article “Bahn frei für die Kryptofonds-Registerführer” published in Börsenzeiten, 17-06-2022.
