The proposed ‘Test’ that will distinguish between ‘security and utility tokens’ in Malta
On 13 April 2018, The Malta Financial Services Authority (MFSA) issued a Consultation Paper on the Financial Instrument Test that has to be applied to distinguish between what are commonly referred to as ‘security and utility tokens’. This test will create legal certainty within the new comprehensive framework being adopted in Malta in relation to the regulation of ICOs, cryptocurrency exchanges and other intermediation services provided in relation to DLT coins and tokens (collectively referred to as DLT Assets).
The test speaks of three types of types of DLT Assets:
- Financial Instruments falling under MIFID (commonly known as “security tokens”)
- Virtual Tokens — Such tokens are not traded on exchanges and have no utility or value outside of the DLT platform on which it is issued and fall outside the scope of regulation)
- Virtual Financial Assets — Used as instruments of payment and will be regulated under the new Virtual Financial Assets Act (commonly referred to as “utility tokens”)
In order for a DLT Asset to fall outside the scope of the MIFID II Directive, it must not qualify as:
- a transferable security;
- a money market instrument;
- a unit in a collective investment scheme;
- a financial derivative;
- an emission allowance.
The most important distinction of the new category of virtual financial assets from ‘transferable securities’ and ‘money market instruments’ is the fact that they are instruments of payment.
In particular, what is extremely important is the distinction of ‘virtual financial assets’ from ‘transferable securities’. The latter are defined as:
(a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares;
(b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities;
(c) any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures.
Under the VFA Act, it is being proposed that ‘Instruments of Payment’ are defined as instruments that do not establish a claim on the issuer (unlike money) and either function as a medium of exchange or have been established as means of payment to initiate or conclude one or more transactions to buy goods or services as agreed between two parties or more.
In order to be determined as a transferable security, the DLT asset, regardless of its negotiability on the capital markets, should embed certain criteria and/or confer certain rights which render it equivalent to shares, bonds or other transferable securities.
So a determining factor is that the token needs to have a payment function for a service or a good and must not establish a claim on the issuer. This must be factored in every new ICO design that is promoted in and from Malta under the new regulatory framework. Nevertheless, each token generation event will have to be tested on a case by case basis by an independent reviewer before it is registered with and approved by the MFSA.
The consultation period ends on the 4 of May 2018 and the full document is available for download here.
This article does not constitute legal advice and does not establish an attorney relationship. If you require legal advice, please contact me on joseph.borg@whpartners.eu or one of my colleagues who helped me with this article and with all blockchain related work at WH Partners at blockchain@whpartners.eu.
Dr. Joseph F. Borg is an Advocate and Partner at WH Partners, heading the Blockchain Advisory and the Gaming and Gambling Advisory sections of the firm. He also practices in the areas of Esports, Corporate, IT, Telecoms and Intellectual Property Law. He also lectures Gaming Law at the University of Malta. Joe is a Co-Founder and currently the Vice-President of Bitmalta, which is a non-profit organisation with a mission to promoting and stimulating discussion about blockchain technology and cryptocurrencies in Malta.
