Crypto42 Watchdog №3
#Regulation
With a recent study of Morgan Stanley showing “That the majority of cryptocurrency trading volumes operate out of companies legally located (with OKEx, BitBay, Binance just recently joining) in Malta” , we thought Malta´s approach to get a pole position in the Blockchain world by bringing out a Distributed Technology Regulation, is worth doing some research work.
Hence, we decided to devote this newsletter to Malta´s upcoming legal framework for Distributed Ledger Technology Regulation.
Malta`s parliament approved the Malta Digital Innovation Act (MDIA), the Innovative Technology Arrangements and Services Act (ITASA) as well as the Virtual Financial Assets Act (VFAA) — forming the DLT (Distributed Ledger Technology) Regulation in the third and last reading as of yesterday, July 4th, 2018.
That said, Malta is the first member state of the European Union to release a Distributed Ledger Technology Regulation and after taking a deep dive into the topic, we think that it is quite a great and forward-looking piece of legislation.
The Malta Digital Innovation Act provides for the set-up of a separate DLT-knowledgeable supervisory authority, the Malta Digital Innovation Authority (MDIA). MDIA is supposed to become the central authority in Malta to regulate, monitor, supervise, promote and support the development of all DLTs matters (i.e. all innovative technology arrangements and innovative technology services) in or from Malta. The MDIA is supposed to grant licenses for Innovative Technology Services Provider as well as for Innovative Technology Arrangements (e.g. smart contracts,..). The authorization (recognition/certification/verification) process (on a voluntary basis) is supposed to ensure credibility for the DLT platforms, provide legal certainty to users wishing to make use of a DLT platform as well as to foster, to promote and to facilitate the advancement of the Innovative Technology Arrangements and their design (compare Part II of the MDIA).
The Innovative Technology Arrangements and Services Act (ITASA) deals with the process for the recognition (Part II) of Innovative Technology Service Providers and the certification (Part III) requirements for Technology Arrangements (“TA”) like DAOs (Decentralized Autonomous Organizations) with the possibility of having the TAs being granted separate legal personality. So a DAO basically can do the same things as a corporation, but instead of shareholder resolutions or management actions, the decisions are made and executed by artificial intelligence and smart contracts. In addition the Act defines guiding principles on behavior of Innovative Technology Service Providers and provides for registered systems auditors and technical administrators for Technology Arrangements.
The Virtual Financial Assets Act (VFAA) sets out the framework for Offerings of virtual financial assets and the regulatory regime on to the provision of services in relation to VFAs. The Act is divided in eleven Parts , with the first Part providing the key definitions:
A “DLT asset” means either (a) a virtual token;(b) a virtual financial asset;© electronic money; or (d) a financial instrument.
“virtual tokens”, or “utility tokens”are defined as tokens which,have no utility, value or application outside of the DLT platform on which they were issued and may only be redeemed for funds on the platform directly by the issuer of the DLT asset.
“virtual financial asset” or a “VFA” are defined as any form of digital medium recordation that is used as a digital medium of exchange, unit of account or store of value and that is not (a) electronic money; (b) a financial instrument; or ( c )a virtual token.
“initial virtual financial asset offering” or “initial VFA offering” means a method of raising funds whereby an issuer is issuing virtual financial assets and is offering them in exchange for funds;(Part I Article 2. (2))
Part II. refers to the Initial Offering requirements of a virtual financial asset. Article 3. (1)(Part II) of the VFAA provides that no issuer shall offer a virtual financial asset to the public in or from within Malta or shall apply for a Virtual Financial Asset’s (VFA´s) admission to trading on a DLT exchange unless such Issuer draws up a whitepaper which -
- (a) complies with the requirements of article 4 of the Act; and
- (b) is registered in accordance with sub-article (2).
Furthermore, the classification of a DLT asset has to be determined by the Issuer and its VFA agent, as appointed by the Issuer in terms of Article 7(1)(b) of the VFA Act (see below). If the DLT asset qualifies as a financial instrument or electronic money, the Issuer shall be required to comply with the applicable laws in lieu of the provisions of this Act (MiFID regulation as well as the Malta national financial instruments regulation).
The VFA Act requires each VFA offering to be registered with the Malta Financial Services Authority (MFSA) and the “confirmed” white paper (the content is prescribed in the VFA Act) to be delivered to MFSA for review for completeness. The confirmation of the white paper for compliance with the requirements of the VFA has to be done by an appointed VFA agent (article 7 (1) of the VFAA). Such a VFA agent shall be registered with the Malta Financial Services Authority (MFSA) being the competent authority and has to prove his/hers experience and competence (lawyers, accountant or auditors, or other corporate service providers,..). A VFA agent is supposed to monitor the VFA issuer on a constant basis, starting out with the confirmation that the Virtual Financial Assets regulation is applicable (applying the Financial Instruments Test) as well as by supporting the application process of the issued VFA on the secondary market (DLT exchange). A VFA agent will serve as both a person of trust ensuring compliance with legal formalities as well as a conduit with the MFSA in order to ensure proper communication, reporting and monitoring. The VFAA is quite clear on the dating and on the matters to be stated within the white paper as well as on advertising matters around the VFA offering. The Act has a separate extensive liability clause (compare Article 10) included for any untrue statements from the Issuer.
Part III and Part IV- refer to the valid licensing requirements for any VFA service providers: Here again VFA agents are required for the application process and have to confirm that the service provider to be licenced is fit and proper and will comply with all requirements. In order for an exchange to be classified as a VFA Exchange under the proposed VFAA, the VFA Exchange would have to limit its activities and any related services to VFAs, to the exclusion of electronic money, financial instruments (which are governed in terms of existing national and EU legislation) and to VTs. The operation of a VFA Exchange is listed as a licensable activity under the Second Schedule of the Act. It follows therefore that a license from the Malta Financial Services Authority (MFSA) as the competent authority will be required prior to the VFA Exchange commencing operations. The licensing requirements also are valid to all other VFA service providers including brokerages, portfolio managers, custodian and nominee service providers, eWallet providers, investment advisors, and so on. Any entity that offers a VFA service or is classified as a VFA service provider is required under the new rules to apply for a license from the MFSA through the guidance of a registered VFA agent.
Part V refers to the obligations of the Issuers regarding the prevention of market abuse: prohibition of insider dealing, prohibition of unlawful disclosure of inside information, prohibition of market manipulation and the obligations of licence holders. Part VI/Part VII T outline the requirement of compliance with the Prevention of Money Laundering Act (AML Act) including compliance with prudential requirements as defined; the qualities, governing principles and responsibilities (including fiduciary obligation toward its customers) of the Issuers.
Part VIII refers to the extensive duty of auditors to be appointed by the licence holders to report immediately adverse facts which result in de-licencing and to report annually to the competent authority on the licence holder’s systems and security access protocols; waiver of the duty of professional secrecy in relation to their reporting obligation.
The remaining Act treat any legal proceedings for appeals, remedies, (Part IX), miscellaneous provisions (Part X) and transitory provisions (Part XI).
Our take on it:
We are impressed by the set legal regime and we think that the approach for the (voluntary) registration of Technology Service Providers and the certification of Technology Arrangements as well the creation of the new Digital Innovation Authority could achieve the target as explained by Parliamentary Secretary Schembri
the aim of the proposed framework is to offer legal certainty to a space that is currently unregulated, and touches on a number of issues, including types of authorisations, legal personality and the applicability of law to smart contracts.
The Types of Digital Assets identified in accordance with the Virtual Financial Assets Act are as follows:
So DLT Assets to be qualified as virtual financial assets (VFAs) under the VFAA can be summarized as follows:
°tradable utility tokens serving also as means on exchange on their respective platforms as well as
°all tradable payment tokens.
We definitely like Malta´s approach regarding the approach for tradable utility tokens. The planned regulation for such VFAs will require a third-party confirmed (more or less “audited”) white paper with prescribed information for an offering of a virtual financial asset and also defines rather straight the liability for the Issuer.
The introduction of the concept of the VFA agent reminds very much to the concept of authorized sponors as proposed by Gibraltar´s ICO regulations— lawyers, accountants, auditors but also other knowledgeable people — who are supposed to be “responsible for assuring compliance with disclosures and with licencing requirements. Such VFA agents are evidently supposed to replace the “Wild-West” of the numerous questionable ICO-Advisors.
An interesting approach but there are evidently some issues which have to be figured out as the responsibilty and the resulting liabilty for the VFA agent seems quite big so:
°how will the fee arrangements will work out and
°how to address the cross-border liablity for such projects? as usual professional indemnity insurances do not cover cross-border damages.
With Malta being the first European member to approve a DLT regulation and with Austria`s authorities announcing only last week that they have plans to require a prospectus for all token sales exceeding 2 million Euro it gets evident that their is no coordination within the different European member countries regarding legal requirements for Initial Coin Offerings. So will Europe miss another big chance for a EU wide regulation of a new alternative finance possibility for startups? Hopefully not!
