Digital Financial Instruments
The rapid spread of internet-based commerce and the idea of having a decentralised banking system, amongst other reasons, have led to the emergence of cryptocurrencies, or more precisely, DLT assets. The term ‘cryptocurrencies’ is often interpreted as including all forms of DLT assets that use cryptographic encryption through the Distributed Ledger Technology (DLT) for their security. Although probably being the most popular forms of DLT assets; Bitcoin, Ether, Litecoin, and other Altcoins are only examples of one form of DLT assets.
The new legislative framework adopted in Malta, the Virtual Financial Assets Act (VFA Act), categorises DLT assets as either: virtual tokens, financial instruments, electronic money or Virtual Financial Assets (VFAs),the latter being a new category of DLT assets provided only under Maltese law.
In this regard, Malta has kept its promise to be at the forefront in attracting business in the blockchain and the DLT industry, mainly by providing the much-needed legal certainty in the industry. Whereas cryptocurrencies remain unregulated in most countries around the world, Malta enacted three legislations which provide legal certainty in relation to initial offerings of DLT assets (ICOs), establish a licensing regime for persons providing services relating to DLT assets, and provide a voluntary option for the certification of technology arrangements such as DLT platforms and smart contracts.
In parallel with the evolution of VFAs, in Malta we have witnessed an increased interest in Digital Financial Instruments. By Digital Financial Instruments we refer to those DLT assets which fall under the definition of ‘financial instruments’, as defined in Section C of Annex I of MiFID. Digital Financial Instruments in the form of DLT assets remain to be regulated by the conventional EU and Maltese legislations relating to financial instruments, namely the Investment Services Act, Cap 370 of the laws of Malta (the Investment Services Act), Directive 2014/65/EU of the European Parliament and of the Council of 15th May 2014 on markets in financial instruments (MiFID), and the Prospectus Regulation (EU) 2017/1129 in the case of public offerings (Prospectus Regulation).
At Zerafa Advocates we offer our experience from previous involvements to provide high-level legal advice in relation to Digital Financial Instruments and have through the years maintained an ongoing relationship with key industry players. We promise to provide the following services in the most time-efficient manner and to the best of our ability:
Structuring, legal and regulatory advice;
Assisting with the entire licensing process for the applicable Investment Services Licence;
Drafting of all internal rules, internal policies, and internal procedures;
Assisting with the Token Classification Test to determine the classification of the DLT asset in question;
Reviewing and/or drafting of offering documentation, whitepaper, or prospectus of the Digital Financial Instruments issuance, as applicable;
Liaising with the competent Maltese authorities on an ongoing basis;
Assisting with the company incorporation; and
Advising to ensure compliance with all the Anti-Money Laundering (AML) requirements and establishing effective KYC procedures.
Primary Market Offerings
A primary market offer is the activity of marketing and making available, to specified persons or to existing holders on behalf of an issuer, newly-issued digital financial instruments or instruments that are issued but not listed on any trading venue.
In terms of the Investment Services Act, in order to carry out the activity of ‘placing of financial instruments without a firm commitment basis’, an investment firm needs to apply to the Malta Financial Services Authority (MFSA) to obtain an Investment Services Licence. The term ‘without a firm commitment basis’ implies that such activity is done without any obligation on the investment firm to purchase from the issuer some or all of the digital financial instruments that it may not succeed in placing with third parties.
A primary market offer may relate to different financial instruments, including transferable securities, units in collective investment schemes, money market instruments and derivative instruments.
Digital Securities Exchanges
One of the services listed in the Investment Services Act is that of ‘operation of a multilateral trading facility (MTF)’, which requires a licence issued in terms of the Investment Services Act for such service to be provided in or from within Malta.
A multilateral trading facility is a trading platform which brings together the buying and selling interest of multiple third-party potential buyers and sellers of financial instruments in a system and in accordance with non-discretionary requirements. An MTF does not include bilateral systems where an investment firm enters into every trade on its own account, as opposed to acting as a riskless counterparty interposed between the buyer and the seller.
A Digital Securities Exchange is an MTF which facilitates third party buying and selling of securities and other financial instruments structured in the form of DLT assets (i.e. Digital Financial Instruments). Where a person operates an MTF for the buying and selling of financial instruments in or from within Malta, a Category 3 Investment Services Licence is required. Correspondingly, where the assets traded on an MTF are Digital Financial Instruments, the operator of such Digital Securities Exchange requires a Category 3 Investment Services Licence.
Security Token Offerings
The Financial Instrument Test (FIT) introduced by the MFSA in accordance with the VFA Act helps distinguish between Digital Financial Instruments and other types of DLT assets. Where Digital Financial Instruments have the characteristics of "transferable securities", then such Digital Financial Instruments may be considered as security tokens which are offered to the public through a security token offering (STO) event.
A traditional transferable security being offered to the public would be subject to the regulatory requirements, particularly those under the Prospectus Regulation. Accordingly, when an issuer intends to issue security tokens in and from Malta, the issuer is subject to the procedures and obligations regulating public offerings of traditional transferable securities.
Where security tokens are offered to the public through a prospectus, the offering documentation must meet the requirements set out in the Second Schedule of the Companies Act. Once it is approved by the MFSA, the prospectus may be made available to the public by the issuer.
An approved prospectus in Malta allows the issuer to offer its security tokens in the other EU member states. Besides that, security tokens present multiple benefits, such as the cost-effective transfer, efficient cross-border trading, and provides greater liquidity compared to traditional transferable securities.
Besides security tokens, another form of Digital Financial Instrument falling under the definition of financial instruments under MiFID is units of collective investment schemes that are issued in the form of DLT assets.
Therefore, a traditional collective investment scheme may be established in Malta in terms of the traditional investment services licensing regime but offers its units to the public in the form of DLT assets (i.e. being based on DLT or on the blockchain).
The fact that the units of a collective investment scheme are DLT assets (i.e. tokenised), does not exempt the collective investment scheme from any legislation, rules or regulations applicable to collective investment schemes in Malta as further explained in the Funds Section. The tokenisation of units in collective investment schemes may be a technical solution opted by such schemes to provide an innovative and cost-effective solution to its investors, and for better liquidity and more efficient cross-border trading. Our legislation already provides for the dematerialisation of shares and therefore technically it already supports the issue of digitised units of collective investment schemes.