Crypto Tokens and Tokenisation – BaFin Publishes Summary of Guidelines for Regulatory Classification

German and EU regulators and legislators are increasingly focusing on regulating crypto assets, i.e. fully digitalised block-chain-compatible assets. Examples of bills initiated by lawmakers include the directive amending the fourth EU money laundering directive (Directive (EU) 2018/843), a German government bill regarding its implementation published in late July 2019 (Government Bill) (see our detailed newsletter) and a draft legislation to promote block chain technology announced by the German Federal Ministry of Finance and the German Federal Ministry of Justice (Blockchain Initiative). The German Federal Financial Supervisory Authority (BaFin) has also provided information on its administrative procedures for digitalised assets on many occasions, most recently in February 2018 in the form of an initial guidance notice on regulatory classification of initial coin offerings (ICOs) and also in 2018 in an article entitled “Blockchain Technology – Thoughts on Regulation”. Now BaFin has issued a second guidance notice on ICOs (Guidance Notice) that serves two purposes: to explain BaFin’s requirements regarding inquiries from market participants requesting clarification of possible prospectus and license requirements and to supplement BaFin’s previous statements on potential prospectus and/or license requirements that can be relevant to ICOs or services related to tokens.

Requirements for Inquiries vis-à-vis BaFin

Market participants have directed numerous inquiries to BaFin for clarification of the regulatory implications of intended ICOs or services related to tokens, prompting BaFin to clarify its expectations of such inquiries. BaFin considered many of these inquiries to be incomplete or unstructured, which made it difficult and in some cases even impossible from BaFin’s perspective to provide quick and conclusive answers.

For this reason, BaFin has now clarified that inquiries should include all relevant documentation and contract documents which are specified in a list attached to the Guidance Notice. Now, an inquiry has to be accompanied not only by all binding documents that are relevant for a legal assessment but also by a specific legal self-assessment, which might have to be adjusted subsequently if any of the facts upon which it is based change at a later date. BaFin lists these requirements in detail in a separate annex, which will presumably be the structure required for future inquiries. In this context, BaFin emphasises that inquiries that do not meet these requirements will result in a slower processing. BaFin also states that particularly in the case of ICOs it is advisable to establish a contact with the regulator at the earliest stage possible.

Categories of Crypto Tokens

In the following, BaFin addresses certain content issues in its Guidance Notice. First, consistently with earlier publications BaFin states that it examines regardless of technology and on a case-by-case basis whether an ICO or other token-related activity is subject to regulation. Then, for its regulatory assessment BaFin differentiates among three categories of crypto tokens already described in other BaFin publications, i.e. utility tokens, payment tokens and security(-like) tokens.

BaFin understands utility tokens (also referred to as app tokens or usage tokens) as crypto tokens that – similar to a voucher – provide access to certain services and products. Most crypto tokens with which BaFin is familiar and which have been issued in Germany in the context of an ICO fall into this category. Consistently with current administrative procedures, such utility tokens are not classified in the Guidance Notice as securities defined in the German Securities Prospectus Act (Wertpapierprospektgesetz, WpPG) or as investment products defined in the German Investment Products Act (Vermögensanlagegesetz, VermAnlG). Likewise, such crypto tokens are often not qualified as financial instruments as defined in section 1 para. 11 of the German Banking Act (Kreditwesengesetz, KWG).

BaFin designates as payment tokens (also referred to as virtual currencies, payment tokens or bare-bones tokens) such crypto tokens that are intended to be alternative means of payment. Payment tokens are likewise not to be qualified as regulated securities or investment products. However, BaFin intends to retain its current administrative practices and will continuously classify payment tokens as units of account (Rechnungseinheit) defined in section 1 para. 11 first sentence no. 7 KWG and thus as a financial instrument. Although this qualification was rejected in a decision by the Berlin Appellate Court (Kammergericht Berlin) (see our newsletter), this is by no means unexpected because the German Federal Government (Bundesregierung) has supported BaFin's position and even initiated the Government Bill that is also intended to implement this legal qualification in a formal statute.

BaFin understands security-like tokens (also referred to as equity tokens, security tokens, investment tokens or asset tokens) to be crypto tokens that convey membership or contractual claims with asset-like contents which are comparable to, for example, the rights of a shareholder or debt security holder. BaFin per se classifies such crypto tokens as securities requiring a prospectus as set out in the EU Prospectus Regulation (EU) 2017/1129 (Prospectus Regulation) and the WpPG and (consistently) also as a financial instrument defined in the KWG. Thereby, BaFin points out that classifying crypto tokens into three categories is only an initial approach and that in particular any mixed forms often found in practice are to be assessed on a case-by-case basis according to the relevant specific circumstances.

Prospectus Requirements

According to the Guidance Notice – and consistent with current administrative practices – whether a specific crypto token is subject to a prospectus obligation under the Prospectus Regulation and/or the WpPG is to be determined according to the scope of the regulatory term “securities”. BaFin states that this depends on three criteria: transferability, tradeability on the financial markets and embodiment of security-like rights in the crypto token.

New in its clarity are BaFin’s statements on a “tokenisation of investment products”. BaFin states that – although classic investments in the meaning of the VermAnlG are not to be classified as securities under the Prospectus Regulation or the WpPG, because they are not comparable with securities in terms of their transferability, standardisation and negotiability on capital markets – the regulatory assessment has changed due to block chain technology causing crypto tokens to be freely transferrable and tradable. In such cases BaFin considers crypto tokens to constitute “unique securities (sui generis)”. BaFin further clarifies that an issuer of crypto tokens in the context of an ICO may have to comply with additional requirements that are not set out in more detail in the Guidance Notice and that can be relevant in the context of value-added transfer and trade chains of crypto token.

BaFin finishes its remarks regarding prospectus requirements by repeating an advice it has given before, i.e. that BaFin is the authority responsible for all public offers made in Germany (such as an unrestricted public offer accessible via the internet).

License Requirements

BaFin further addresses possible license requirements that could result from activities involving crypto tokens under the KWG, German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz, ZAG) or the German Investment Code (Kapitalanlagegesetzbuch, KAGB). In essence, the Guidance Notice does not provide any new information in this respect but merely describes the decisive factors in a clear manner. Thereby, BaFin distinguishes between issuing crypto tokens and providing token-related services.

Regardless of an ICO’s specific structure, in particular issuing crypto tokens is likely to entail a license under the KWG as deposit business, under the ZAG as electronic money business and under the KAGB as investment business.

Further, license requirements may apply following an ICO for the provision of additional regulated banking and financial services related to issued crypto tokens. Such potential license requirements again depend in particular on the classification of the relevant crypto token as a financial instrument (e. g. financial commission business, investment brokerage or the operation of a multilateral/organised trading system).

Summary

In publishing the Guidance Notice, BaFin essentially continues its current administrative practices without going beyond minor clarifications of content. BaFin’s new accents include statements regarding the tokenisation of assets, i.e. that it could be necessary to classify crypto tokens as unique securities (sui generis) as a consequence of their tradeability. Despite its limited new material content the Guidance Notice is not to be underestimated, because it includes specific expectations of BaFin regarding the form and content of inquiries. Anyone who wishes to address such inquiries to BaFin in the future should take these expectations seriously. Otherwise, BaFin’s incentive for materially dealing with such inquiries could be rather limited. In general, the Guidance Notice may be understood as an indicator of the crypto market continuing to mature and becoming more professional. This is particular the case as the Guidance Notice will contribute to freeing up BaFin’s resources for serious inquiries. However, it is already foreseeable that the Guidance Notice will probably only have a short application period: Once the Government Bill and the Blockchain Initiative will be adopted and implemented, there will be a new legal environment.