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|France’s new action plan for business growth and transformation regulation (PACTE Law), introduced on May 24 2019, uncovered a new and previously unheard of investment product. The PACTE Law set out the concept and the legal provisions of digital assets, as defined by article L. 54-10-1 of the French Monetary and Financial Code (FMFC). The creation of this new investment product calls into question the scope of investor protection under the PACTE Law, revealing a dichotomy between the innovation and the reality of its implementation.|
In accordance with the conditions set forth in the PACTE Law, investments in digital assets may be made either directly by an investor to an issuer by subscribing units or shares of an investment fund, or where appropriate, by concluding financial contracts involving one or more digital assets as underlying assets (or an index related to the evolution of these assets’ value).
In line with article L. 54-10-1 of the FMFC, as amended by the PACTE Law, a digital asset consists of either a token within the meaning of article L. 552-2, a cryptoasset such as a cryptocurrency, or more broadly: “any digital representation of a value which is neither issued or guaranteed by a central bank or by a public authority; is not necessarily related to a currency which is a legal tender; and does not have the legal status of a currency; but is accepted by legal entities or natural persons as a mean of exchange and can be transferred, stored or exchanged digitally”.In this, way, the regulations introduced in the PACTE Law complete Statute n° 2014-559 of the May 30 2014 on crowdfunding, which allows the use of distributed ledger technology such as blockchain for such operations. This is a new concept in French law.
An alternative to blockchain financing is an initial coin offering (ICO), a fundraising operation whereby a company issues tokens to investors who pay in a cryptocurrency.
These utility tokens are traditionally opposed to tokens which confer voting or financial rights (security tokens/security token offering or STO), which are more similar to financial instruments. These allow investors to benefit from the company's products or services.
This distinction is clearly drawn in the PACTE Law, which excludes financial instruments from the scope of the notion of token, defined as "any intangible asset representing, in a digital form, one or several rights capable of being issued, written, stored or transferred by means of a blockchain which allows, directly or indirectly, the identification of the owner of the aforementioned asset".
Investment in digital tokens will naturally shift towards offers subject to an optional visa by the Autorité des marchés financiers (AMF). Indeed, the PACTE Law implements a specific regime under which companies willing to acquire a visa must, among other things, produce a white paper containing sufficiently clear, precise information about the issuer and the ICO.
When granting the visa, the AMF confirms that is has verified the offer's white paper and that it is complete and understandable for the investors. The AMF will then publish a white list on its website of the ICOs that have been granted visas, along with a black list of issuers or ICOs that do not comply with the AMF regulations, for investors and the public.
The AMF's rules concerning ICO visas state that the duration of the visa shall not exceed six months, and may only be delivered in regard to the ICO itself, not the issuer orissuing company of the tokens. During this time period the AMF may withdraw the visa in the case where the ICO becomes incompatible or non-compliant with the white paper. Besides, attention should be drawn to the fact that as the ICO is by nature based on the blockchain technology, the AMF does not check the computer programmes linked to the digital offer of tokens.
Other protective measures for investments in tokens established by the PACTE Law include the obligation for the issuer of tokens to implement a process for tracking and safeguarding the assets, which requires further regulatory input.
One of the main investor protection tools lies in digital asset service providers' obligation to register with the AMF. Digital asset service providers are a brand new category under French law, which is specific to France and therefore not currently eligible to any EU passport mechanisms, unless relying on another regime such as electronic money, and through such regime exclusively. They are defined as companies providing digital asset custody services or those who buy and sell digital assets in exchange for legal tender currencies.
It is important to ensure that this latter business, and more generally the services delivered by the provider throughout the blockchain, does not constitute an operation of issuance or distribution through the blockchain of an electronic payment instrument or the delivery of a payment service, which would otherwise require specific authorisation (unless exempt). A violation of such rules would trigger criminal sanctions as a matter of French law.
This new opportunity may allow…the exposure of certain types of life insurance contracts to digital assets
Other services on digital assets are regulated by a regime of optional authorisation by the AMF, including the reception and transmission of orders on digital assets on behalf of third parties, and the sale and purchase of digital assets in exchange for other digital assets (brokerage of digital assets).
Unless they are authorised as payment service providers or are exempt from such authorisations, a digital assets service provider, even licensed to provide one or more services on digital assets, shall not deliver payment services – unless specifically licensed to do so in accordance with the Payment Services Directive 2 (PSD2) licensing framework.
Likewise, the financing of a purchase of digital assets is likely to enter the scope of the banking monopoly (article L. 511-5 et seq. of the FMFC) and the performance of transactions on financial contracts (such as derivatives contracts) involving a digital token, or an index based on the evolution of that token's value, may require an authorisation as investment services provider (unless, here again, an exemption is applicable) for each relevant investment service on such contracts.
The terms for the constitution of rights, particularly rights in rem rights such as a pledging of digital assets or title transfer agreement on such assets, will require the applicable regulations to be clarified along with the conditions of their potential sale or transfer. In the current state of the law, it is relevant to question the terms and conditions of the assignment of a digital asset as collateral or security under the French regime set forth in article L. 211-38 of the FMFC aiming to implement the EU Collateral Directive into French law. Further, a legal instrument should be created under private international law determining with clarity the law applicable to digital assets de minima at an EU or EEA level.
In addition, the market expects regulators to further clarify the regulatory framework of the secondary market for tokens. The existence of a secondary market must be expressly specified on the white paper the AMF receives (where the issuer has chosen the regime with the optional visa referred to above). Besides, the management or operation of a service of trading platform on digital assets falls within the scope of the provision of services on digital assets submitted to a regime of optional authorisation, which triggers the supervision of the regulator – representing further protection for investors.
With this in mind, if the AMF visa does not itself amount to a condition for the validity of the ICO, the absence of that visa limits the possibilities of marketing or commercialising the token. Solicitation canvassing, public offer and sponsorship in particular are generally prohibited for ICOs which have not obtained a visa from the AMF and for providers that are not authorised as digital asset service providers in accordance with the PACTE Law. The involvement of the AMF as a regulator for investments in digital assets provides protection for investments but limits the powers of investors to freely operate.
Fund opportunities for professional investors
Specialised professional funds (SPFs) and private equity professional funds (PEPFs), both of which are open to professional investors, will be able to invest in digital assets. This new opportunity may allow, subject to compliance with certain conditions, the exposure of certain types of life insurance contracts to digital assets.
So far, only alternative investment funds by purpose (other AIFs) were able to invest in digital assets as they're not subject to restrictions on the composition and nature of their assets, as opposed to SPFs and PEPFs (which are alternative investment funds by nature).
Therefore, Article 88 of the PACTE Law widens the scope of assets that are eligible to an SPF to those registered in a blockchain. Article L. 214-154 of the FMFC provides that: "notwithstanding articles L. L. 214-24-29, L. 214-24-34 and L. 214-24-55 [of such code], a specialised professional fund may invest in property if they comply with the following rules: The ownership of the asset is based either on a register, an authenticated/certified document or a private agreement whose value is recognised by French law; the condition pertaining to the register is deemed fulfilled for the assets registered on a blockchain".
It is also possible, on the basis of article L. 214-154 of the FMFC, that an SPF be exposed to tokens or cryptoassets by holding financial derivatives whose underlying assets are tokens or cryptoassets. As a reminder, in 2018, the AMF clarified that a derivative whose underlying asset is a cryptoasset and which closes out by a payment in cash is deemed a financial contract.
The goal of allowing a French private equity vehicle to invest in this new category is to stimulate digital asset fundraising in France
In the same vein, the PACTE Law widens the scope of assets that a PEPF may hold. The Senate introduced this measure and justified via rapporteur that the new legal provisions initiated by this amendment were encouraged by a will to create investment opportunities for "informed professionals with a strong appetite for risk".
The goal of allowing a French private equity vehicle to invest in this new category is to stimulate digital asset fundraising in France, in conjunction with the implementation of the optional visa also provided in the PACTE Law. This opening is yet limited: given the risks at stake, investments in digital assets cannot exceed 20% of the fund's assets (article L. 214-160 of the FMFC). Plus, holding derivatives whose underlying asset consists of tokens or cryptoassets is not possible for a PEPF according to the conditions applicable to the holding of financial contracts by a PEPF and mentioned in articles R. 214-32-22 to R. 214-23-26 of such code.
The issue of the custody of this category of assets by the depositaries of these investment funds shall also be raised: they may be unwilling to offer such a service when one considers the reluctance of credit institutions to open a deposit and payment account to token issuers and digital asset service providers. Such reluctance has indeed pushed the legislator to widen the scope of the right to an account to these same operators (article L. 312-23 of the FMFC).
Lastly, the PACTE Law has introduced the possibility of investing in SPFs and PEPFs, thus allowing indirect exposure to cryptoassets in life insurance contracts (article L. 131-1-1 of the French Insurance Code (Code des assurances). On the basis of decree n° 2019-1172 aiming at encouraging investment in the real economy via private equity, this exposure should remain relatively limited due to several constraints.
The first pertains to the holding limit of digital assets to 20% of the assets of a PEPF, which is expected to be transposed to the PEPF whose subscription would occur via life insurance contract units. The second restriction is applicable to investments in PEPFs and professional funds dedicated to retail investors, stating that it shall not exceed 50% of such units of account products assets, and 10% for PEPFs.
In a nutshell, the use of these new financing instruments appears to be more accessible when implemented directly by investors rather than indirectly through investment funds. this may occur at the cost of investor's protection as regulations applicable to third party asset management provide that, through funds exclusively open to professional investors, investors may access digital assets in a more robust and protective regime, which includes the supervision of the manager by the AMF, the controls operated by the depositary and the auditor of the fund on the fund's assets, and of eligibility limited to professional clients within the meaning of Mifid II.
This first attempt at establishing a legal framework for the new market of digital assets in France by the PACTE Law should be adjusted in light of feedback from the operators of this growing market.
Translations to English are for information purposes only in the context of this article and are not meant to constitute an official translation of such provision. Only the original provision in French language set forth in the French Journal Officiel is legally binding as a matter of French law.
DLA Piper, Paris
DLA Piper, Paris