A new set of rules applicable to DLT and blockchain-related business activities could come into force by 2021. Daniel Haeberli and Urs Meier of Homburger dig into key aspects of the existing and potential future Swiss regulatory framework
In December 2018, the Federal Council (ie Switzerland's federal government) published a detailed report covering the legal framework for DLT and blockchain in Switzerland. The report concluded that the existing Swiss regulatory framework was fit-for-purpose for technical developments such as DLT and blockchain but it also identified a need for selective improvements.
Just a few months later, the Swiss federal government had an initial draft law prepared, which then went through a comprehensive public consultation process. Based on feedback in that consultation, the Swiss federal government published the finalised draft law on November 27 2019 (DLT Draft Law). The DLT Draft Law is currently being discussed in the Swiss parliament and its entry into force in 2021 seems possible.
Under current Swiss law, there are three key regulatory aspects usually relevant in the context of DLT and blockchain-related business activities: first, the general token categories; second, the categorisation of stablecoins; and third, which tokens qualify as financial instruments.
General token categories
Tokens can be defined as data or information units, which are stored in a DLT or blockchain based register. In its 'Guidelines for enquiries regarding the regulatory framework for initial coin offerings' of February 16 2018 (ICO Guidelines), the Swiss Financial Market Supervisory Authority (FINMA) distinguishes the following three basic categories of tokens.
Payment tokens: according to FINMA payment tokens are synonymous with 'pure' cryptocurrencies. They are tokens which are intended to be used, now or in the future, as a means of payment for acquiring goods or services or as a means of money or value transfer. These cryptocurrencies do not give rise to any claims towards an issuer or a third party. Consequently, according to the prevailing view of Swiss legal scholars, the tokens are "purely factual intangible assets". Examples of these cryptocurrencies are Bitcoin (including numerous altcoins built upon the basic technical framework used for Bitcoin) or Ether.
Utility token: utility tokens are tokens that are intended to provide access digitally to an application or service by means of a DLT-based infrastructure.
Asset tokens: asset tokens represent assets such as a debt or equity claim against the issuer. Asset tokens promise, for example, a share in future company earnings or future capital flows. In terms of their economic function, therefore, such tokens are analogous to equities, bonds or derivatives. According to FINMA, tokens which enable physical assets to be traded on a DLT-infrastructure also fall into this category.
FINMA furthermore also points out that tokens may fall into more than one of the three basic categories; such hybrid tokens include, for example, asset tokens or utility tokens, which at the same time also qualify as payment tokens.
On September 11 2019, FINMA published a supplement to its ICO Guidelines that focused exclusively on stablecoins (Stablecoins Guidelines). These additional guidelines were published against the background of a request by the Libra Association, the not-for-profit entity domiciled in Geneva, which fosters the development of the envisaged global currency Libra. The Libra Association had asked FINMA for an assessment of how the Libra project, in particular the issuance of the Libra stablecoin, would likely be treated under Swiss financial market law. FINMA took this opportunity to not only provide its initial views on Libra, but to also publish the comprehensive Stablecoins Guidelines, which indicate how FINMA will likely assess projects involving tokens linked to assets in general.
FINMA will continue to apply a substance-over-form approach as a general principle and also with regards to stablecoins
In the Stablecoins Guidelines, FINMA pointed out that it will continue to apply a substance-over-form approach as a general principle and also with regards to stablecoins, just as it did and still does with any other kind of tokens. FINMA also mentioned that the design and the technical details of stablecoins vary substantially. Nonetheless stablecoins may, on a high-level, be categorised based on two key features: the type of 'underlying' or asset backing the coin, and the rights which coin holders have. We must therefore look in detail at the key characteristics and the design of each stablecoin.
If a stablecoin is backed by currencies and the coin holders have a right towards the issuer to redeem the coin at a fixed price (for example, one coin for one Swiss franc), the issuer may be deemed to be accepting deposits from the public and hence the licensing requirements under the Swiss Banking Act might be triggered. If a coin is backed by a basket of currencies and if the coin holders have a right towards the issuer to redeem the coin at the current value of the basket (the net asset value), the coin may qualify as a unit in a collective investment scheme and trigger licensing requirements under the Swiss Collective Investment Schemes Act. And finally, currency-backed stablecoins may also constitute a payment system under the Swiss Financial Market Infrastructure Act.
If a stablecoin is backed by commodities, the regulatory consequences depend on the type of commodity and whether the coin holders only have a contractual claim against an issuer or a right in rem with regards to the underlying commodity. In the latter case, financial market regulation does generally not apply and the stablecoin does in particular not qualify as a security, if certain requirements are met. If the coin only grants a contractual claim, however, this likely triggers requirements under the Swiss Banking Act (if the commodities are precious metals) or the coin may qualify as a security or a derivative (if the commodities are other commodities than precious metals). Furthermore, commodity-backed stablecoins may also constitute units in collective investment schemes.
If a stablecoin is backed by real estate, the coin likely constitutes a unit in a collective investment scheme and triggers licensing requirements under the Swiss Collective Investment Schemes Act.
If a stablecoin is backed by a single security – for example shares of a particular company – then the coin will likely qualify as a security too and may, depending on the specifics of the case, constitute a derivative or even a structured product. If the coin is backed by a basket of securities, however, it will in most cases constitute a unit in a collective investment scheme.
It must be noted that FINMA's Stablecoins Guidelines are of indicative nature only and not legally binding. In any case, the particularities of a stablecoin project will need to be assessed based on the relevant details of the envisaged design of the coin and the legal relationships between the parties involved.
What tokens qualify as financial instruments?
On January 1 2020, the new Swiss Financial Services Act (FinSA) entered into force. It primarily establishes rules on how financial services have to be provided and how financial instruments have to be offered.
Under the FinSA, the definition of "financial instrument" covers equity and debt securities, including bonds, units in collective investment schemes, structured products, derivatives and certain types of deposits. To decide whether a token (or coin) qualifies as a financial instrument for the purposes of the FinSA, several considerations must be taken into account.
It will be possible to register uncertificated register securities with a ‘traditional’ custodian (for instance a bank)
Whether a token is a financial instrument or not depends on its economic function and, derived from this, the rights that are represented by or linked to that particular token. Consequently, whether a particular token is a financial instrument from a Swiss law perspective must be assessed on a case-by-case basis.
Asset tokens, hybrid tokens and stablecoins that grant their holders participation and voting rights in a corporation or rights to the repayment of debt, for example, are likely to be classed as financial instruments for the purposes of the FinSA. Payment tokens are, to date, not treated as securities by FINMA and are generally not financial instruments for the purposes of the FinSA. Utility tokens are also not treated as securities by FINMA, provided that their sole purpose is to confer digital access rights to an application or service and that the tokens can already be used in this manner when they are issued. Such 'pure' utility tokens, which neither partially nor exclusively function as an investment in economic terms, are also not classed as financial instruments for the purposes of the FinSA.
Future framework – what are the cornerstones of the DLT Draft Law?
The cornerstones of the DLT Draft Law of November 27 2019 are the introduction of "uncertificated register securities", an envisaged new licence category for operators of DLT trading venues, and the introduction of rules governing the segregation of cryptoassets as well as data in insolvency.
The DLT Draft Law proposes the introduction of a new concept of so-called "uncertificated register securities" (Registerwertrechte), which aims to increase legal certainty in connection with the "tokenisation" of rights and financial instruments. If this concept is introduced as envisaged, Swiss law would provide for the possibility of an electronic registration of rights that has the same functionality and entails the same protection as a negotiable security.
Legal positions admissible as underlying rights of such uncertificated register securities include rights against issuers, such as contractual claims or membership rights (for example, shares in a corporation). Consequently, asset tokens, utility tokens, hybrid tokens, as well as stablecoins, may be issued in the form of uncertificated register securities. Payment tokens however, cannot be issued in this form since they do not give rise to any claims, which could serve as an underlying right.
In order to create uncertificated register securities, the parties (for example, the issuer of an instrument as debtor and the holders of the instrument as creditors) need to enter into a registration agreement. Based on this agreement, the relevant right is entered into a register of uncertificated securities and may exclusively be asserted based on and transferred via this register.
The register used must meet certain statutory minimum requirements:
- the register must, by means of technical procedures, grant the creditors, but not the debtor, power of disposal over their rights;
- the register's integrity must be ensured by implementing the appropriate technical and organisational protective measures that prevent unauthorised changes (for example, joint administration by several independent parties);
- the content of the registered rights, the functioning of the register itself and the registration agreement need to be recorded either directly in the register itself or in accompanying data / documents (for example, a prospectus or articles of association) linked to the register;
- creditors must be able to view the information and data which concerns themselves and they must be able to verify, without third party support or intervention, the integrity of the content of the register concerning themselves.
In its dispatch of the DLT Draft Law, the Swiss federal government mentions certain existing DLT-systems that are currently deemed suitable to fulfil the statutory minimum requirements. Both permissionless (for example, Ethereum) as well as permissioned (for example, Corda and Hyperledger Fabric) systems are mentioned in this (non-exhaustive) list.
Should the DLT Draft Law enter into force as currently planned, it will also allow participants to bridge the new framework with the 'traditional' book-entry securities concept. In particular, it will be possible to register uncertificated register securities with a 'traditional' custodian (for instance a bank) and to subsequently book them into a 'traditional' securities account. Hence, uncertificated register securities could easily be transferred to the 'old world', if desired.
DLT trading venues
Under current Swiss law, there are three categories of trading facilities: stock exchanges, multilateral trading facilities and organised trading facilities. Due to certain reasons, these categories are deemed unsuitable for trading involving cryptoassets, for example, because retail clients may to date not have direct access to stock exchanges or multilateral trading facilities. Instead, these trading venues are currently only open to holders of a securities firm licence and certain other regulated participants.
The licensing requirements for DLT trading venues are largely modelled on the existing requirements for traditional trading venues
In the DLT Draft Law, the Swiss federal council therefore proposes the introduction of a new licence category for (centralised) financial market infrastructures. These DLT trading venues may offer services in the areas of trading, clearing, settlement and custody of DLT-based assets not only to regulated financial market participants but also to unregulated corporates, as well as individuals, potentially including retail clients.
A DLT trading venue licence will be obtainable by trading venues that allow for the simultaneous exchange of offers between several participants and the conclusion of contracts based on non-discretionary rules and, in addition, provide for: (1) the admission of unregulated corporates or individuals; (2) the custody of DLT securities based on uniform rules and procedures; or (3) the clearing and settlement of trades in DLT securities based on uniform rules and procedures. DLT securities are securities that are suitable for mass trading and either have the form of uncertificated register securities or other uncertificated securities held in distributed electronic registers and which, by means of technical procedures, grant the creditors, but not the debtor, the actual power of disposal over the uncertificated securities.
The licensing requirements for DLT trading venues are largely modelled on the existing requirements for traditional trading venues (for instance stock exchanges and multilateral trading facilities). However, they are modified by adding specific rules with respect to, for example, the admission of participants and the admission of DLT securities.
Cryptoassets (kryptobasierte Vermögenswerte) such as cryptocurrencies and tokenised financial instruments are often stored with third party custodians, for example exchanges or wallets providers.
It is currently unclear whether cryptoassets held by a custodian on behalf of a client will be segregated in bankruptcy, especially if the creditor or investor does not hold (any) private key(s). The DLT Draft Law proposes to introduce a new segregation regime that will allow the segregation of cryptoassets for the benefit of the relevant creditors or investors, if certain requirements are met, including, in particular, the following:
- First, the relevant custodian must have the obligation vis-à-vis the relevant creditor or investor to keep the cryptoassets available for him at all times. This means that the custodian cannot, for example, use the cryptoassets for proprietary business or own-account transactions.
- Second, the cryptoassets will only be segregated if they can be either unambiguously allocated to the individual creditor or investor (however, there will be no need that such allocation occurs directly on the relevant DLT-system itself) or allocated to a community and it is evident what share of the joint holdings belongs to a given creditor or investor. The latter option will allow a pooling of cryptoassets held for several creditors or investors.
In addition, the access to data in insolvency in general shall become regulated too. Under current Swiss law, it is unclear whether digital data stored by a third-party custodian (for instance a cloud provider) can be segregated from the bankruptcy estate, if such a custodian becomes insolvent. The Swiss federal government therefore proposed an amendment to Swiss insolvency law, which would establish a right to request segregation of digital data regardless of whether such data has any (market) value or not (for example a holiday picture). The person requesting the segregation must show that they have a particular entitlement to the data to be segregated (for instance, a statutory or contractual claim).
|About the author|
Daniel Haeberli is a partner in the banking and finance and capital markets teams. He is a specialist in banking and finance, as well as in structured products and derivatives. His practice focuses on secured lending, syndicated debt and structured financing, derivatives, retail structured products, investment funds and bond offerings. He is the co-head of the Homburger TechGroup and head of legal and regulation at the Swiss Structured Products Association.
|About the author|
Urs Meier is a senior associate in Homburger's banking and finance team and the firm's tech group. His practice focuses on advising banks, securities dealers, funds and other financial intermediaries with regard to financing transactions and regulatory matters. His areas of work include in particular distributed ledger technology and other fintech-related topics.