Luxembourg joins Cryptosecurities Club

While France may have DEEP Securities, Luxembourg now has ‘DEES securities’. These securities refer to securities transmitted by way of a “dispositif d’enregistrement électronique sécurisé” or, freely translated, a ‘secure electronic recording device’. This concept includes distributed electronic registers or databases. In other words, Luxembourg is the latest EU country to implement legislation enabling cryptosecurities.

This happened by means of the Luxembourg Act of 1 March 2019
(hereinafter colloquially referred to as the Cryptosecurities Act), which entered into force on 9 March 2019.

The Cryptosecurities Act modifies the Act of 1 August 2001 regarding the circulation of securities (as amended) by adding an Article 18bis to it. The first paragraph of this new Article 18bis is as follows:

Le teneur de comptes peut tenir les comptes-titres et effectuer les inscriptions de titres dans les comptes-titres au sein ou par le biais de dispositifs d’enregistrement électroniques sécurisés, y compris de registres ou bases de données électroniques distribués. Les transferts successifs enregistrés dans un tel dispositif d’enregistrement électronique sécurisé sont considérés comme des virements entre comptes-titres. La tenue de comptes-titres au sein d’un tel dispositif d’enregistrement électronique sécurisé ou l’inscription de titres dans les comptes-titres par le biais d’un tel dispositif d’enregistrement électronique sécurisé n’affectent pas le caractère fongible des titres concernés.

This paragraph can be freely translated into English as follows:

The account provider may maintain securities accounts and make entries in securities accounts within or through secure electronic recording devices, including distributed electronic registers or databases. Successive transfers recorded in such a secure electronic recording device shall be considered as transfers between securities accounts. The maintenance of securities accounts within such a secure electronic recording device or the registration of securities in securities accounts through such a secure electronic recording device shall not affect the fungibility of the securities concerned.

Luxembourg’s conception of cryptosecurities is both broader and narrower than the implementations of cryptosecurities in France and Delaware, which were discussed in a previous post.

French legislation so far only provides a framework for non-listed securities; Delaware legislation so far only provides a framework for shares and not for other types of securities. The Luxembourg Cryptosecurities Act, by contrast, enables cryptosecurities in all instances where regular dematerialised securities can be issued.

However, by drafting its Cryptosecurities Act from the perspective of the provider of securities accounts, the Luxembourg legislator may give the impression that DLT’s primary added value is to serve as back office technology for intermediaries. In terms of back office technology, DLT may turn out to be somewhat unwieldy compared to the efficient back office software currently used by intermediaries. French and Delaware legislators, on the other hand, drafted their bills from the perspective of the issuer of securities. This leaves more leeway for ‘disruptive’ applications of DLT.

Launch of CryptoSecurities.eu research project

Distributed Ledger Law (DLL) today announces the launch of its legal research project “CryptoSecurities.eu.” DLL’s founder took up a position as PhD researcher at KU Leuven, Europe’s most innovative university according to Reuters, to engage in a multi-annual research project on the legal aspects of cryptosecurities.

Several jurisdictions have adopted or are currently adopting legislation to permit the issuance of cryptosecurities by private companies. However, the current securities law framework may not be equipped to provide an adequate answer to what cryptosecurities are and how they can be transferred in a valid and effective way. The main reason for this is that the current securities markets are centralised, intermediated, and built on the assumption of imperfect traceability of securities. By contrast, distributed ledger technology is designed to facilitate decentralisation, disintermediation and perfect traceability. The CryptoSecurities.eu research project seeks to map and mitigate the legal risks that emerge from the clash of these paradigms.

This objective will be pursued by starting from three seemingly simple questions:

  1. To what extent do cryptosecurities differ from traditional securities?
  2. What legal gaps occur when the current legal framework governing the nature and transfer of traditional securities is applied to cryptosecurities?
  3. How can these gaps be bridged?

The project’s full working title is “The Nature and Transfer of Cryptosecurities: Mapping and Mitigating Legal Risk.” Progress updates will be shared here on Distributed Ledger Law.

Classifying Cryptosecurities

Introduction

Distributed Ledger Law recently published an article in the Belgian legal journal Tijdschrift voor Rechtspersoon en Vennootschap – Revue pratique des sociétés (TRV-RPS).[1] The article discussed, among others, some of the legislative initiatives that were taken so far by jurisdictions in the US and Europe to enable the issuance of “cryptosecurities”: securities (such as shares or bonds) that are held, transferred and/or issued by means of distributed ledger technology.

One of the article’s takeaways is a proposed classification of cryptosecurities.

Classification matrix

Cryptosecurities exist in many variations, depending on the extent to which distributed ledger technology (DLT) is used, and the extent to which the cryptosecurities receive legal recognition.[2] A distinction can be made between (i) the recording (i.e., keeping the securities ledger up to date), (ii) the transfer and (iii) the issuance of cryptosecurities. In this matrix, we propose a descriptive classification of cryptosecurities based on these three elements.

Use of DLT and legal recognition are essential parameters of a cryptosecurity. It can therefore be useful to compare initiatives relating to cryptosecurities with one another on the basis of these parameters. This helps in quickly getting to the essence of an initiative, and facilitates the communication around the initiative. The classification matrix is intended to provide a framework for this.

Examples

Let’s apply the proposed classification to some real-world examples.

1. Example of a cryptosecurity of category A1: Borsa Italiana has launched an initiative to allow non-listed SME’s to keep track of their stock ledger by using a DLT platform.[3] The platform will only be used to keep track of the cap table, not to transfer shares. Hence, there is only a weak use of DLT (i.e., category A). The project will stay within the boundaries of the existing legal framework; there is no explicit legal recognition of the DLT principles used (i.e., category 1).

2. Example of a cryptosecurity of category B1: In December 2016, Overstock.com Inc., a North-American online retailer listed on Nasdaq, completed the first-ever issuance of cryptoshares.[4] The cryptoshares were issued in the form of book entry shares (for which no share certificates were issued) registered in the stock ledger of the issuer in the name of the shareholders.[5] The shares are exclusively traded on a multilateral trade facility that is operated by a subsidiary of Overstock. com Inc. Transactions in the cryptoshares are settled almost immediately (t+0). The platform comes with some quite radical transfer restrictions built in: the cryptoshares cannot be sold short nor pledged.

In summary, a transaction would unfold as follows.[6] First, the transaction is recorded in the internal ledger of the multilateral trade facility. The updated ledger is then automatically published on the internet (on an anonymised basis). Finally, a cryptographic hash of the updated ledger is registered on the Bitcoin blockchain. This cryptographic hash serves as a digital fingerprint that can be used to verify the accuracy of the internal ledger.

Taking this structure into account, the Overstock cryptoshares can be classified as category B1: there is a moderate use of DLT (category B), but no explicit legal recognition (category 1).

Category C3 cryptosecurities

Several jurisdictions (such as Delaware, France and Wyoming) have been industriously enacting legislation to enable the issuance of cryptosecurities by companies that are governed by their respective laws. If one follows the proposed classification matrix, this makes them the first “category 3 jurisdictions”. Undoubtedly, the first category C3 cryptosecurities will soon be issued.


Footnotes:

[1] M. Van de Looverbosch, “Crypto-effecten: tussen droom en daad”, TRV-RPS, 2018(3), pp. 193-207.

[2] For a classification of cryptosecurities according to legal recognition, see Direction Générale du Trésor (France), “Consultation publique sur le projet de réformes législative et réglementaire”, 24 March 2017, pp. 4-5, https://www.tresor.economie.gouv.fr/Ressources/File/434688. For a discussion of degrees of integration of DLT with the current intermediated structure of listed securities, see P. Paech, “Securities, Intermediation and the Blockchain: An Inevitable Choice between Liquidity and Legal Certainty”, LSE Law, Society and Economy Working Paper 20/2015, 26-28. For a reflection on degrees of technological support, see K. Werbach, “Trust, But Verify: Why the Blockchain Needs the Law”, pp. 43-48, https://ssrn.com/abstract=2844409.

[3] See https://www.reuters.com/article/us-lse-blockchain/london-stock-exchange-group-tests-blockchain-for-private-company-shares-idUSKBN1A40ME.

[4] Zie http://investors.overstock.com/phoenix.zhtml?c=131091&p=irol-newsArticle&ID=2230245 (bezocht 30 december 2017).

[5] This is remarkable, because in the US almost all shares of listed companies are registered in the stock ledger of the issuer in the name of Cede & Co., a nominee of Depository Trust Company.

[6] See the prospectus dated 9 December 2015, pp. 34-36, in particular p. 36, and the prospectus supplement dated 14 November 2016, pp. S-52 – S-57, both available via the EDGAR database of the US Securities and Exchange Commission, at https://www.sec.gov/edgar.

DEEP Securities

France beat other European countries to the draw. On 8 December 2017 an Order was given by the French President to allow non-listed securities to be issued on a blockchain. The Order is yet to be ratified by the French Parliament and will enter into force on 1 July 2018 at the latest. After Delaware, France thus becomes the second jurisdiction to enact legislation expressly allowing companies to issue cryptoshares. Other jurisdictions are expected soon to follow.

The French Order differs from the Delaware Bill in two main respects:

  1. Unlike the Delaware Bill, the French Order only allows for the issuance of non-listed securities on a blockchain.
  2. Unlike the Delaware Bill, the French Order is not limited to shares, but also permits the issuance of securities other than shares (such as bonds or units in collective investment undertakings).

The French Order also has at least two things in common with the Delaware Bill:

  1. Like the Delaware Bill, the French Order is limited to minimal additions to the existing legal framework. Words and phrases are surgically added to the French Monetary and Financial Code and the French Commercial Code.
  2. Like the Delaware Bill, the technical framework of the French Order is yet to be worked out. An implementing decree will need to be adopted in order to specify more detailed requirements of DLT-platforms used for issuing cryptosecurities.

The French Order expressly provides that cryptosecurities will be eligible to be pledged according to the same procedure as book-entry securities. The implementing decree will need to specify how that will work.

The French wouldn’t be the French if they wouldn’t have come up with a French translation of distributed ledger technology: “dispositif d’enregistrement électronique partagé”. Although its acronym is far catchier: “DEEP”.

Links: Order (French) | Report to the President (French)