Why we need evolutionary, not revolutionary, regulatory initiatives

This July, Luxembourg — the world’s second-largest domicile for investment funds behind the United States — submitted a draft law updating a law from March 1, 2019 that allowed for the registration and transfer of securities by custodians. With this draft law, issuance itself can be based on distributed ledger technology, thereby introducing truly dematerialized DLT or blockchain-based securities.

Furthermore, a central “issuance account” keeper (transfer agent) is required to assume responsibility, and the account keeper has to be authorized by any member state of the European Economic Area, which means that non-Luxembourg credit institutions and investment firms can be the central account holder.

Two weeks later, on Aug. 11, Germany’s Federal Ministry of Finance and its Federal Ministry of Justice and Consumer Protection submitted a draft bill for the introduction of electronic securities. The bill intends to revamp both Germany’s securities law and the corresponding supervisory law, with a focus on blockchain strategy.

The draft differentiates between the keeping of a central electronic securities register by a central securities depository and the keeping of registers for issuing electronic bonds made possible by distributed ledger technologies. It also provides greater regulatory clarity: The Federal Financial Supervisory Authority will track the launch and upkeep of “decentralized registers” as new financial services in agreement with the Electronic Securities Act, the German Banking Act Kreditwesengesetz and the key securities depository rule.

The proposed changes to the legal framework, by adopting blockchain and other new technology, aims to bolster Germany as a hub of business and magnify “transparency, market integrity and investor protection.”

For now, the draft bill is limited to bonds, but it can be extended to any security, including stocks and investment funds. The aim is to receive comments from the German states by Sept. 14 and to pass the regulation later in 2020.

The draft law also provides several changes to the prospectus law, the custody account law and other rules so that all electronic securities are treated like legacy nondigital securities. With this, the draft law clears a major regulatory hurdle to the mass adoption of digital assets.

What does it mean for the industry?

Germany’s very conservative government is taking the digital transformation of its securities markets extremely seriously and recognizing the advantages in terms of speed, settlement times and transparency that blockchain technology has to offer. Having first updated existing Anti-Money Laundering/Combatting the Financing of Terrorism legislation to allow banks to store and sell cryptocurrencies to both institutional and retail customers (effective on Jan. 1), it has now turned its attention to dematerializing securities with the use of permissioned DLT or permissionless blockchain technology (e.g., public Ethereum). In effect, the draft law states that an electronic security in the form of a token, for instance, carries the same rights and legal investor protections as a paper certificate.

This new draft galvanizes the philosophy that there is no need for radical new legislation — rather, legislation should be technology-neutral — while clarifying the legal tie between a real-world asset and its representative digital token. More can be done, of course — for instance, introducing machine-readable policies that can update compliance software with zero or minimal manual intervention.

At the same time, projects in the blockchain space continue to provide thought leadership and remove technology hurdles by combining secure digital identity with strong online privacy (e.g., private transactions on public chains) and compliance oracles that tie digital attributes and attestations to automated policy enforcement in both the area of cryptocurrencies (e.g. compliance with the Financial Action Task Force’s Travel Rule) and digital securities.

Ultimately, digital transformation with the use of blockchain technology will lead to significant cost reductions through the elimination of many error-prone manual processes, better compliance and more effective crime-fighting through increased transparency, greater global accessibility to high-quality assets and, hence, greater financial inclusion.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.