In its search for innovation, Malta, nicknamed the Blockchain Island, has attracted numerous investors who seek to learn how they may prosper by engaging in crypto business in Malta. With the decline of the ICO, issuers are seeking to raise capital through securitised tokens (STOs), which is deemed to offer more legal certainty and security for investors than the ICOs which have been very popular in 2017 and 2018. In this regard the regulator has issued a consultation paper on such issues, to tackle the divergences in law between a traditional securities issue and the new security token concept, which has left a number of unanswered questions to be dealt with, especially when dealing with the technical aspect of the issues. Apart from the latter objective, this Consultation Paper also represents the first step towards a revised local capital markets strategy.
In order to deal thoroughly with all aspects of STOs, the Consultation Paper has been divided into six different sections, whose main points shall be reflected upon hereunder.
1) Defining STOs
The MFSA is proposing to distinguish between two different types of STOs: those involving traditional transferable securities such as shares, bonds, and derivatives, which are referred to as “Traditional STOs” and those involving a technology representation, like for instance a token which are referred to as “Other STOs”. Both of these STOs are intrinsically dependent upon or utilises Distributed Ledger Technology (DLT); however, the MFSA is proposing to initially limit the suggested framework to Traditional STOs, with the reason being that further analysis of the risks and challenges represented by the Other STOs is needed.
2) Applications for approval of prospectuses and/or admissibility to listing and trading of Traditional STOs
A matter which has been debated upon and which falls under this heading is that of what should be the legal nature of the issuing entity in order for it to register a prospectus or apply for admissibility to the listing. The MFSA has been presented with proposals of various possible corporate structures including foundations, trusts, and securitisation cell companies. Notwithstanding the numerous options, the MFSA is suggesting a cautious approach by firstly limiting applications to limited liability companies. Other possible structures may then be introduced later on after a full review of their impact vis-à-vis regulatory requisites.
Upon receipt of an application, the MFSA highlights the need for there to be carried out an assessment of an applicant’s financial soundness; corporate governance and compliance with transparency requirements. In order to evaluate an issuer’s financial soundness, the MFSA would check upon his insolvency and it may consider it necessary to ask him to draw up a Financial Due Diligence Report. The second requisite regarding corporate governance then entails that the board of directors of a prospective issuer has sufficient knowledge and understanding of the issuer’s business in its entirety. In the event that such board is responsible for the innovative technology arrangements underpinning the storage and transaction in the securities, it should be ensured that there is also a Systems Auditor in order to prepare a systems audit report. Lastly, in order for the transparency requirement to be satisfied, the MFSA is recommending that when an issuer would like to offer and/or list a Traditional STO on a Regulated Market in Malta and Malta is deemed as the Home Member State in terms of the Prospectus Regulation, that issuer/offeror would need to submit a detailed prospectus to the Authority for its approval.
3) Additional ongoing obligations following an Offer and/or Listing and/or Trading of Traditional STOs
A further requirement that the MFSA is considering relates to when Companies, who would like to issue a security token, actually own the DLT platform on which the token is issued. In this regard, the MFSA is proposing that companies operating their own DLT should be required to prepare annually a Type 2 Systems Audit in line with MDIA rules. Such a requirement would however only typically apply to issuers which have not listed their securities for trading, since in such cases the requirement of a central securities depository kicks in.
4) Secondary Markets
Efficient trading venues are fundamental in ascertaining effective secondary markets, which are currently lacking in number. In the context of DLT, trading venues can be structured to operate and function in two different ways: a centralised exchange system or a decentralised exchange system. In the consultation paper, the MFSA explores the differences between the two and proposes that, for the scope of Traditional STOs, a decentralised system needs to be permissioned, allowing solely intermediaries with a MiFID II licence to be the users of the chain and provide direct electronic access for the DLT to their clients. This would in turn ascertain that there is proper adherence with MiFID/MiFIR transaction reporting requirements.
5) Market Abuse Regulation
In order to be in line with Regulation EU 596/2014 on Market Abuse and to safeguard market integrity, it was only to be expected for the consultation paper to include also provisions deterring illicit market practices. In this regard, the MFSA is seeking to regulate better trading venues by making it expressly obligatory for them to have in place effective arrangements, systems and procedures aimed at preventing, detecting and reporting market abuse. Moreover, the MFSA suggests that amongst other criteria, the issuers of Traditional STOs should disclose inside information as soon as possible, and that managers should notify the MFSA of every transaction carried out on their own account or by closely associated persons. The identities of parties involved in every transaction should also be known and verified; with this in mind, the MFSA once again discourages the use of permission-less systems, given that investors could access trading platforms directly, without the involvement of an authorised intermediary, and thus, this may increase the chances of their identity remaining unknown.
6) Post- Trade Settlement
In its consultation paper, the MFSA has also examined the need for a CSD and a Securities Settlement System (SSS). Apart from enunciating the indispensability for there to be operational and settlement certainty in this regard, the MFSA is also seeking to obtain legal certainty in terms of what governing law should apply given that the participants in the DLT may be dispersed across multiple jurisdictions. The CSD, being the central authority would be the natural candidate to act as an anchor to governing law; alternatively, upon registration for active participation in the DLT, the participants would be required to sign up to a particular governing law which allows the CSD to choose the law of the jurisdiction in which its operating platform is based.
The way forward
The Consultation Paper represents Malta’s seriousness and determination to regulate well this sector. It is one of the initial steps taken by the MFSA to achieve its Vision 2021, which Joseph Cuschieri, the MFSA CEO has promised to be “the start of a transformative journey supported by an ambitious change programme focused on innovation, investment in FinTech and RegTech, modernisation of supervision, and technological development.” The Consultation period regarding this Consultation Document is open to the public until the 30th of August 2019, and all industry participants and interested parties are encouraged to send their feedback to the MFSA.