In our first part, we have already dealt with the core questions and problems related to the safekeeping of digital assets under investment law.
Now the long-awaited “Draft Bill for a Law on the Introduction of Electronic Securities” (the “draft bill”) has been published. Some of our previous key questions and problems have been answered or further discussed. In view of this, based on the first part of our publication, we would like to pick up on some of the key points and look at them further below:
Which license is needed for crypto custody and register keeping services?
As already explained, a crypto custody license is required for the safekeeping, administration and protection of crypto assets or private cryptographic keys that are used to hold, store or transfer crypto assets for others (Sec. 1 para. 1a no. 6 KWG (German Banking Act) in conjunction with Sec. 32 para. 1 sentence 1 KWG). Even after the implementation of the draft bill there will be no change in the basic obligation to obtain permission. However, “crypto securities” (which in the future will be considered securities within the meaning of the DepotG (German Securities Deposit Act) have now also been expressly included in the crypto custody definition as crypto assets that can be held in safe custody. From the explanatory note to the draft bill it follows for the future that their safekeeping and administration as well as the safekeeping and administration of securities are subject to the custody business according to Sec. 1 para. 1 sentence 2 no. 5 KWG. The safekeeping and administration of crypto securities are therefore also covered by the custody business. This corresponds to the previous concept of the crypto custody business, as far as securities are concerned. Thus, depositaries which have a permission for the deposit business can in the future also keep corresponding cryptographic keys in the context of the deposit business with crypto securities. An additional licence for the crypto custody business is not required for this purpose.
Nothing else should also apply to branches of EEA institutions, which offer the deposit business in Germany as a passported business (Sec. 53b KWG). This would be a change of the legal situation compared to the current legal situation. Since at present from the BaFin Guidance notice – guidelines concerning the statutory definition of crypto custody business and from the Guidelines on applications for authorisation for crypto custody business it is to be understood that for the crypto custody business the application of the license is necessary by a firm resident in Germany and no passporting is possible.
In addition, the draft bill introduces or expands the KWG’s scope of permissions without changing the requirement for a crypto custody license. Thus, the “central register of electronic securities” (Sec. 12 eWpG (Law on Electronic Securities) ) and the crypto securities register (Sec. 16 eWpG) were introduced by the draft bill. While it was clarified for the central register of electronic securities that these, too, are to be kept by a central securities depository (CSD) (cf. Sec. 1 para. 1 sentence 2 no. 6 in conjunction with para. 6 KWG), the draft bill introduced a new activity requiring authorization for other institutions with the “crypt securities register keeper” (Sec. 1 para. 1a no. 8 KWG n.F.).
It is interesting in this context that the CSD (as it already does not need a licence for crypto custody business) can offer the registry keeping activity directly to electronic securities and does not have to apply for any additional license.
Unregulated companies that intend to offer crypto custody and crypto securities registry keeping services to the German market basically need two different licenses for these services. In the future, the crypto security register keeper will require equity capital of at least EUR 730,000 (Sec. 33 para. 1 sentence 1 no. 1 letter c KWG). Crypto security register keepers must essentially comply with the regulations on significant shareholders (Sec. 2c KWG), on reporting obligations (Sec. 24 KWG), on organizational obligations (Sec. 25a KWG – concretized by MaRisk and BAIT), on initial capital and managers (Sec. 33 KWG) as well as on the submission of annual financial statements and the performance of an annual audit (Sec. 26 and 28 KWG). In addition, they are also subject to anti-money laundering regulations and must comply with regulations on internal security measures (Sec. 25h KWG) and on increased due diligence (Sec. 25k KWG). They are also obligated within the meaning of Sec. 2 para. 1 no. 2 GwG (Money Laundering Act).
Are custodians in Germany allowed to apply for the crypto custody and crypto securities register license?
Contrary to what we explained in our first part, in the future foreign custodians would not have to establish a new firm in Germany or spin off the German branch as a subsidiary to hold crypto securities for German customers. This activity would probably be included in their passported custody business.
The situation is different, however, with the crypto securities register keeper, for which the draft bill does not make a clear statement. The draft bill (Sec. 7 para. 4 eWpG) clarifies that the register keeper as such is not a custody business in the sense of the German Securities Deposit Act and therefore not a custody business per se. The aim of register keeper is to make available and maintain an issuing infrastructure for electronic securities. Issuing means in principle the first issue, including the script, as well as the subsequent second issues (disposals) of the registered electronic securities. However, the keeping of the register can be classified in the overall view as safe custody in the sense of the Custody Act if the register keeper itself is entered in the register as a custodian, e.g. the central depository for securities. In this way, the custody business could also cover the crypts securities register keeping. Then it could be also that the activity within the scope of the deposit business would be included in the passported deposit business.
How to custody crypto assets?
Apart from obtaining the crypto custody license, there are further challenges for the custody of the crypto assets.
For the custody of assets, the custodian (Sec. 81 para. 1 no. 1 and no. 2 KAGB (German Capital Investment Code) shall either:
- provide safekeeping services to financial instruments within the meaning of MiFID or
- for other assets (non-financial instruments) to provide checks of the ownership situation.
As long as crypto assets are not financial instruments within the meaning of MiFID (this could change in the future with the Markets in Crypto Assets Directive), it is obvious to classify crypto assets as other assets. For the examination of the ownership in the asset, the draft law now provides clarification.
Since, in the case of electronic securities, it is not possible to determine the applicable law according to the location of the asset (in this case the securities certificate), and since the securities register is also difficult to locate in the case of electronic register keeping, the law of the state under whose supervision the register keeper is registered should apply. In the case of the central register of electronic securities, this would be governed by the law of the CSD and its jurisdiction. In the case of the crypt securities register keeper, on the other hand, this could only be German law, assuming that only German institutions with a KWG license may offer the crypto securities register keeping. If, on the other hand, one were to assume in the future that branches of an EEA institute may also offer the crypto securities register keeping in Germany, the law of the home country would apply, since the respective EEA institutes are supervised by the supervision of their home country.
The draft bill could already become a bill at the end of this year. Until then, the draft could still change and the explanatory notes to the law could be expanded. If the draft law is passed promptly, the new act for electronic securities and crypto securities should apply in Germany from 2021. On the European level, a first draft of the Markets in Crypto Assets Directive is announced. In this context, it is interesting to see what will remain of the German crypto regulation as soon as a European directive is implemented.
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