Issues of tokenised shares and bonds already in Slovakia? DLT Regulation

We have tried tokenisation of assets in the Slovak legal environment several times. Whether it was a standard STO (security token offering) or the distribution of tokens representing specific values. However, we have always had to creatively set up the issuance regime from both a legal and tax and accounting point of view, in such a way that it is flexible enough for the needs of transfers on the relevant DLT and does not pose an unreasonable tax and administrative burden. At the same time, we have already written quite a bit about the legal and tax aspects of asset tokenization (for example, here: https://cryptotaxlaw.sk/) and lectured, including within the tax platform at the level of the Ministry of Finance of the Slovak Republic. Tokenisation of assets is thus a hot topic for us. That is why we are very pleased with the EU initiative and its latest, already tangible legislative action in this area.

As of 23.3.2023, the EU applies the so-called. The Regulation on a pilot regime for market infrastructures based on distributed transaction database technology (“DLT Regulation“)[1], which establishes a pilot regime for market infrastructures based on distributed transaction database technology (“DLT“) and aims to test the trading and settlement of transactions in crypto-assets that qualify as financial instruments (“tokenised financial instruments”). While until now the issuance of tokenised financial instruments in the EU has only been possible as long as Member States’ laws regulated and allowed for it, the DLT Regulation creates a legal framework for their implementation across the EU. This will not only help issuers, but also advisers, who can rely on harmonised legislation and do not need to research the relevant legislation in each Member State where the distribution or issuance is to take place.

What are tokenised financial instruments (for example, tokenised shares or bonds)?

First of all, the EU’s efforts (also outside MiCA[2]) to define basic concepts should be seen as a clear signal of the EU’s intention to have a comprehensive and uniform legislative grasp of economic transactions within the “crypto world”. The DLT Regulation therefore defines DLT as a type of technology, albeit in a rather technically complicated manner. It states that it is a ‘distributed transaction database’, which is an information repository that holds records of transactions and is shared across a set of DLT network nodes and synchronised between DLT network nodes, using a consensus mechanism (rules and procedures by which agreement is reached between DLT network nodes that a transaction is verified). In simplified terms, the NCB describes DLT as a technology that enables the sharing of records across a computer network.3 One of the most well-known types of DLT is Blockchain.

From a financial regulatory point of view, the DLT Regulation significantly interferes with some fundamental concepts of financial law. In fact, the DLT Regulation modifies MiFID II[4] by introducing a new type of financial instrument. A financial instrument is defined as a financial instrument that is issued through distributed transaction database technology. As this is a major conceptual change, The DLT Regulation introduces only the so-called. pilot scheme . Jeho výsledky sa budú postupne analyzovať, čo bude mať za následok prípadné ďalšie legislatívne úpravy.

At the same time, however, the DLT Regulation will not apply to all financial instruments, but only to those that the DLT Regulation defines as follows:

(a) Shares (subject to a limitation on the maximum or provisional market capitalisation of their issuer);

(b) Bonds, other forms of securitised debt or money market instruments (the limitations are primarily on the maximum amount of the issue and such a financial instrument cannot contain a derivative); and

(c) Some shares or interests in so-called. UCITS funds

(“Tokenised Financial Instruments“).

In practice, this means that in the Slovak legal environment it should be possible to issue only the above mentioned Tokenised Financial Instruments under DLT.

Legal framework for the issuance of Tokenised Financial Instruments

DLT The tool creates the so-called. It creates a DLT market infrastructure to exist alongside the infrastructure for trading and settling trades in existing financial instruments. This new infrastructure consists of the following systems:

(a) DLT Multilateral Trading Facility (“DLT MTF“), which is a multilateral trading facility that only accepts Tokenised Financial Instruments for trading;

(b) DLT Settlement System (“DLT SS“), which is a settlement system that settles transactions in Tokenised Financial Instruments against payment or against delivery; and

(c) the DLT Trading and Settlement System (“DLT TSS“), which combines the services provided by the DLT MTF and the DLT SS.

Tokenised financial instruments will be admitted to trading on the DLT MTF, respectively. DLT TSS, while the settlement of these financial instruments will take place on DLT SS, resp. The issuance and subsequent trading of Tokenised Financial Instruments will be subject to the current regulation that also applies to “non-tokenised” financial instruments (in particular the Central Securities Depositories Regulation[5] and the Markets in Financial Instruments Regulation[6]), however, the DLT Regulation allows for certain exemptions to apply in certain circumstances. Among the most important exemptions of this pilot regime are:

(a) Elimination of the obligation to report full and accurate details of transactions in financial instruments.

(b) Exclusion of provisions on book-entry form, transfer order and securities account. Thus, the DLT Regulation does not create a separate category of “tokenized” form of a security, but if the book-entry form is incompatible with DLT under the law of a Member State, it may not apply for the purposes of the Tokenized Financial Instruments.

(c) Exclusion of financial settlement provisions. Settlement of Tokenised Financial Instruments will also be possible through non-cash money, also in tokenised form or also through electronic money tokens.

Who will operate and provide the infrastructure for the issuance of tokenised financial instruments?

To operate DLT systems, it will be necessary to obtain a permit from the National Bank of Slovakia. The operation of DLT MTF, resp. For example, a securities trader or an exchange will be able to apply for a DLT TSS. A central depository will be able to apply to operate a DLT SS. At the same time, other legal entities will also be able to apply for authorisation to operate DLT systems if they also apply for the relevant “parallel” authorisations (in a non-DLT environment), e.g. However, they will also be able to apply for a permit to the extent that it is sufficient for them to operate exclusively in the DLT environment).

Special permits to operate DLT systems will be valid throughout the EU, but only for a period of six years, given that the DLT Regulation constitutes a test regime for the issuance of Tokenised Securities.

Who will the issuance of Tokenised Financial Instruments be for in practice?

As it follows from the above, the DLT Regulation creates a pilot scheme consisting in the creation of infrastructures that are parallel to the existing infrastructures in the current financial market (depositary, MTF). At the same time, the applicability of this pilot scheme in individual Member States may vary depending on what regulation of tokenised financial instruments already exists in the national legislation of individual Member States. The European Securities and Markets Authority (“ESMA“) in its opinion on the DLT pilot regime[7] dated 27 September 2022 states[8] inter alia that:

(a) DLT Regulation should allow not only the tokenization of existing (issued) financial instruments, but also the issuance of new “from inception” tokenized financial instruments; and

(b) DLT Regulation will also allow OTC trading of Tokenised Financial Instruments.

Motivation for financial market participants to use DLT infrastructure for the purpose of issuing Tokenised Financial Instruments, resp. In particular: (i) transparency, (ii) eliminating the need for intermediation (facilitating direct access to secondary markets); and (iii) efficiency (e.g. real-time execution of transactions).

Change to the Securities Act

In order to implement the changes of MiFID II into the Slovak legal order, an amendment to the Securities Act[9] was submitted to the National Assembly of the Slovak Republic on 23 February 2023, which provides, among other things, that financial instruments are also considered to be financial instruments that are issued through distributed transaction database technology. The proposed effective date of the amendment is 1.7.2023. Thus, to this extent, the Slovak Republic has taken the opportunity of an extension of the deadline to align its legislation with the DLT Regulation effective as of 23.3.2023.

[1] Regulation (EU) 2022/858 of the European Parliament and of the Council of 30 May 2022 on a pilot regime for market infrastructures based on distributed transaction database technology and amending Regulations (EU) No 600/2014 and (EU) No 909/2014 and Directive 2014/65/EU

[2] Regulation of the European Parliament and of the Council on cryptoassets markets and amending Directive (EU) 2019/1937

[3] https://nbs.sk/dohlad-nad-financnym-trhom/fintech/technologia-distribuovanych-zaznamov-dlt/

[4] Directive 2014/65/EU of the European Parliament and of the Council of 15. on markets in financial instruments amending Directive 2002/92/EC and Directive 2011/61/EU

[5] Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving the settlement of securities transactions in the European Union, central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012

[6] Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012

[7] https://www.esma.europa.eu/sites/default/files/library/esma70-460-111_report_on_the_dlt_pilot_regime.pdf

[8] The opinion is not legally binding, but it allows us to better understand the purpose and possibilities that the DLT Regulation brings.

[9] https://www.nrsr.sk/web/Default.aspx?sid=zakony/zakon&MasterID=9153

If you are interested in this topic, please do not hesitate to contact us.