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20190316 - CLBFest - Blockchain & the law - Willem Van de Wiele

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Willem (https://twitter.com/WVandewieleW) took it upon him to update us on the legal aspects of blockchain and crypto-assets:
(1) at the EU level
a) the 2018 FinTech Action plan: https://ec.europa.eu/info/publications/180308-action-plan-fintech_en
b) the 2019 ESMA report: https://www.esma.europa.eu/system/files_force/library/esma50-157-1391_crypto_advice.pdf
c) the 2019 EBA report: https://eba.europa.eu/-/eba-reports-on-crypto-assets

(2) at the national level
a) Luxembourg
b) France
c) Italy
d) Germany

The context was the second (2019) edition of the Computational Law and Blockchain Festival (#CLBFest), Brussels' node.

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20190316 - CLBFest - Blockchain & the law - Willem Van de Wiele

  1. 1. Blockchain & Law An update 2019 Computational Law & Blockchain Festival 16 March 2019
  2. 2. Introduction  Overview of recent EU statements  Focus on some selected national initiatives  Regulatory policy approaches  New issues arising 1
  3. 3. New EU Statements  Background: EU Fintech Action Plan [2018]  Two different reports – European Securities and Markets Authority (ESMA) – European Banking Authority (EBA)  Relevancy of the reports – Reports are advice, not binding regulation – Guidance about the interpretation of the current legal framework – Indication about possible new areas of regulation 2
  4. 4. 3
  5. 5. ESMA Report – Key Considerations Risks • At this stage – no financial stability issues • Fraud • Cyberattack • Market integrity and market manipulation • Consumer protection • Money laundering Benefits • Recognition that there are benefits, but early stage nature of technology • Tokenization, facilitating the issuance process, enhancing liquidity of financial assets (unlisted shares, syndicated loans), reducing the need for intermediaries • Introduction of smart contracts in order to automate the execution of contract obligations (reducing risks and costs) 4
  6. 6. ESMA - Legal Framework Lack of clarity • Need to clarify the application of existing regulations Existing regulation not adapted • Need to reconsider existing regulations (Perceived) gaps in regulation • Consider need for new regulations 5
  7. 7. ESMA – Legal Status of Crypto-assets • Profit rights attached • Without having necessarily governance rights attached • Financial instruments Investment type • E.g. “voucher” • [Howey-test?] • No financial instruments Utility type • [Bitcoin] • “Unlikely to qualify as financial instruments” Pure payment type crypto-assets • Combination of different characteristics • Assessment to be made on a case by case basisHybrid instruments 6
  8. 8. ESMA – Application Existing Framework  Wide range of EU financial regulations  Business model chosen will have impact on the concrete application of the EU financial regulations  Lack of clarity and precedents about application of certain regulations  Guidance likely to continue to evolve … 7
  9. 9. ESMA – Prospectus Regulation Scope of application of the Prospectus Regulation • Investigate possibility to rely on safe harbours Application of Prospectus Regulation • Prospectus Regulation follows certain « disclosure schedules » • No specific schedules for ICOs/crypto-assets • Concept of seeking adapated information? 8
  10. 10. Prospectus (Example Belgium) 9
  11. 11. ESMA - Transparency Directive Transparency Directive • Disclosure of accurate, comprehensive and timely information about issuers whose securities are admitted on regulated market Application • Will depend on whether certain crypto-assets will be admitted to “regulated markets” 10
  12. 12. 11
  13. 13. ESMA – MiFID II  MiFID II: regulation of financial services and activities in relation to financial instruments  ESMA focus on the applicability of MiFID II to trading platforms 12
  14. 14. ESMA – Trading Platforms Platforms trading crypto- assets with central order book and/or matching orders under other trading plaforms Regulated Markets (managed by market operator) Multilateral Trading Facilities (market operator/investment firm) Organized Trading Facilities (market operator/investment firm) Operators dealing on own account and executing orders against their propietary capital Broker/dealers providing MiFD II services Platforms used to advertise buying and selling interests, no genuine trade execution or arranging taking place Bulletin boards outside the scope of MiFID II 13
  15. 15. ESMA – Trading Platforms Capital requirements •Minimum capital requirements Organizational requirements •Rules and procedures for fair and orderly trading •Resilience, circuit breakers and electronic trading and tick sizes •Monitor compliance as members •Listing admission (depending on type of platform) Market access •Transparent and non- discriminatory rules for access to their facilities •Organizational requirements for members Pre-and post trade transparency •Information pre- and post-trading Transaction reporting and obligations to maintain records •Reporting on transactions to authorities 14
  16. 16. ESMA – Trading platforms  No clearly identified operator for decentralized platforms?  Conducting checks on individual members is time and resource intensive and requiring these test may result in loss of advantages of disintermediation?  Lack of consistent application of transparency requirements across member states?  Current reporting technical standards not adapted to cryptocurrencies 15
  17. 17. ESMA – Market Abuse and Short Selling Regulation  Market Abuse Regulation – Disclosure of inside information – Market manipulation  Issues – Manipulative trading activity in crypto-assets not qualifying as financial instruments – New abuse behaviours (information held by miners, wallet providers 16
  18. 18. 17
  19. 19. ESMA – Settlement Finality (SFD) and Central Securities Depositories Regulation (CSDR)  Securities settlement system – formal arrangement between 3 or more participants – with common rules and standarized arrangements – for the clearing or execution of transfer order orders – designated as a system by the Member State 18
  20. 20. ESMA – SFD and CSDR  Identification of a system operator and autorisation as a Central Securities Depository  Participants in the system: only certain regulated institutions (banks, investment firms)  Settlement periods and settlement discipline – Delivery versus Payment and cash leg? 19
  21. 21. ESMA – CSDR – Book-entry form  Where crypto-assets qualify as transferable securities and are trade on trading venues, their issuer shall arrange for such securities to be represented in book- entry form with an authorized CSD  Particular form of initial book-entry form determined by national law, but must be with an authorized CSD 20
  22. 22. ESMA – AML  Bring in scope of AML regulations – Providers of exchange services between crypto-assets – Providers of financial services for ICOs 21
  23. 23. ESMA – gaps (1) • Having control of private keys could be considered as custody • Technical changes to existing requirements Custody and safekeeping • Greater certainty about application of these concepts • Governance issues with permissionless DLTs • Role of miners Concepts of settlement and settlement finality • Potential need for enhanced requirements • Novel cybersecurity risks Risks regarding technology 22
  24. 24. ESMA – Gaps (2)  Dealing with situations where there is no platform operator  Adapting pre- and post-trade transparency requirements  Reporting requirements  Study of interaction between crypto-assets and other financial instruments 23
  25. 25. ESMA – Non-financial crypto  2 options – Bespoke Regime? – Do nothing? 24
  26. 26. European Banking Authority  Application of current legal framework – Electronic Money • Token issued on the receipt of fiat currency and is pegged to that fiat currency • Certain other specific cases – Payment Services Directive • Payment services in connection with a crypto-currency that qualifies as electronic money 25
  27. 27. European Banking Authority  “Advice on need for further advice” – No threat for financial stability – However, following issues identified • Crypto-assets custodian wallet provision and crypto-asset trading not regulated • Consumer protection and market integrity • Emergence of divergent approaches – concern about level playing field 26
  28. 28. European Banking Authority  Holistic approach  Activities based approach  Access points to traditional financial system  Coordinated international approch  Future proofing 27
  29. 29. National initiatives - Luxembourg 28
  30. 30. 29
  31. 31. National initiatives - France  « Loi Pacte » – Specific French regime for ICOs – Concerns regarding scope? – Not yet adopted  « Ordonnance Blockchain » 30
  32. 32. 31
  33. 33. National initiatives - Italy 32
  34. 34. National initiatives - Germany  German Blockchain Action Plan  Ongoing consultation 33
  35. 35. 34
  36. 36. Smart contracts: legal framework • Potentially less an issue in permissioned ledgerContract formation • Potentially less an issue in permissioned ledgersEvidence • No possibility to cancel a contract (e.g. when questions around validity arise) • Contracts could be programmed as impossible to breach – no efficient breach possible • Elasticity can have a positive side Self-enforcing nature vs. classic contract doctrines • General considerations are relevant herePrivacy and data protection • Who is responsible for the code? (Governance) • Cf. developments regardng High Frequency Trading – Code to be compliant with existing legislation and need to monitor compliance “Management of the code” • Who is responsible for the code? Liability issues around irreversible and automatically executed contracts 35
  37. 37. Smart contracts: due diligence New need for type of legal and technical due diligence • Cf. “test environments” under MiFID II (algo trading) • Transactional/specialist lawyers, smart contract lawyers and code lawyers • “The lost tribe”: need to bring lawyers and coders together Interesting new questions “spirit of the law/code” 36
  38. 38. Consortia and IP  Consider implications of the use of “open source” software  Consider the impact of agreements within certain consortia and the impact on intellectual property rights (cf. Hyperledger project and licenses) 37
  39. 39. 38
  40. 40. IP: Race to secure protection  “Blockchain is very intriguing for us, the technology is fascinating. It’s very important in the intellectual property world to reserve our spot even before we know what the commercial application may be” (Catherine Bessant, Bank of America, WEF, 2016)  Various patents requested by different institutions (data analytics, IOT, mobile platform, security, cloud computing, crypotocurrency)  Race to secure protection: the story of the Wright Brothers and airplanes in the United States 39
  41. 41. RegTech: general considerations •Financial institutions that pursue strategies not aligned with future regulatory schemes might have to change course, perhaps at significant cost Uncertain development paths •careful due diligence on every potential regtech partner to ensure their systems are secure and protected against cyberattacks and data breachesProvider reliability •Systems that provide regulators with greater access to data may also invite greater scrutiny, enabling regulators to analyze such information however they see fit Increased regulatory scrutiny •At a minimum, financial institutions and regulators should build gates into their systems that enable people to conduct checks and exercise judgment in complex scenarios. Limited judgment •Any time an organization collects data about individuals, it must take steps to ensure it does not violate privacy rules. This can be particularly difficult because rules often vary by jurisdiction. Privacy 40
  42. 42. Innovation: Governance and Compliance NBB best practices • Governance and organization • Internal control functions • IT systems • Data management • Consider risks of using fintech 41
  43. 43. Innovation: Governance and Compliance • Develop and implement an innovation strategy • Board members with expertise, combined with advisory panel • Identifable innovation function with bank (executive board member as head of innovation • Involve staff from different background and functions, including compliance • Innovation friendly culture • Human resources strategy Governance and organization 42
  44. 44. Innovation: Governance and Compliance • Develop and implement an innovation strategy • Board members with expertise, combined with advisory panel • Identifable innovation function with bank (executive board member as head of innovation • Involve staff from different background and functions, including compliance • Innovation friendly culture • Human resources strategy Governance and organization 43
  45. 45. Innovation: Governance and Compliance • Strong involvement of independent control functions • Involve risk and compliance functions at an early stage in the development of products and services, while maintaining their independence • Clear policy for partnerships (start-ups and Bigtech) Internal control functions 44
  46. 46. Innovation: Governance and Compliance • Link with legacy systems • Consider use of cloud computing [?] • Cybersecurity and resilience IT systems • Proper data management and quality • Swift, broad and continuous access Data management 45
  47. 47. Some observations to conclude  Early days - increased scrutiny  All about the model – e.g. permissioned/permissionless  Watch the status quo - impact existing regulation 46
  48. 48. Some observations to conclude  Enabling legislation – welcoming jurisdictions  Beyond financial regulation, e.g. GDPR  Beyond legal aspects e.g. governance, standard setting 47
  49. 49. Long Term Considerations  Interaction with AI  Geopolitical issues  Governance issues  Antitrust and competition law issues  “Who will control the decentralized infrastructures?” 48
  50. 50. Contact details Willem.vandewiele@whitecase.com Twitter @WVandeWieleW Tel. +32 2 239 25 75 49