Tech
A new technology law in Switzerland secures the legal environment and allows blockchain to thrive
In September 2020, Switzerland passed reforms collectively called the Distributed Ledger Technology (DLT) Act. The parts of the DLT Law that allow for the introduction of register-based securities came into force on 1 February 2021.
Part of this law introduces newly defined uncertificated registry securities or “Registerwertrecht” – digital securities that can be transferred without banks or intermediaries, unlike traditional securities. What implications does this new security category have for the issuance and trading of digital assets?
This new formal type of security is important because it creates legal certainty regarding the ownership and transfer of those tokens, in particular that (a) they represent a claim against third parties (e.g. right to payment of interest against the issuer of the token ) or (b) a company right under company law and can therefore be considered a guarantee. These “counterparty tokens” include tokens that are not pure payment tokens (such as cryptocurrencies like Bitcoin and Ethereum) or pure utility tokens.
Legal certainty is important to access the full potential of blockchain technology and enable Switzerland to maintain its position as an attractive destination for the issuance of DLT-based securities.
According to Swiss law, credits can only be transferred in writing. This means that theoretically an assignment contract must be signed manually or via digital signature. As it stands, if a request token is transferred without one of these, the transfer is effectively neither valid nor legally binding. However, this additional administrative layer is useless in the context of automated DLT applications.
Under the new law, these tokens will be able to be issued and transferred as uncertified registry securities within the token registry and DLT system without the anachronistic signature procedure. This legal framework provides further certainty regarding the valid transfer of ownership of such securities and places Switzerland ahead of most jurisdictions.
Could a company with common shares listed on the Swiss Stock Exchange and wishing to issue digital equity securities face legal or administrative challenges?
The company would have to amend its articles of association to include uncertified registry securities that would require shareholder consent and related formalities such as certification by a notary.
It is basically possible for a company to issue securities using different methods (such as traditional physical issuance of shares and issuance of uncertificated registry-registered securities) while a shareholding register on the blockchain is considered a valid shareholder register. However, the company should ideally maintain in some way a consolidated overview of the securities held in the different shareholder registers.
DLT trading facilities were introduced as a new type of exchange for digital assets, enabling trading by private clients, trading of cryptocurrencies (as a secondary activity to trading DLT securities), and on-chain settlement. However, CCPs still play a role in terms of clearing and supervision. Is there still a long way to go before we see a fully decentralized cryptocurrency platform operating in Switzerland?
At the moment, we are only halfway between the traditional world and what will likely turn out to be a more decentralized world with this new legislation – and that is the key.
The new law does not provide a legal basis for fully decentralized structures. The principle is to maintain an entity that controls the DLT trading structure and is responsible if something goes wrong, and that means fitting the new technology into the existing legal framework.
These DTL trading institutions are traditional institutions, meaning they are companies established with a license from the regulator to operate a DLT trading facility. The setup is still conventional, at least in terms of licensing requirements. The company will have to demonstrate to the Swiss Financial Market Supervisory Authority (FINMA) that it has sufficient guarantees in terms of capital reserves and operational structures to manage onboarding and trading, including compliance (AML, KYC).
The novelty concerns the way in which trading takes place using DLT securities. Furthermore, there are new implications in terms of combining and automating clearing, settlement and payment. Everything else is quite traditional.
The new regulatory framework for custody providers clarifies the treatment of digital assets in the event of custodian bankruptcy (in favor of customers). Does this improve custodial services from a customer or intuitive perspective?
The new DLT law clarifies that in the event of bankruptcy of the custodian, the digital assets do not become part of the bankruptcy estate but are assigned directly to the customer in certain circumstances. This represents a great advantage for the customer as the counterparty risk is largely eliminated.
It is necessary that the assets are assigned to a specific client and have been issued, for example on the basis of DLT. However, it is not necessary to record the assignment to a customer on the blockchain itself. This means that institutions can hold digital assets in omnibus accounts, which is beneficial for institutions from an operational and cost perspective. In extreme cases, an Excel table could theoretically be sufficient for the allocation of digital assets, although such a solution cannot be expected to be accepted by FINMA or the auditor.
It is also very positive for the institution because the asset is not held on its balance sheet and as such does not attract liquidity or capital requirements.
The SEC’s action against Ripple Labs (the company behind the XRP token) has brought to the fore the discussion of what constitutes “digital asset security” in the United States. How important is the distinction between cryptocurrencies and securities and how are they considered in Switzerland?
In the United States, Ripple’s control of XRP has led to legal action by the SEC on the grounds that XRP is a security.
From a Swiss legal perspective, the use of the token is the determining factor. If the functionality is limited exclusively to payments, the token is generally not considered a security in Switzerland. If cryptocurrency does not constitute a right against a third party, it generally does not constitute a security in the legal sense. Even if the token has voting rights associated with it, for example to determine protocol changes, the token is still unlikely to be classified as a security; it is more likely to be considered a utility token.
The classification of Bitcoin as a financial instrument has also been highly debated in various jurisdictions. In Switzerland, however, it is clear that Bitcoin and other payment tokens are private means of payment and therefore not securities.
These clear definitions make issuing cryptocurrencies in Switzerland attractive as they provide legal certainty. In the United States, for example, authorities are much quicker to consider a token as a risky security.
In case the token does not qualify as a security or financial instrument, there are much fewer legal and regulatory requirements from a financial market perspective. For example, trading in securities requires a securities trading license, which is not the case for trading exclusively in cryptocurrencies in Switzerland.
Furthermore, institutions that manage or advise on financial instruments must meet additional requirements in terms of verifying the suitability and suitability of the product for a client.
How is DLT regulated in Switzerland and how does the process of changing laws and regulations work? Is it significant that Switzerland changed existing federal laws instead of creating new legislation?
Unlike Liechtenstein, Gibraltar or Malta, Switzerland does not have specific legislation regarding DLT.
The new law that comes into force is not actually a stand-alone law and is formulated largely in a technology-neutral way. It is, in fact, a general act that amends existing laws, including specific amendments to civil law (regarding securities), the Financial Market Infrastructure Law (DLT Trading System), the Banking Law and securities regulations. failures.
Personally, I think it’s a good way to approach the question because we don’t know what future technological innovations will emerge. If we create a new law specifically for existing innovations, it will potentially need to be constantly adapted. The wording of changes should be as principled as possible to easily accommodate future changes.
Furthermore, having a single and autonomous law becomes a challenge when it is necessary to implement it. If there is not a sufficiently close connection with the existing legal framework, questions will arise and gaps will exist, at least until practice and jurisprudence catch up.
Interview conducted by Stephanie Hurry, Olabisi Ayodeji, Matteo Conti and Emon Goswami
PwC’s banking, fintech and blockchain legal services include regulatory guidance and legal advice for both established financial institutions and start-ups.
This is the eleventh edition of Fintech Chain Mail. You can access the complete series Here.