If until now it was unthinkable for any authority in the European Union to approve a prospectus for the issue of a financial instrument represented by tokens registered in a public blockchain, the BaFin (the regulatory body for financial markets in Germany) has just done so and has approved an STO of €250,000,000 aimed at retail investors throughout the European Union.
This event is, without any doubt, the most important event of the last 12 months as far as the asset tokenization in Europe is concerned. Having said this, and without further delay, we will now analyse the main terms and conditions of the issue and the conflicts it creates with current regulations (as interpreted throughout the EU to date).
Main terms and conditions of the issuance
Below are the most relevant terms and conditions of the issuance for the analysis of the conflicts that arise with the European securities regulations and their interpretation until now.
Link to the prospectus (it has only been drafted in German).
|Issuer||Fundament RE Germany GmbH|
|Amount Issued||€262,500,000€ (€250,000,000 + 5% Premium)|
|Use of proceeds||Purchase of real estate assets for their commercial operation and future sale. €32,000,000 will be allocated to marketing, legal advice, development and distribution of ERC-20 tokens.|
|Prospectus registration date||18 July 2019|
|Tokens amortisation date||31 December 2033. The Issuer is entitled to extend the amortisation of the tokens till 31 December 2043.|
|Coupon||Floating (it will be calculated based on the revenue generated by the underlying real estate assets). Annual (it will be paid on 31 July of each year).|
|Target investor||Retail, profesional and institutional investors (although the prospectus sets out a preference for institutional investors).|
|Ranking upon insolvency||Unsecured. Subordinated (in case of insolvency of the Issuer, the tokenholders will be the last creditors to receive money).|
|Recording||ERC-20 tokens. The transfer of the tokens will be carried out on the Ethereum blockchain (on-chain). No paper certificates or other forms or electronic representations will be used for the tokens.|
|Secondary marketing trading||The Issuer has not applied for the tokens to be admitted to a secondary market (crypto exchanges are not MiFID licensed and traditional markets do not have the technology to manage wallets). The liquidity of the tokens will be through P2P transfers.|
|Allocation of tokens||No bank will act as dealer of the tokens. The Issuer will carry out the distribution of the tokens.|
|Selling restrictions||Tokens may not be sold to US citizens or to US residents, the same applies to Canada, Iran or Australia.|
Conflict with regulations and market practice
We said at the beginning that the approval of the prospectus was one of the most relevant events for asset tokenization, mainly because this prospectus has been approved without the Issuer having provided solutions to the various points of friction that regulators in other countries regarded as redflags and therefore made it impossible for token prospectuses to be approved.
1. Liquidity: To date, regulators have required projects with security tokens to provide some mechanism to provide liquidity to retail investors by admitting tokens to a regulated financial market. However, the best-known platforms were not licensed as a Multilateral Trading Facility (MTF) under MiFID II and traditional markets do not have the technology to launch and manage tokens in a public blockchain. In this case, BaFin assumes that the Issuer does not have a mechanism to provide liquidity to the tokens and yet approves the prospectus.
2. Complex financial product and marketing: In 2016, the European Financial Markets Authority (ESMA) launched a set of guidelines for issuers and investment banks to assess whether the financial product to be issued should be considered a complex financial product.
According to these guidelines, tokens would be considered as a complex financial instrument (coupon payment depends on the performance of the underlying real estate assets, the coupon calculation formula is complex and the bonds are subordinated debt of the Issuer) and, therefore, investors will have to pass an appropriateness MiFID test, otherwise they will not be able to acquire the financial product. Most retail investors would not pass the test and if the Issuer does not diligently perform the appropriateness test, it would be exposed to sanctions and having to return the money to the investors. Finally, the tools that would allow the Issuer to manage the convenience test with agility and efficiency, can represent a significant cost of between 3-5€ per investor.
In view of the above, it is shocking that BaFin approves a prospectus for a complex product aimed at retail investors which, moreover, does not take into account the MiFID II product governance guidelines that are required for traditional complex financial products.
3. Control of KYC and wallets: since the adoption of European Directive V on the prevention of money laundering and terrorist financing, emphasis has been placed on the controls of Know Your Customer and AML in the crypto environment due to the difficulty of linking a wallet to a natural person. In this case, as the tokens will follow the ERC-20 standard and can be transmitted on the Ethereum blockchain from wallets outside the Issuer’s control, although the Issuer will perform a KYC verification the first time it sells the tokens to investors, subsequent sales between the investors themselves would be outside the Issuer’s control of KYC and AML, potentially generating a contingency for non-compliance with Directive V.
In addition, it will be interesting to see how they articulate the mechanism for making coupon payments to tokenholders and how they comply with their AML obligations.
Although there are many other points of friction (e.g. FATCA or MiFID reporting of transactions with financial instruments), the elements we have analysed give a clear idea of the significance of BaFin’s decision. While most of us lawyers who have experienced in our own flesh the refusal of regulators to approve prospectuses for token issues would like to see a change in trend, we are aware that progress in STOs cannot be made at the expense of reducing the protection of retail investors. We will follow this project very closely and, who knows, maybe we are looking at the take-off of real STOs.
Lawyer – Of Counsel