When it comes to choosing a jurisdiction for a digital securities offering, Malta is among the first on the list. In the course of the past several years, Malta has taken a unique position as the “blockchain island”, fostering technological innovation by introducing advanced blockchain legislation, friendly tax policies and progressive approach to regulation.
This article provides a comprehensive overview of the legal status of digital securities in Malta, based on the months of research and personal communication with Maltese regulator and local lawyers, while we have been structuring our platform for digital securities offering on the island.
Digital securities on Malta are regulated, first and foremost, by traditional legislation on financial instruments and services, the most important of them being the Companies Act and Investment Services Act. These acts incorporate themselves into provision of the EU legislation, namely MiFID II, Prospectus Regulation and others.
Apart from the existing set of laws, Malta has also introduced a specific legislation on innovative blockchain-based financial instruments that defines what should be regulated by the traditional legislation and what falls under the scope of the new ones.
This approach is different from the one adopted by countries with a common law system that don’t require a specific legislation to define the legal status of an innovative object, relying on the existing one instead.
There are three main acts referring to the digital securities particularly:
- Virtual Financial Assets (VFA Act), which defines DLT-based assets and the rules governing them
- Malta Digital Innovation Authority (MDIA), which established MDIA as a governing entity and its role in regulating blockchain companies
- The Innovation Technology Arrangements & Services (ITAS), which introduced the term “innovative technology arrangement”, the procedure and conditions for the licensing
A separate act regarding STOs as a fundraising method is currently under development.
Apart from that, there are several guidelines and strategies. The most relevant of them are the MFSA STO Consultation Paper that outlines the MFSA approach to STO and MFSA Fintech Strategy, which, inter alia, discusses plans to establish regulatory sandbox for fintech ventures.
Below, I am taking a closer look at the most important aspects of the existing legislation.
There are two main regulatory bodies governing digital securities on Malta: The Malta Financial Services Authority (MFSA) and The Malta Digital Innovation Authority (MDIA).
MFSA is the single regulator of financial services in Malta, which regulates both financial services providers and issuers of any types of financial instruments. This has two implications for digital securities issuers:
- They need to work with MFSA-licensed service providers
- Their offering has to be approved by the MFSA
The role of MDIA is to set and enforce rules and standards for technological innovation. In digital securities regard, the regulator reviews and authorizes the technical infrastructure of crypto and security token exchanges and other infrastructural projects to make sure they are reliable and secure.
In order to get an MFSA (prevailing financial authority) license, you do not necessarily need MDIA authorization – in most cases, system audit is enough and MDIA opinion remain voluntary. However, if transaction volumes exceed certain levels, the authorization by the latter becomes mandatory.
Obviously, MDIA has limited bandwidth and cannot check every application for authorization itself, so the regulator attracts third-party MDIA-licensed system auditors to review the technical blueprint of the suggested system. There are currently five of them, including consulting giants KPMG and PwC. Once the audit is done, MDIA makes the final decision to grant the authorization based on the auditor assessment, business model, senior management personalities and qualifying shareholders of the innovative technology company.
The competent authorities are pursuing three priority goals: protecting investors, supporting
Malta’s reputation of the “center for excellence for technological innovation” and promoting healthy competition and choice.
The strong focus on reputation makes Malta different from other blockchain-friendly jurisdictions, such as Estonia. Although Malta does much to promote blockchain-based business by establishing clear legislation, creating regulatory fintech sandbox and so on, getting licenses here is more difficult. To get licensed, a company needs to comply with strict requirements, pass systems audit to ensure the resilience of infrastructure, defend its business model.
One of the necessary requirements to get authorization for any regulated activity on Malta are so-called “fit and proper checks” for all qualifying shareholders (>25% stake) and senior management – another mechanism to prevent fraud, protect investors and good reputation of Malta.
Such measures create an additional credibility for a company licensed on Malta, which in its turn creates incentives for decent companies to establish business activities there.
Virtual Financial Assets Act: providing classification
VFA Act introduced the legal framework for virtual financial assets and asset offerings in November 2018. The Act defines four types of DLT-assets:
- electronic money – common money, accounted for on DLT
- virtual tokens – units that have value only inside a system, for example, loyalty points
- financial instruments – assets defined by MiFID II regulations which include, inter alia, transferable securities and units in collective investment undertakings
- virtual financial assets – everything that does not fit into any of the above
The beauty of the Act is that when an asset does not fall into conventional forms, it is dealt with on a case-by-case basis. Many jurisdictions don’t adopt such a granular approach, preferring to qualify DLT-based assets broadly as security, utility and payment tokens with the same rules for every group of assets.
While it might seem like a good idea to create a separate category for cryptocurrencies, the problem is that, as we know, they can be very different by their essence: some are native tokens of a blockchain, others are not, some are anonymous, some are not, some are decentralized, and some are not.
VFA Act is mostly focused on procedures regarding the issuance or offering of virtual financial assets. However, it is unclear from the act itself how security tokens should be qualified depending on their nature. Thus MFSA has issued further guidelines and is working on a specific legislation for digital securities, which is going to cover all specific use cases in the industry.
STO Consultation Paper: defining digital securities
STO Consultation Paper divides security token offerings into traditional and non-traditional.
Units, offered during traditional STO, are classified as financial instruments under MiFID. Thus, they are regulated mostly by MiFID and Investment Services Act. At Stobox we call such units “digital securities”, and mostly work with them.
All other exotic types of investment units fall under the definition of non-traditional STOs. The most common example may include a unit that provides a right to a revenue share but does not represent a company’s equity, thus being some sort of a derivative contract. Many of the security token offerings conducted so far have been of such nature, although the regulation they fall under differs depending on the jurisdiction. Most security token offerings conducted so far have been of that nature.
MFSA has not yet issued an opinion on non-traditional STOs.
Prospectus regulation: offering & trading digital securities
The offering of digital securities is regulated mainly by the Prospectus Regulation, which requires issuers to register a Prospectus when making a public offering. However, European legislation courteously offers exemptions under which the offering can be conducted without registering a Prospectus.
The two most widely used include:
1) offering targeted solely on accredited investors (private sale)
2) offering with a total consideration under EUR 5 million in the European Union during a 12 months period.
Nonetheless, if the issuer is seeking to get listed on a trading venue it has to comply with the listing rules and prepare a Prospectus-like Admission Document, thus reducing the benefits of an exempted offer.
However, there are secondary market arrangements that do not fall under the definition of a regulated trading venue and, thus, can introduce less strict admission rules. One of them is bulletin board, which is a market at which participants can place their buying and selling interests, but there is no automated matching. Instead transaction is initiated when another clients agrees with the proposed terms and chooses to become a counterparty of the trade. Although there is no precedent of a kind on Malta yet, UK’s Financial Conduct Authority, which is subject to the same EU legislation, does not consider such arrangement an MTF:
“In our view, any system that merely receives, pools, aggregates and broadcasts indications of interest, bids and offers or prices should not be considered a multilateral system. That means that a bulletin board should not be considered a multilateral system. This is because there is no reaction of one trading interest to another other within these types of facilities.”
Malta has introduced one of the most progressive legislative frameworks for digital securities in the world, which finds balance between investor protection and facilitating innovation. Creating comprehensive legislation from scratch is an non trivial task and takes a lot of time –– it explains why the majority of digital securities offerings to the date took place in other jurisdictions. However, exactly due to the fact that Malta has put so much time and effort into it, Maltese providers and companies can be trusted from both the perspective of long-term regulatory stability and correspondence to prudential standards.
Shopin Faces Multiple Fines from the SEC
Not only does the SEC allege that Shopin hosted an unregistered securities offering in the form of the ICO, but that the founder used more than half a million dollars of the funds raised for his personal expenses.
The ICO in question was, at the time, a successful endeavour for Shopin. While performed in violation of multiple laws, the company managed to raise over $42 million.
Those that took part in the ICO were informed by Shopin that a platform, aimed towards revolutionizing online shopping through the use of blockchain technology, would be built. This was found to be a lie –to date there has been no platform developed.
To create trust among ICO participants, the company also indicated that they maintained various relationships with established companies. This was also found to be a lie.
After a long period of inactivity, the SEC has used 2019 as a launching platform for their assault on improperly/fraudulently run ICOs. Shopin is simply the latest entity to have found themselves as the subject of the SEC’s attention. The following articles are just a few of those that have found themselves on the receiving end of similar fines, over the past year.
All for Show?
While the exodus of bad actors within the world of blockchain is definitely a positive thing, are fines being levied by the SEC actually effective?
It was recently reported how Gladius, a company which saw themselves in the crosshairs of the SEC, failed to pay nearly $13 million in fines. Time will tell if the various companies, which also find themselves in similar situations, actually pay up, or claim broke.
While not addressing the situation involving Shopin directly, SEC Chairman, Jay Clayton, recently reiterated his stance towards the blockchain community.
“This past year, the Commission has brought actions against a number of issuers of digital assets for allegedly engaging in fraud and for violating the registration provisions of the federal securities laws,” he said. “The Commission also filed charges related to the unlawful promotion of initial coin offerings (ICOs) and the unlawful operation of a digital asset trading platform.”
“Overall, I believe we have taken a measured, yet proactive regulatory approach that both fosters innovation and capital formation while protecting our investors and our markets.”
As is often the case, a representative elaborated, in their announcement, on the decision to charge Shopin. Marc P. Berger, Director of the SEC’s New York Regional Office, had the following to say on the matter.
“As alleged in today’s action, the SEC seeks to hold Eyal and Shopin responsible for scamming innocent investors with false claims about relationships and contracts they had secured in support of a blockchain-based universal shopper profile…Retail investors considering an investment in a digital asset that meets the definition of a security must be afforded the same truthful disclosures as in any traditional securities offering.”
Founded in 2017, Shopin maintains headquarters in New York. The company set out with the intent to evolve e-commerce through an influx of blockchain technology.
CEO, Eran Eyal, currently oversees company operations.
Bank of China Moves to Regulate STO
This month, executives from the bank of China unveiled some major announcements regarding the future of blockchain technology in the country. Apparently, the Bank of China will now create its own centralized cryptocurrency. Additionally, the bank intends to roll out a robust security token protocol in the coming weeks.
In the past, Chinese officials have been very critical of cryptocurrencies. The country famously banned exchanges back in 2017. Also, Chinese officials have been hard on miners in the country despite the fact that the Chinese government operates some of the largest mining facilities in the world.
Pivot Towards Blockchain – Bank of China
Now it appears as if Chinese officials got the memo that blockchain technology is here to stay. At the recent Finance Technology Summit in Beijing, the Chief Scientist of the Bank of China, Weimin Guo described the country’s new strategy moving forward.
National Digital Currency
China now intends to release its own cryptocurrency called China’s Digital Currency Electronic Payment (DCEP). This cryptocurrency will serve as the only national digital currency of the country. Interestingly, the token will be a stablecoin pegged to the Chinese RenMinBi (RMB).
Developers hope that the integration of blockchain and cryptographic technology will streamline the outdated financial practices currently in use. Blockchain tech brings some serious advantages to the table. For one, the tech eliminates the frictions seen in traditional payment systems.
Shade on Bitcoin
After acknowledging the huge benefits gained from blockchain technology, Guo stated that Bitcoin had failed its purpose to provide a safe haven from the traditional market manipulations. He stated that Bitcoin’s launch was poorly timed and its primary goal to disrupt the global economy was “impossible.”
Strict Regulations – Bank of China
While China loosens its blockchain leash, it’s obvious the country wants to keep the technology in check. For example, all STOs are to operate within a strict “regulatory sandbox mechanism” at first. Basically, the country wants to promote innovation with new technology but desires a measured integration to maintain complete control over the sector.
It’s no surprise that China feels the pressure from blockchain adoption. At one time, China controlled a large majority of the crypto market. Since that time, the country continually targeted crypto investors and traders.
Additionally, regulators expressed concern about major tech firms such as Facebook issuing a cryptocurrency. Not surprisingly, regulators only want currency creation to originate from a national bank or government agency.
China’s Big Hope
Chinese regulators now believe that the DCEP has the potential to evolve into a leading global currency. Bank officials seek to integrate the currency into the main economy as soon as possible. This integration will span the scope of the Chinese economic sector from retail all the way to major investment firms.
China Inches Back into the Game
It’s interesting to see how Chinese regulators continue to embrace blockchain technology. China has always been on edge over the emergence of cryptocurrencies, but as it stands today, the country has to embrace the technology or fall to the wayside against the growing competition.
VNX Exchange Hopes to Get in Front of Upcoming AMLD5 Legislation with Sumsub Collaboration
Recently launched platform, VNX Exchange, and compliance expert, Sumsub, have announced a new collaboration. This will see Sumsub provide the necessary technology, which will allow VNX Exchange to ensure compliance with European laws surrounding AML/KYC.
This move is a proactive one, being taken by VNX Exchange. They have indicated that they chose to collaborate with Sumsub, as they possess the ability to remain compliant with the upcoming AMLD5 European legislation.
These compliance measures are what allow for regulatory bodies to keep nefarious activity in check. This is done by, first, knowing who they are dealing with. This part is taken care of through KYC checks, which gather information such as legal names, place of residence, passport info, and etcetera. Next, AML puts roadblocks in place, designed to prevent the origins of money from being clouded.
Unfortunately, blockchain based endeavours (including digital securities), remain synonymous with nefarious activity, to date. Much of this stems from past markets that saw the ICOs boom and bust. The entire point of digital securities, however, is to offer the benefits of tokenization, through a regulatory compliant and legal manner. For this to be achieved, and to dispel pre-existing notions (warranted or not) surrounding blockchain based endeavours, AML and KYC remain of utmost importance.
As indicated above, compliance measures surrounding AML and KYC are of the utmost importance within the digital securities sector. Many companies have recognized this, and are in the midst of developing their own solutions for the issue at hand. The following companies are but a few of those leading the way.
Upon announcing their collaboration, representatives from each, Sumsub and VNX Exchange, took the time to comment. The following is what each had to say on the matter.
Alexander Tkachenko, CEO of VNX Exchange, stated,
“VNX Exchange is very serious about all aspects related to compliance and investor protection. For these purposes, we are leveraging the benefits and advantages of innovative compliance systems provided by Sumsub to create a seamless client experience and open access to the new class of liquid digital assets backed by venture capital investments.”
Jacob Sever, Cofounder of Sumsub, stated,
“AMLD5 is soon to gain full power and influence among all financial entities in Europe with reinforced AML demands. With many clients based in Luxemburg, such as JobToday, Wecan Group, etc., we see the demand for compliance and anti-fraud measures, and know how to ensure them. VNX is a serious and mature project, with founders and management from traditional well-respected foundations, so we are happy to provide them with a high-level solution, optimising compliance under the Luxembourg regulations.”
Founded in 2015, Sumsub is a tech provider operating out of London, U.K. Above all, services offered by Sumsub revolve around compliance. This includes KYC/AML, investor onboarding, and more.
CEO, Andrey Severyukhin, currently oversees company operations.
Founded in 2018, VNX Exchange operates out of Luxembourg. The team at VNX Exchange has recently announced the launch of their digital securities issuance platform, along with their inaugural STO.
CEO, Alexander Tkachenko, currently oversees company operations.
In Other News
Both, VNX Exchange and Sumsub, have found themselves in our headlines in the past. Now their past work has brought them together, as they work with one another moving forward. The following articles touch on past events pertaining to each company.