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The Impact of Security Token Offerings to the Current Regulatory Landscape

and to the Financial Services Market

Thesis · May 2020

DOI: 10.13140/RG.2.2.23084.69761

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 The Impact of Security Token Offerings to the Current
Regulatory Landscape and to the Financial Services Market

Jake Desira

Dissertation submitted in partial fulfilment for the Degree of

Bachelor of Laws (Honours) (LL.B. Hons)

Faculty of Laws
University of Malta

May 2020
 ABSTRACT

Chapter 1 of this dissertation analyses current STO legislation. The author focuses on the
approach adopted at an EU level, namely the legislation pertinent to ‘transferable
securities’ whilst also focusing on Maltese law. However, albeit recognising the
importance of the Central Securities Depositories Regulation, due to the limited word
count, the author solely refers to such regulation in passing. Secondly, an analysis of the
definition of a ‘security’ under USA and Singapore’s regulation is undertaken, since STO
legislation is primarily dependent on the definition of a ‘security’. Which analysis is later
referred to in Chapter 4.

Chapter 2 provides an analysis of the rationale and objectives behind STO legislation.
Reference is also made to the reasoning and objectives behind financial services
legislation in general and their interplay within the STO context.

Chapter 3 discussed the impact posed by STOs to the financial services sector,
specifically to the financial market pillar, given that it will be the most impacted field of
financial services. This chapter delves into the interplay between ICOs, STOs and
traditional public offerings, the concept of a global public offering and the impact thereof;
as well as the potential implications which the widespread use of STOs could potentially
bring to the financial markets.

Chapter 4 discusses the issues present in Maltese STO regulation, in order to provide a
solution for such deficiencies. Focus is placed on the classification issues surrounding
hybrid tokens, the regulatory concerns arising from the concept of a ‘global public
offering’ as well as amendments required at the level of the Companies Act in order for
such act to be rendered compatible with DLT.

Due to the constant regulatory changes, the author decided to implement an information-
collection cut-off date set at 20 April 2020.

Keywords: STO – Security Tokens – Tokenisation – DLT – Financial Services

i
 TABLE OF CONTENTS

ABSTRACT ……………………………………………………………………………..i

TABLE OF CONTENTS .……………………………………………………………….ii

TABLE OF LEGISLATION ……………………………………………………………vi

TABLE OF JUDGEMENTS …………………………………...……………………..viii

ACKNOWLEDEMENTS ………………………………………...…………………….ix

ABBREVIATIONS …………………………………………….……………………….x

INTRODUCTION: DEFINING DLT, BLOCKCHAIN & STOs …………..……….1

LITERATURE REVIEW ………………………………………………………………..6

RESEARCH METHODOLOGY ………………………………………………………..8

CHAPTER 1: THE REGULATORY LANDSCAPE SURROUNDING STOS …….9

1.1) The European Union …………………………………………………………….…9

1.1.1) The Markets in Financial Instruments Regime - MiFID II & MiFIR ……………10

1.1.2) The Prospectus Regulation ……………………………………………………..11

1.1.3) Market Abuse – The Market Abuse Directive & Market Abuse Regulation ..…..12

1.2) Malta ……………………………………………………………………………...14

1.2.1) The Virtual Financial Assets Act ……………………………………………….14

1.2.2) MFSA Feedback Statement to the Consultation Document on STOs …………..14

1.2.2.1) Defining STOs ………………………………………………………………...15

1.2.2.2) Applications For Approval of Prospectuses and/or Admissibility to Listing and

Trading of Traditional STOs …………………………………………………………...15

1.2.2.3) Additional Ongoing Obligations Following an Offer and/or Listing and/or

Trading of Traditional STOs …………………………………………………………...16

1.2.2.4) Secondary Markets ………………………...………………………………….17

1.2.2.5) Market Abuse Regulation ……………………………………………………..17

1.2.2.6) Post-Trade Settlement ………………………………………………………...18

1.3) United States of America …………………………………………………………18

1.3.1) Defining the Term ‘Security’ ………………………………………………...…19

1.4) Singapore …………………………………………………………………………21

ii
1.4.1) Defining ‘Securities’ ……………………………………………………………22

1.4.2) Defining ‘Capital Markets Products’ …………………………………………..22

CHAPTER 2: LAW & SOCIETY – THE RATIONALE BEHIND STO

REGULATION ….…………………………………………………………………….24

2.1) The Overarching Objectives behind Financial Services Legislation ……………...24

2.1.1) Safeguarding the Financial System’s Stability ………………………………….24

2.1.2) Investor Protection ……………………………………………………………..25

2.1.3) The Preservation of Market Integrity …………………………………………...26

2.2) The Rationale behind STO Legislation …………………………………………...26

2.2.1) Investor Protection & Preservation of Market Integrity in the Context of a Global

Public Offering …………………………………………………………………………27

2.2.2) Investor Protection and Systemic Stability in the Context of Tokenisation ……..28

2.2.3) Investor Protection and System Stability in relation to Hybrid Tokens …………29

CHAPTER 3: THE IMPACT OF STOs TO THE FINANCIAL SERVICES

MARKET ……………………………………………………………………………...30

3.1) The Interplay between ICOs, STOs and Public Offerings ………………………...30

3.2) Creating a Global Public Offering ………………………………………………..31

3.3) Potential Implications for Financial Markets ……………………………………..32

3.3.1) Efficiency Gains ………………………………………...………...……………32

3.3.2) Fractional Ownership & its Impact on SMEs …………………………………...33

3.3.3) Trading Implications ……………………………………………………………34

3.3.4) Liquidity Implications ………………………………………………………….35

3.3.5) Pricing Implications …………………...……………………………………….36

3.3.6) Post-Trade Settlement Implications …………………………………………….37

CHAPTER 4: ADDRESSING REGULATORY PROBLEMS AT THE NATIONAL

LEVEL ………………………………………………………………………………...39

4.1) Achieving Regulatory Harmonisation ……………………………………………39

4.1.1) Hybrid Instruments: Securities or Not? …………………………………………39

4.1.2) Extra-Community Offerings – Reaching the East & the West ………………….40

iii
4.2) Company Law Considerations ……………………………………………….......43

CONCLUSION .……………………………………………………………………….47

BIBLIORAPHY .……………………………………………………………………….51

iv
To my parents

v
 TABLE OF LEGISLATION

European Union:

Directives:

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

Directive 2014/57/EU of the European Parliament and of the Council of 16 April 2014
on criminal sanctions for market abuse (market abuse directive) [2014] OJ L 173/179.

Regulations:

Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June
2017 on the prospectus to be published when securities are offered to the public or
admitted to trading on a regulated market, and repealing Directive 2003/71/EC

Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April
2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of
the European Parliament and of the Council and Commission Directives 2003/124/EC,
2003/125/EC and 2004/72/EC

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

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

vi
Regulation EU No 1092/2010 of the European Parliament and of the Council of 24
November 2010 on European Union macro-prudential oversight of the financial system
and establishing the European Systemic Risk Board

Malta:

Virtual Financial Assets Act, Chapter 590 of the Laws of Malta

Companies Act, Chapter 386 of the Laws of Malta

Duty on Documents and Transfers Act, Chapter 364 of the Laws of Malta

Capital Gains Rules, Subsidiary Legislation 123.27

United States of America:

Securities Act of 1993, 15 U.S.C. § 77b (2018)

Securities Exchange Act of 1934, 15 U.S.C. § 78a (2018)

Singapore:

Securities and Futures Act (Cap. 289)

Payment Services Act 2019

vii
 TABLE OF JUDGEMENTS

United States of America:

Securities and Exchange Commission v. W.J. Howey, Co 328 U.S. 293 (1946)

Majors v. S.C. Sec. Comm’n, 644 S.E.2d 710 (S.C. 2007)

SEC v. Int’l Loan Network, Inc., 968 F.2d 1304, 1307 (D.C. Cir. 1992)

SEC v. ETS Payphones, Inc., 408 F.3d 727 (11th Cir. 2005)

viii
 ACKNOWLEDEMENTS

I would like to express my sincere gratitude towards my supervisor Dr Wayne Pisani who
despite his busy schedule, guided me throughout my research and provided me with
invaluable assistance.

I would also like to thank my family and my loved ones for continuously supporting me
and pushing me every step of the way.

ix
 ABBREVIATIONS

CSD Central Securities Depositary

CSDR Central Securities Depositaries Regulation

DLT Distributed Ledger Technology

ESMA European Securities and Markets Authority

EU European Union

FCA Financial Conduct Authority

FIT Financial Instrument Test

ICO Initial Coin Offering

IPO Initial Public Offering

MAS Monetary Authority of Singapore

MDIA Malta Digital Innovation Authority

MFSA Malta Financial Services Authority

MiFID II Markets in Financial Instruments Directive

MiFIR Markets in Financial Instruments Regulation

OECD Organisation for Economic Co-operation and Development

SEC Securities and Exchange Commission

SME Small and Medium-sised Enterprise

STO Security Token Offering

UK United Kingdom

USA United States of America

VFA Virtual Financial Asset

x
 INTRODUCTION: DEFINING DLT, BLOCKCHAIN & STOs

Blockchain technology has been around since 1991 when Stuart Haber and W. Scott
Stornetta began working on a cryptographically secured chain of blocks wherein no one
could tamper with the timestamps of documents.1 However, it was only in late 2008,
during the midst of the 2007-2009 financial crisis when an unknown entity utilising the
pseudonym of ‘Satoshi Nakamoto’, published a paper entitled ‘Bitcoin: A Peer-to-Peer
Electronic Cash System.’2 It was at this very moment, through the creation of the concept
of bitcoin as a medium of exchange of value, where blockchain history started gaining
relevance. Historian Joseph Anthony Debono equates this technology to mythological
titan Prometheus’ innovation, revolution and disruption of established dominions. This is
an undeniably justified comparison given that the rationale behind bitcoin was the
creation of a decentralised and immutable system for recording and transmitting data,
which makes use of peer-to-peer transactions through the use of a non-governmental
virtual currency, without requiring any central authority to intermediate such processes.3
Nevertheless, blockchain’s meteoric rise in popularity came during late 2017 due to the
surge in popularity of ICOs.

The words ‘blockchain’ and ‘DLT’ are frequently used interchangeably, however, they
differ in meaning. Blockchain refers to a particular type of DLT, whilst DLT is a
collective term which encompasses all types of distributed ledgers. Therefore, DLT can
be defined as a database existing across several locations or among multiple participants
wherein data is recorded in multiple places at the same time.4 Blockchain is simply one
type of DLT which records information in so called ‘blocks’ of data, with such blocks
being linked in a sequential manner and encrypted through cryptography, each block
having a fraction of the previous one. It is also essential to distinguish between
permission-less and permissioned DLTs. In the former, anyone can become part of the
network, whilst in the latter, permission is required to access certain parts of the network.

1 Swati Goyal and Swati Goyal, 'Blockchain Technology History: Ultimate Guide' (101 Blockchains, 2020)
<https://101blockchains.com/history-of-blockchain-timeline/> accessed 23 March 2020.
2 Patrick L Young and Joseph A Debono, DLT Malta: Thoughts From The Blockchain Island (DV Books
2019).
3 Ibid.
4 Oliver Belin, 'The Difference Between Blockchain And Distributed Ledger Technology' (TradeIX)
<https://tradeix.com/distributed-ledger-technology/> accessed 23 March 2020.

1
Essentially, blockchain is based on four core principles: decentralisation, distribution,
transparency and immutability. Decentralisation refers to the network being operated by
several different parties, instead of being run by a central intermediary. Meanwhile,
distribution denotes that in addition to the fact that the administration of the blockchain
is conducted by different parties, the data itself is also replicated in several different places
simultaneously. The principle of transparency refers to the fact that each and every action
occurring on a blockchain is effectively stored and recorded on the blockchain itself. As
for the final principle of immutability, this refers to the security enshrined within
blockchain technology which provides effective safeguards against tampering. 5

Figure 1

Figure 1 depicts a classic centralised database wherein the ‘Central Intermediary’ is

receiving and transmitting data between the different users participating in the network.

5 Max Kops, Assets On Blockchain: Security Token Offerings And The Tokenization Of Securities (2019).

2
 Figure 2

Figure 2 depicts a Distributed Ledger whereby the network is completely decentralised

and as a result data is received and transmitted directly between the users in a peer-to-
peer manner.

Having delved into the technological foundations behind STOs it is also imperative, at
the outset, to delve into and differentiate between the three main types of commonly
referred to DLT assets, namely: payment tokens, utility tokens and security tokens. This
notwithstanding, one should keep in mind that this categorisation is not universal, and
that different names may be adopted for each category. 6 This distinction is of utter
importance in order to further differentiate between traditional public offerings, Initial
Coin Offerings (ICOs) and Security Token Offerings (STOs).

First of all, payment tokens constitute a storage of value which are used as medium of
exchange, means of payment and/or unit of account which in turn can be traded for
traditional currency or other digital assets. 7 Utility tokens are more akin to vouchers, as
they can exclusively be used to purchase goods or services developed by the issuer of

6 ESMA, 'Own Initiative Report On Initial Coin Offerings And Crypto-Assets' (2018)
<https://www.esma.europa.eu/sites/default/files/library/esma22-106-1338_smsg_advice_-
_report_on_icos_and_crypto-assets.pdf>.
7 Ibid.

3
such token.8 Therefore, their use is often limited exclusively to the platform on which
they were created. Security tokens, (also referred to as asset tokens), are securities which
provide ‘voting rights or a share in the future revenues of the issuing venture’9 such as
shares and bonds which are digitally recorded on a token through the use of DLT. Hence,
security tokens are standard securities which are issued on top of a DLT However, the
underlying technology allows for the creation of certain hybrid instruments10 which could
potentially fall outside the currently established definitions and as a result cause
regulatory uncertainty.

The above mentioned categorisation is essential for the purpose of understanding the
differences between traditional public offerings, ICOs and STOs. Firstly, a traditional
public offering is essentially an offer to the public of a company’s securities, such as an
IPO, wherein a company lists its shares on an exchange for the first time. Secondly, an
ICO is the initial offer to the public of a particular payment or utility token in exchange
for funding11, which is analogous to an IPO, saving for the issued unit. Thirdly, STOs are
offers to the public of security tokens.12 In essence, STOs can be described as a
combination of an ICO and a traditional public offering. In that, STOs are analogous to
ICOs from a technological perspective since both make use of DLT whilst simultaneously
resembling traditional public offerings from a regulatory standpoint, given that both are
regulated by securities regulations.

The author shall firstly set forth the question “How are STOs currently regulated?”. In
this regard, an analysis of the regulatory regime at an EU level shall be discussed, whilst
also delving into national initiatives undertaken by Malta. Furthermore, a comparative
analysis in relation to the definition of the term ‘security’ in selected jurisdictions outside
the EU, namely the USA and Singapore will also be undertaken. Apart from that, the
author shall then set forth the questions, “What is the rationale behind STO legislation?”.

8 Ibid., (n 6).
9 Ibid.
10 MFSA, ‘Security Token Offering – MFSA Capital Markets Strategy’, Ref: 12-2019 4
<https://www.mfsa.mt/wp-content/uploads/2019/07/20190719_Security-Token-Offering Consultation-
Document.pdf>.
11 Ibid., (n 6).
12 Are Token Assets The Securities Of Tomorrow? (Deloitte 2019)
<https://www2.deloitte.com/content/dam/Deloitte/lu/Documents/technology/lu-token-assets-securities-
tomorrow.pdf>.

4
Subsequently, the author shall also ask the question, “What is the impact which STOs can
pose on the financial services market?”. Finally, the author will delve into the question,
“What are the deficiencies of the Maltese regulatory framework and how can they be
amended?”.

5
 LITERATURE REVIEW

Given that STOs are particularly innovative in nature, the author consulted and evaluated
a multitude of electronic sources related to this subject. A number of books were also
referred to and although reference to such books was quite brief, it was still essential to
the author’s research. This literature review involved a thorough analysis of the existing
EU law Directives and Regulations as well as specific USA and Singapore legislation.

In writing this paper, the author was able to analyse the Council Directive of 2014/65/EU
on markets in financial instrument, particularly in defining ‘transferable securities’. Such
analysis also led the author to evaluate Council Regulation (EU) 2017/1129, Council
Directive 2014/57/EU and Council Regulation 596/2014. Furthermore, this research led
to the evaluation of the Securities Act of 1993, 15 U.S.C. § 77b (2018) and the Securities
and Futures Act (Cap. 289) respectively defining the term ‘security’ under USA and
Singapore legislation.

The author went a step further and delved into other literature such as, the various
publications issued by regulators, which provided various views and insights in relation
to the current and proposed regulation surrounding STOs. In this regard, the author made
particular references to the 'Own Initiative Report On Initial Coin Offerings And Crypto-
Assets' issued by ESMA, the ‘Consultation Document on Security Token Offerings’ and
the feedback thereto issued by the MFSA clarifying existing and proposed legislation.

Furthermore, other online publications were also consulted. In particular, ‘An evaluation
of the Theories and Objectives of Financial Regulation post the 2007-2009 Financial
Crisis: A European Perspective’ provided for a comprehensive examination of the
rationale behind financial services regulation and the importance thereof.

In addition, the author made thorough reference to the ‘The Tokenisation of Assets and
Potential Implications for Financial Markets, OECD Blockchain Policy Series’, published
by the OECD. This publication provided an extremely useful and professional analysis
on the potential impacts and implications which STOs may pose on the financial services
sector.

6
Given the innovative character of this topic, there is little to no relevant jurisprudence.
However, the author made reference to select judgements in relation to the definition of
a ‘security’ under USA law, namely the judgement of ‘Securities and Exchange
Commission v. W.J. Howey, Co 328 U.S. 293 (1946)’ as well as a few other cases which
provide further elaboration on the legal ramifications of this judgement.

7
 RESEARCH METHODOLOGY

In order to complete this dissertation, a purely qualitative research method was adopted,
which method is known as ‘Desk Research’. This type of research was used to analyse
the current literature pertinent to the subject of security token offerings. The author
referred to a multitude of online sources, such as online journals and publications
published by various regulators and renowned organisations in the financial and
technological spheres. The Official Journal Eur-Lex was a key source to the author since
all the required legislation was available through such journal. Furthermore, a number of
consultation documents were also evaluated in order to better understand the implications
surrounding STOs.

The author provided a holistic methodology so as to analyse the efficiency of the legal
system in its battle to keep up with the constant evolutions of technology. In order to
achieve such results, the author relied on the ‘Black Letter’ method. Through this method,
the author was able to focus on the securities legislation of the European Union pertaining
to STOs, as well as the securities legislation of the USA and Singapore, particularly with
regards to what constitutes a security. It was this research method which lead the author
to reach a number of conclusions that raised a multitude of issues in relation to the
widespread use of STOs, which the author addressed in the final chapter.

Contact was made with the author’s Tutor, Dr Wayne Pisani in order to ensure that such
findings and conclusions were accurate and precise. Such consultation was of invaluable
support to the author and critical for the completion of this dissertation.

8
 CHAPTER 1: THE REGULATORY LANDSCAPE SURROUNDING STOS

Digital assets have captured the attention of various regulators and organisations which
caused a multitude of legislative reforms. However, security tokens are regulated by
established securities regulations, saving some ongoing legislative modifications aimed
at adapting current regulation to the relative technological advancements.

1.1) The European Union:

In accordance with MifID II,13 security tokens, with the exception of certain hybrid
instruments which might fall outside the remit of the directive, are classified as ‘financial
instruments, particularly as ‘transferable securities’. Therefore, an analysis of the most
pertinent legislation regarding financial instruments, particularly ‘transferable securities’
is a must. Such legislation includes, namely, MiFID II, the Prospectus Regulation14 and
the Market Abuse Regulation15 and Directive. 16 This notwithstanding, one should note
that in 2020 the European Commission issued a consultation ‘On an EU framework for
markets in crypto-assets’17, inviting respondents to fill out a questionnaire on the most
pertinent issues surrounding digital assets, which could potentially lead to a legislative
reform in the near future.

13 Directive-2014/65/EU-of-the-European-Parliament-and-of-the-Council-of-15-May-2014-on-markets-
in-financial-instruments-and-amending-Directive-2002/92/EC-and-Directive-2011/61/EU.
14 Regulation-(EU)-2017/1129-of-the-European-Parliament-and-of-the-Council-of-14-June-2017-on-the-
prospectus-to-be-published-when-securities-are-offered-to-the-public-or-admitted-to-trading-on-a-
regulated-market,-and-repealing-Directive-2003/71/EC.
15 Regulation-(EU)-No-596/2014-of-the-European-Parliament-and-of-the-Council-of-16-April-2014-on-
market-abuse-(market-abuse-regulation)-and-repealing-Directive-2003/6/EC-of-the-European-
Parliament-and-of-the-Council-and-Commission-Directives-2003/124/EC,-2003/125/EC.and 2004/72/EC.
16 Directive-2014/57/EU-of-the-European-Parliament-and-of-the-Council-of-16-April-2014-on-criminal-
sanctions-for-market-abuse-(market abuse directive)-[2014]-OJ-L-173/179.
17 European Commission, 'CONSULTATION DOCUMENT On An EU Framework For Markets In
Crypto-Assets' (2020)
<https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/2019-
crypto-assets-consultation-document_en.pdf>.

9
1.1.1) The Markets in Financial Instruments Regime - MiFID II & MiFIR18:

MiFID II lays down the term ‘financial instruments’, which is defined by reference to the
list provided under Annex I Section C of the directive. Which list includes; transferable
securities, money-market instruments, units in a collective investment scheme,
derivatives instruments (options, swaps, futures and forwards), financial contracts for
differences and emission allowances. With regards to transferable securities, these are
defined under Article 4(44) of MiFID II as ‘those classes of securities which are
negotiable on the capital market, except for instruments of payments.’ Examples of such
include, inter alia, shares in companies, and comparable interests in partnerships and
other entities and equivalent securities, bonds and other forms of securitised debt; as well
as depository receipts in respect of the shares and bonds.

However, one should note that the definition of ‘transferable securities’ is not completely
harmonised at EU level, given that its transposition into the legal framework of different
Member States was not identical.19 Nevertheless, numerous scholars and regulators have
identified three formal criteria for a financial instrument to qualify as a transferable
security. These three formal criteria are transferability, negotiability on the capital
markets and standardisation. 20

‘Transferability’ refers to the fact that the security in question can be freely transferred,
thereby excluding pure utility tokens, which cannot be traded outside the platform in
which they were created, from being classified as transferable securities. In this regard,
Philip Hacker states that if such transferability is restricted on a contractual basis in
accordance with the terms of issue, such token would still satisfy the requirement of
‘transferability’ 21. Obviously, should the terms of issue render the transfer of ownership
of a token technically impossible, the token would not be transferable and thus would not
qualify as a transferable security. Furthermore, for transferability to subsist, it is essential

18 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.
19 ESMA, 'Annex 1 Legal Qualification Of Crypto-Assets – Survey To Ncas' (2020)
<https://www.esma.europa.eu/sites/default/files/library/esma50-157-1384_annex.pdf>.
20 Philipp Hacker and Chris Thomale, ‘Crypto-Securities Regulation: ICOs, Token Sales and
Cryptocurrencies under EU Financial Law’ (2017).
21 Ibid.

10
that upon a transfer of a particular token, there is no alteration in the legal content or
technical nature of such token.22

The second requirement is the ‘negotiability’ of the securities, in that they must be easily
tradeable on the capital market. Although, as of now, security token exchanges are still in
their early stages, this should not exclude many security tokens from being qualified as
transferable securities. 23 This is particularly the case, due to the fact that the term ‘capital
market’ is not defined under EU law but it is a broad concept which is ‘meant to include
all contexts where buying and selling interest in securities meet.’ 24

The third and final requirement is that of ‘standardisation’. This arises through the use of
the phrase ‘those classes of securities’ in MiFID II, which basically implies that the issued
unit must share certain features in order to be classified as a certain type. Numerous
scholars argue that for an instrument to fall under a particular category of securities, its
units must be defined by common features so that it is adequate to refer to the type and
number of units to trade them. 25 Consequently, this requirement also implies the notions
of ‘fungibility’ or ‘interchangeability’. Thus, provided that security tokens are
standardised, transferable and negotiable, they should qualify as ‘transferable securities.’

1.1.2) The Prospectus Regulation:

With the exception of the securities listed in Article 1(2) of the Prospectus Regulation,
any offer of securities made to the public or the listing of such securities in a Member
State must be accompanied by a prospectus in line with the Prospectus Regulation. 26 This
obviously applies to STOs, insofar as the relative security tokens are classified as
financial instruments under MiFID II. The rationale behind the prospectus is to allow

22 Hagen Weiß, 'Tokenisation' (BaFin, 2019)

<https://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Fachartikel/2019/fa_bj_1904_Tokenisierung
_en.html;jsessionid=271C05DE66B1E99851CCCA010DF34377.1_cid361> accessed 27 March 2020.
23 MFSA, ‘Feedback Statement to the Consultation Document on Security Token Offering’ Ref No: 12-
2019 <https://www.mfsa.mt/wp-content/uploads/2020/02/20200225-Feedback-Statement-to-the-
Consultation-Document-on-Security-Token-Offering.pdf>.
24 European Commission, ‘Your questions on MiFID: Markets in Financial Instruments Directive
2004/39/EC and implementing measures’ (Q&A, 31 October 2008) (MiFID Q&A).
25 Ibid., (n 22).
26 Ibid., (n 14), Article 3(3).

11
prospective investors to properly assess the investment. In particular, the prospectus must
include the information necessary to enable investors to make an informed assessment of:
i) “the assets and liabilities, profits and losses, financial position, and prospects
of the issuer and of any guarantor;
ii) the rights attaching to the securities; and
iii) the reasons for the issuance and its impact on the issuer.”27

The prospectus is comprised of three parts: the summary note, the registration document
and the securities note. The summary note essentially summarises the key information
needed by investors in order for them to understand the nature and the risks of the issuer,
the guarantor and the securities offered / admitted to trading.28 The registration document
describes the company’s organisation, business, financial position, earnings and
prospects, governance and shareholding structure.29 Whilst the securities note provides
all the details pertaining to the securities being offered. 30 Furthermore, it also includes
sections relating to inter alia, the risk factor associated to the securities and how the funds
will be used.

Aside from the abovementioned, the Prospectus Regulation also lists a number of
instances where an offer is exempt from the requirement of publishing a prospectus,
specifically, where an offer of securities does not exceed the €1 million threshold,
calculated over a period of 12 months. This definitely provides an incentive to SMEs to
consider funding through the capital markets, which reasoning is furtherly supported by
the fact that each Member State is authorised to extend this exemption for offers of
securities which do not exceed the €8,000,000 threshold, calculated over a period of 12
months. 31

1.1.3) Market Abuse – The Market Abuse Directive & Market Abuse Regulation:

EU market abuse legislation applies to all financial instruments which have been admitted
to trading, or for which a request for admission to trading has been made. As well as to

27 Ibid., Article 6.
28 Ibid., Article 7.
29 Ibid., Article 9.
30 Ibid., Annex III.
31 Ibid., Article 3(2).

12
financial instruments, the value of which depends on or has an effect on the price or value
of other financial instruments.32 This legislation seeks to properly maintain and safeguard
market integrity. In doing so, it empowers regulators to issue hefty penalties in relation
to any acts of insider dealing, unlawful disclosure of inside information and market
manipulation.33 Case in point, in 2017 the UK FCA issued a £70,000 fine to Tejoori Ltd
for breaching such regulation.34 Apart from that, ESMA has noted that the use of DLT
could potentially give rise to new abusive behaviour which may escape the remit of
current legislation.35 This seems to suggest that a new or rather amended market abuse
regime might be on its way.

Insider dealing arises when a legal or natural person is in possession of inside

information36 and on the basis of such information, performs trades in financial
instruments to which such information relates. Furthermore, cancelling or amending an
order pertaining to a financial instrument on the basis of inside information which relates
to such order and which was obtained after the order was placed, also amounts to insider
dealing. 37 Unlawful disclosure of inside information occurs where a legal or natural
person has knowledge of inside information and discloses such inside information to a
third party with the exception of scenarios wherein disclosure is made in the normal
exercise of an employment, a profession or duties. 38 Finally, market manipulation, arises
in a situation wherein a legal or natural person, intentionally attempts to affect the market,
thereby creating an untrue and misleading appearance of the price or market relating to
the financial instruments.39 Such manipulation can be either transaction based, where
fictitious orders are placed to transmit false or misleading signals to the market, or
information based, where misleading or false information is transmitted to the public.

32 Ibid., (n 10).
33 Ibid., (n 15), Preamble (7).
34 David Heffron, 'FCA Imposes First Ever Fine Under EU Market Abuse Rules' (Pinsentmasons.com,
2017) <https://www.pinsentmasons.com/out-law/news/fca-imposes-first-ever-fine-under-eu-market-
abuse-rules>.
35 Ibid., (n 10).
36 Inside information refers to commercially sensitive information which is not publicly known.
37 Ibid., (n 15), Article 8(1).
38 Ibid., Article 10(1).
39 Ibid., Preamble (43).

13
1.2) Malta:

Being an EU Member State, Malta has transposed the aforementioned directives and must
abide by the abovementioned regulations. In addition to that, Malta has been on the
forefront of DLT and digital asset legislation and has enacted further legislation in this
space. However, domestic measures to further regulate STOs are still at their inception,
given that there is no clear framework in place. For the time being, the MFSA has issued
a consultation document and subsequently published a feedback statement on the future
of STOs in Malta.

1.2.1) The Virtual Financial Assets Act:

The VFA Act40 primarily regulates ICOs, aside from the licensing of VFA service
providers. Nonetheless it is also pertinent in relation to STOs, since it established the
concept of a DLT asset, which is then categorised into: (1) Virtual Financial Assets
(VFAs), which is the equivalent of a payment tokens; (2) Virtual Tokens, which is the
equivalent of a non-listed utility token; (3) Financial Instruments; and (4) Electronic
money. 41 In this regard, pursuant to article 47 of the Act, the MFSA has also created the
Financial Instrument Test which serves to categorise the relative DLT asset. Hence, the
importance of the VFA Act in relation to STOs arises from the fact that the FIT is the
primary step which needs to be undertaken in order to categorise the relative DLT asset
and consequently determine the applicable regulatory regime.

1.2.2) MFSA Feedback Statement to the Consultation Document on STOs:

On the 19th of July 2019, the MFSA issued a six-part consultation document tackling the
area of STOs,42 insofar as they constitute an ‘offer of securities to the public’ in terms of
Article 2(3) of the Companies Act 43. Subsequently, practitioners and stakeholders in the
industry submitted their feedback which was then compiled and published by the MFSA

40 Virtual Financial Assets Act, Chapter 590 of the Laws of Malta.

41 Ibid., (n 15), Article 2(2).
42 Ibid., (n 10).
43 Companies Act, Chapter 386 of the Laws of Malta.

14
on the 25th February 2020. Apart from summarising the responses received, this feedback
statement also illustrates the MFSA’s response and position thereto.44

1.2.2.1) Defining STOs:

After the relative feedback, the MFSA did not proceed further with its suggestion to
classify security tokens falling within the definition of ‘transferable securities’ as either a
‘traditional STO’ or an ‘Other STO’. ‘Traditional STOs’ were defined as traditional
transferable securities which have been tokenised. While ‘Other STOs’ were defined as
securities which may share some qualities with transferable securities and may be
classified as ‘other securities’ in terms of MiFID II, which securities are dependent upon
the use of DLT.45 The MFSA has acknowledged that such categorisation might cause
confusion, given that the category of transferable securities is a unified legal notion under
EU law.46 Thus, the Authority has proposed that where a particular DLT asset cannot be
easily classified through the FIT, particularly where it demonstrates certain features of a
financial instrument which are not captured by the FIT, independent legal advice should
be sought and a case by case assessment with a principles-based approach may need to
be undertaken. Moreover, further guidance in relation to the classification of DLT assets
is to be issued by the MFSA in the near future.47

1.2.2.2) Applications For Approval of Prospectuses and/or Admissibility to Listing

……..and Trading of Traditional STOs:

The MFSA affirmed that it will solely consider applications filed by limited liability
companies. This seems quite restrictive, however may be argued as understandable, at
least for the time being, as it would avoid instances wherein the MFSA is also burdened
with issues which might arise from the adoption of different structures, such as trusts,
foundations and partnerships, rather than focusing solely on the offering itself.
Furthermore, the Authority has stated that it is currently collaborating with the Malta

44 Ibid., (n 23).
45 Ibid., (n 10).
46 Ibid., (n 23).
47 Proposed amendments to cater for this problem shall be discussed in Chapter 4.

15
Business Registry, in order to amend certain provisions of the Companies Act so that such
piece of legislation can accommodate the use of DLT.48

Upon an application for an approval of prospectus and/or for admissibility to listing, the
Authority shall conduct a three pillar assessment of an applicant’s financial soundness,
corporate governance and compliance with transparency requirements. In this regard, the
MFSA confirmed that the requirement of a financial due diligence report for the purposes
of determining an applicant’s financial soundness shall be identical for the same type of
securities, whether tokenised or not. This demonstrates that the MFSA is adopting a
substantive approach, rather than differentiating between such instruments on the basis
of their underlying technology. With regards to corporate governance, boards of directors
which are responsible for the technology underpinning the storage and transaction of the
securities will have to adhere to cyber security and IT infrastructure requirements in terms
of the VFA Act and appoint a Systems Auditor to perform a Systems Audit Report in line
with MDIA guidelines. 49 Needless to say, this requirement is essential in order to ensure
the adequate operation of the technology at play. As for transparency, it was further
confirmed that the Prospectus Regulation and the Annexes thereto are adequate in the
case of STOs, given that such tokens are still securities.

1.2.2.3) Additional Ongoing Obligations Following an Offer and/or Listing and/or

____..Trading of Traditional STOs:

After analysing the respondents’ feedback, the MFSA reconsidered its initial proposal
and decided that an issuer shall be required to have in place at all times, a Systems Auditor
which shall prepare a Systems Audit Report in line with MDIA Guidelines in the
following cases:
a) Where the issuer operates or has in place an innovative technology arrangement
(ITA), such as a distributed ledger or a smart contract; and/or
b) Where the issuer operates a technological infrastructure which interrelates with
such ITA, such as a wallet.50

48 The most prominent amendments required at the level of the Companies Act shall be addressed in
Chapter 4.
49 Ibid., (n 23).
50 Ibid.

16
1.2.2.4) Secondary Markets:

The MFSA also dealt with the importance of having in place an efficient yet secure
secondary market. After analysing the feedback provided, the Authority reached the
conclusion that permission-less decentralised exchanges are likely to pose challenges in
ensuring compliance with MiFIR reporting obligations. In this regard, the author
acknowledges such challenges, particularly given the lack of a central operator which is
responsible for the platform’s non-compliance. On this point, the Authority stated that
prospective applicants shall have the responsibility to prove satisfactorily that the relative
platform will comply with existing legislation. 51

Moreover, albeit recognising the fact that current regulations are burdened with a high
degree of intermediation, the MFSA affirmed that some level of intermediation is
necessary, which reasoning is definitely comprehensible, given that complete
disintermediation might create new problems. This reasoning seems to reiterate the
Authority’s stance in relation to permission-less DLTs as these would result in a much
more disintermediated environment.52 Further to this, the respondents recognised the
regulatory issues in relation to permission-less DLTs, such as: the lack of an identified
market operator and issues with regards to compliance with money laundering and
terrorism financing regulations. As a solution, respondents proposed embedding certain
restrictions in the code of the token or wallet rather than that of the DLT. Nevertheless,
the Authority replied that such proposal must be carefully scrutinised. 53

1.2.2.5) Market Abuse Regulation:

Most respondents agreed with the MFSA that the prevention of market abuse is mostly
reliant on transaction reporting. In this regard, the Authority stated that it shall analyse
how to adequately adopt DLT in its market oversight function so as to prevent and detect
market abuse. DLT could definitely play a crucial role in market abuse detection given
the inherent transparency on which the technology is established. As for the use of
decentralised exchanges, the Authority shall be conducting practical evaluations so as to

51 Ibid.
52 Ibid.
53 Ibid.

17
identify and address any lacking within the platform’s system in the market abuse context,
which is understandable. Furthermore, a case by case basis approach shall be adopted
with regards to the admission to trading of security tokens on decentralised exchanges,54
which is understandable given the issues which may arise from the complete elimination
of central operators.

1.2.2.6) Post-Trade Settlement:

The feedback provided by the respondents emphasised the fact that the legal requirements
set out in the CSDR55 are too stringent and will likely hinder the application of DLT.
Respondents further proposed the use of exchanges which are operated by an operator,
which would in turn qualify as a settlement internaliser. This notwithstanding, the
requirement of a CSD cannot be completely eradicated since Article 3(2) of CSDR
requires listed transferable securities to be recorded in book entry-form in a CSD.
Therefore, for the CSDR to embrace the use of DLT with regards to the settlement
process, it was further suggested that such regulation needs to be amended. On this point,
the MFSA held that such regulation will undoubtedly hinder the application of DLT
within the context of secondary markets, however this is a query which is to be addressed
at an EU level. 56

1.3) United States of America:

In the USA, there is no holistic framework regulating digital assets. This notwithstanding,
one should note that a bill amending current securities legislation entitled the ‘Token
Taxonomy Act of 2019’57 is currently undergoing the legislative process. However as
things stand, the Commodity Futures Trading Commission has affirmed that certain
digital assets are to be viewed as commodities, while the SEC has categorised most digital

54 Ibid.
55 Regulation-(EU)-No-909/2014-of-the-European-Parliament-and-of-the-Council-of-23 July-2014-on-
improving-securities-settlement-in-the-European-Union-and-on-central-securities-depositories-and-
amending-Directives-98/26/EC-and-2014/65/EU-and-Regulation-(EU)-No 236/2012.
56 Ibid., (n 23).
57 H.R.2144 - Token Taxonomy Act of 2019.

18
assets as securities. 58 For the purposes of this dissertation, the author shall focus on the
SEC’s approach, whereby security tokens which satisfy the definition of a ‘security’ are
subject to federal securities regulations, namely, the Securities Act of 199359 and the
Securities Exchange Act of 1934.60

1.3.1) Defining the Term ‘Security’:

Section 2(a)(1) of the Securities Act 1993 defines a security by providing an extremely
lengthy list of instruments which are deemed as securities as seen in the table below.

Table 1: The Definition of a ‘securities under USA Law

Jurisdiction Definition
USA The term ‘security’ means any:
(Securities Act note, stock, treasury stock, security future, security-based swap,
1993) bond, debenture, evidence of indebtedness, certificate of interest or
participation in any profit-sharing agreement, collateral-trust
certificate, preorganization certificate or subscription, transferable
share, investment contract, voting-trust certificate, certificate of
deposit for a security, fractional undivided interest in oil, gas, or
other mineral rights, any put, call, straddle, option, or privilege on
any security, certificate of deposit, or group or index of securities
(including any interest therein or based on the value thereof), or
any put, call, straddle, option, or privilege entered into on a
national securities exchange relating to foreign currency, or, in
general, any interest or instrument commonly known as a
“security”, or any certificate of interest or participation in,
temporary or interim certificate for, receipt for, guarantee of, or

58 'Crypto Regulations In The United States' (ComplyAdvantage, 2020)

<https://complyadvantage.com/knowledgebase/crypto-regulations/cryptocurrency-regulations-united-
states/> accessed 29 March 2020.
59 15 U.S.C. § 77b (2017).
60 15 U.S.C. § 78a (2018).

19
 warrant or right to subscribe to or purchase, any of the
foregoing.’61

The most important instrument here above mentioned is definitely the investment
contract, given that its wide definition renders it a catch-all category of securities. 62 For
the purposes of clarifying what constitutes an investment contract, the US Supreme Court,
in the case of Securities and Exchange Commission v. W.J. Howey Co. 63 developed the
‘Howey Test’. Essentially this test provides that for an investment contract to exist, four
cumulative criteria must be fulfilled, which criteria are illustrated in the table hereunder:64

Table 2: The Four Criteria of the Howey Test

Criteria Overview

An investment In Majors v. South Carolina Securities Commission65 it was stated

of money that this criterion is triggered whenever an investor commits an
asset to the enterprise in a way which subjects such investor to
financial loss. From such flexible interpretation, this criterion is
generally satisfied in the moment that a digital asset is purchased in
exchange for value, whether the consideration takes the form of fiat
currency or any other asset, including a digital asset.66

In a common The SEC has stated that Courts usually have examined the
enterprise requirement of a ‘common enterprise’ as a distinct element of an
investment contract. Furthermore, it has also affirmed that through
its experience, digital asset investments typically constitute a
‘common enterprise’ because ‘the fortunes of digital asset

61 Ibid., (n 59).
62 Michael-Mendelson, -'From Initial-Coin-Offerings-To-Security-Tokens:-A-U.S.-Federal-Securities-
Law-Analysis'-[2019]-Stanford-Technology-Law-Review
<https://law.stanford.edu/wp-content/uploads/2019/01/Mendelson_20180129.pdf>.
63 Securities and Exchange Commission v. W.J. Howey, Co 328 U.S. 293 (1946).
64 Ibid.
65 Majors v. S.C. Sec. Comm’n, 644 S.E.2d 710 (S.C. 2007).
66 Securities and Exchange Commission, 'Framework For “Investment Contract” Analysis Of Digital
Assets' <https://www.sec.gov/files/dlt-framework.pdf>.

20
 purchasers have been linked to each other or to the success of the
promoter’s efforts.’67

With the For the fulfilment of this requirement, one needs to carry out an
expectation of assessment as to whether there is a reasonable expectation of
profits profits. Such profits can be, inter alia, capital appreciation arising
from the development of the investment or the business or a
participation in earnings resulting from the use of purchasers’
funds. 68 That being said, any price increase resulting exclusively
from external market forces would generally not be considered as
profit under the Howey test.69

Solely from the Most courts do not appear to take the “solely from the efforts of
efforts of others others” element of the Howey test in a literal manner. Instead focus
is shifted on the degree of managerial control which an investor has
over an enterprise. In fact, in ETS Payphones,70 the Court stated
that the more control that is retained by the investor, the less it
becomes likely that an investment contract truly exists.

1.4) Singapore:

On the 1st August 2017, the Monetary Authority of Singapore (MAS) issued a guide on
digital token offerings. This guide affirmed that digital tokens falling under the definition
of ‘securities’ and/or ‘capital markets products’ in terms of the Securities and Futures
Act71 are subject to securities laws.72 Thereby adopting a similar approach to that
undertaken in the above mentioned regulatory regimes. Having said that, this section shall

67 SEC v. Int’l Loan Network, Inc., 968 F.2d 1304, 1307 (D.C. Cir. 1992).
68 Ibid., (n 62).
69 Ibid., (n 66).
70 SEC v. ETS Payphones, Inc., 408 F.3d 727 (11th Cir. 2005).
71 Securities and Futures Act (Cap. 289).
72 Monetary Authority of Singapore, 'A GUIDE TO DIGITAL TOKEN OFFERINGS' (2019)
<https://www.mas.gov.sg/-/media/MAS/Sectors/Guidance/Guide-to-Digital-Tokens-Offering---23-Dec-
2019.pdf>.

21
analyse the conditions under which a security token will be categorised as a security or
financial market product in terms of Singapore law.

1.4.1) Defining ‘Securities’:

Article 2(1) of the Securities and Futures Act defines ‘securities’ as:
i) Shares, units in a business trust or any instrument conferring or representing
ownership interest in a company, partnership or limited liability partnership;
ii) Debentures, including: any debt securities issued by an entity, whether
constituting a charge or not, on the issuer’s assets and any debt securities
issued by a trustee-manager of a business trust or a trustee of a REIT, acting
in his capacity as trustee, whether constituting a charge or not, on the issuer’s
assets. With the exception of cheques, orders for payment of money or letters
of credit; or
iii) Any other product or class of products as may be prescribed.

However, the term ‘securities’ does not include: units in a collective investment scheme,
bills of exchange, certificates of deposit issued by a bank or finance company, or such
other products or class of products as may be prescribed.73

1.4.2) Defining ‘Capital Markets Products’:

On the other hand, article 2(1) of the Securities and Futures Act defines ‘capital markets
products’ as any:

“securities, units in a collective investment scheme, derivatives contracts, spot foreign

exchange contracts for the purposes of leveraged foreign exchange trading, and such
other products as the Authority may prescribe as capital markets products.”74

As per the MAS, some examples of ‘capital markets products’ include, apart from shares
and debentures:

73 Ibid., (n 71).
74 Ibid.

22
i) Units in a business trust, which confer rights of ownership in the trust property
of a business trust; and
ii) Securities-based derivatives contracts, which include any derivative contracts
of which, the underlying thing is a share, debenture, or unit in a business trust;

23
 CHAPTER 2: LAW & SOCIETY – THE RATIONALE BEHIND STO
REGULATION

Knowledge of the regulatory framework surrounding STOs discussed in the previous

chapter is undoubtedly essential when considering the use of such fundraising
mechanism. Nevertheless, in order to acquire a fully holistic and comprehensive
understanding of such legislation, it is essential to look past the letter of the law and
analyse the rationale behind it.

2.1) The Overarching Objectives behind Financial Services Legislation:

It is widely recognised that financial services legislation is based on economic policy

objectives aimed at creating economic stability and growth, 75 so much so that studies
have shown that such legislation has substantial effect on economic growth.76 Conversely,
financial market failures could result in disastrous economic consequences and severe
impact on public confidence. 77 In fact, the safeguarding of the financial system’s stability,
safety and soundness is this economic factor which underpins the principal objective of
financial regulation. Furthermore, such regulation has also two other paramount
objectives. The protection of the investing public and the preservation of market integrity.
In this regard, even though regulation is constantly changing, particularly in the light of
the 2008 financial crisis and the continuous technological developments such as
blockchain technology, the rationale behind such regulation still rests on these three
overarching objectives.78

2.1.1) Safeguarding the Financial System’s Stability:

The maintenance of a stable financial system is essential, since financial stability ensures
that a favourable business environment is in place and that the economy is functioning in

75 David H Gowland, The Regulation Of Financial Markets In The 1990S (E Elgar 1991).
76 Alain DeSerres and others, Regulation Of Financial Systems And Economic Growth (OECD Publishing
2006) <https://www.oecd.org/economy/growth/40505986.pdf>.
77 Ibid.
78 Christopher-P.-Buttigieg,-'AN-EVALUATION-OF-THE-THEORIES-AND-OBJECTIVES-OF-
FINANCIAL-REGULATION-POST-THE-2007-2009-FINANCIAL-CRISIS:-A-EUROPEAN-
PERSPECTIVE'-[2012]-Elsa-Malta-Law-Review-
<http://www.elsa.org.mt/wpcontent/uploads/2015/02/9.-Essay-Christopher-Buttigieg.pdf>.

24
an adequate manner.79 However, financial systems are prone to what is known as systemic
risk80, which is defined as;

“A risk of disruption in the financial system with the potential to have serious negative
consequences for the internal market and the real economy. All types of financial
intermediaries, markets and infrastructure may be potentially systemically important to
some degree.”81

The system’s vulnerability to systemic risk is evidently a priority for policy makers and
regulators. Therefore, financial services legislation seeks to prevent and mitigate the
occurrence of systemic failures as much as possible. This protection is achieved, namely
through micro and macro prudential supervision measures such as the imposition of strict
capital requirements and reporting obligations. 82

2.1.2) Investor Protection:

Specific investor protection regulation is essential for the appropriate development of the
financial markets and the financial system as a whole. In fact, there is substantial research
demonstrating that a State’s level of investor protection has a direct impact on the value
of companies, the financial market’s development and overall economic growth.83 This
is quite evident when considering that financial markets exclusively depend on investor
confidence. Therefore, investor protection measures seek to preserve investor confidence
in the financial market. This is achieved through the creation of safeguards aimed at
protecting investors from the potential consequences arising from the information
irregularities existing between investors and financial services providers. 84 Concisely,

79 Ibid.
80 From-the-outset,-one-should-differentiate-between-systemic-risk-and-systematic-risk:
Systemic-risk-is-the-risk-that-an-event-at-the-company-or-industry-level-could-trigger-a-huge-collapse, -
like-the-2008-financial-crisis;
While,-systematic-risk-is-the-risk-inherent-to-the-entire-market,-attributable-to-a-mix-of-factors-
economic,-socio-political-and-market-related.
81 Regulation-EU-No-1092/-of-the-European-Parliament-and-of-the-Council-of-24-November-2010-on-
European-Union-macro-prudential-oversight-of-the-financial-system-and-establishing-the-European-
Systemic-Risk-Board,-Article-2.
82 Ibid., (n 78).
83 Raphael-La-Porta-and-others,-'Investor-Protection-And-Corporate-Governance'-[2000]-Journal-of-
Financial-Economics-<https://scholar.harvard.edu/files/shleifer/files/ip_corpgov.pdf>.
84 C. A. E Goodhart, The Central Bank And The Financial System (MIT Press 1995).

25
investor protection measures seek to level the playing field between investors and
financial professionals, which is generally achieved through rigorous conduct of business
rules, the aim of which is to compel financial institutions to act in the best interest of the
investor. Finally, one must keep in mind that albeit the fact that investor protection is
perhaps the key objective behind financial services legislation; it is of utmost importance
that such legislation is implemented in a proportional manner to avoid over-regulation,
which some argue is the case for the Maltese ICO industry.

2.1.3) The Preservation of Market Integrity:

Financial markets play a vital part in economic growth and financial stability. Their main
purpose being the conversion of savings accumulated by various individuals into
financing for businesses.85 For there to be a proper financial market, such markets must
provide investors with the possibility of transacting in a fair and informed setting wherein
the prices are dictated by the full and correct information made available to the public. 86
That being said, financial markets are very susceptible to abuse and manipulation,
particularly given the potential gains resulting from market malpractice. Which conduct
may negatively affect investor confidence and consequently damage businesses in need
of financing. 87 As such, financial services legislation seeks to maintain market integrity
by implementing transparency and disclosure requirements as well as by imposing
sanctions for market malpractice.88

2.2) The Rationale behind STO Legislation:

As a sub-category of the financial market pillar, the scope and rationale behind STO
legislation is still comprised of the aforementioned three objectives. Nevertheless, it is
the author’s opinion that due to the significant differences existing between STOs and
traditional public offerings, the rationale underpinning STO legislation, albeit similar,

85 Jennifer A. Elliot and Ana Carvajal, 'Strengths And Weaknesses In Securities Market Regulation: A
Global Analysis' [2007] International Monetary Fund.).
86 Ibid., (n 78).
87 Ibid.
88 Vide section 3.2 for more detail on the global public offering concept.

26
bear certain differences. Particularly in light of the innovative character of STOs and the
endless possibilities arising from the use of DLT in the financial market context.

2.2.1) Investor Protection & Preservation of Market Integrity in the Context of a

iiiiiGlobal Public Offering:

One of the most significant advantages that STOs have over traditional public offerings
is the possibility of creating a global public offering. Generally, an IPO would be carried
out exclusively in the jurisdiction in which the company is present, or countries in which
said company has some sort of presence, saving certain instances where the exchange
itself has a presence in international markets. Conversely, the technology underpinning
STOs allows an offering to be issued on a platform that renders the offer accessible in a
multitude of different jurisdictions. 89

The prospect of a ‘global public offering’, albeit posing several advantages, also exposes
the market to certain perils. First, the increase in exposure is likely to increase the number
of investors at play, which clearly render investor protection measures more important
than ever. Secondly, additional problems might also arise in light of the fact that such an
offering would be accessible from multiple jurisdictions. From a market abuse
perspective, this transnational element might cause negative implications to the
enforcement of market abuse measures, since there are different jurisdictional approaches
to the same market integrity principles and the fact that malpractice might be carried out
from several different jurisdictions. In this regard, proper cooperation between competent
authorities would be a must. Ultimately, one can clearly note that both investor protection
and the preservation of market integrity, apart from being essential in the financial
services sphere as a whole, are specifically instrumental in the STO context. Particularly
given that the STO space, like the traditional financial markets pillar, is mostly dependant
on investor confidence, which confidence bears a high risk of distortion given the
aforementioned aspects.

89 'Security Token Offerings (STO) VS Initial Public Offerings (IPO)' (Medium, 2018)
<https://medium.com/comistar/security-token-offerings-sto-vs-initial-public-offerings-ipo-
6a8885ee721a> accessed 1 April 2020.

27
2.2.2) Investor Protection and Systemic Stability in the Context of Tokenisation:

Through the process of tokenisation, any type of asset be it an interest in real estate, an
artwork or even an intangible such as a piece of intellectual property, may be
fractionalised into many different parts which are represented by tokens.90 This may also
be accompanied with multiple benefits, given the increase in asset liquidity. This would
consequently render investments much more accessible due to the possibility of buying
solely a fraction of a particular asset, which as a whole might be too expensive.91

However, such surge in investments is also accompanied with its risks and as such, the
financial markets must be as robust and fair as possible, with investor protection being a
key element. Especially given that people may start investing in assets which were
previously inaccessible to them and due to such previous inaccessibility, their knowledge
regarding such assets might be particularly limited. This reasoning is further substantiated
by the fact that more often than not, investors will likely have no idea of the technological
elements at play. These elements have a crucial role in the STO context, since in essence,
the token itself and the rights pertaining to it are all governed by its underlying constituent
technology. Consequently, in the light of the abovementioned considerations, systemic
stability may be exposed to greater risks, particularly due to the lack of knowledge and
the inexperience of investors, which may be exploited by intermediaries. Similar risks
might also arise due to the lack of knowledge and the inexperience of the intermediaries
themselves, which might result in several errors that affect investor confidence. In this
regard, intermediaries, particularly investment advisers and brokers, should be monitored
as closely as possible, at least until the industry evolves in such a way that it reaches a
state of establishment rather than still being at its inception. All of this emphasises the
vital role which the prevention of systemic risk plays in the STO space and the importance
of having enhanced prudential supervision in place.

90 Ibid., (n 5).
91 Vide section 3.3 for further detail on the phenomenon of tokenisation and the implications thereof.

28
2.2.3) Investor Protection and System Stability in relation to Hybrid Tokens:

DLT allows for the possibility of creating new kinds of tokens which are of a hybrid
nature, as evidenced in section 1.2.2 by reference to the MFSA’s proposal to distinguish
between ‘Traditional STOs’ and ‘Other STOs’. The peculiarity of such tokens could
potentially bring about an element of confusion and uncertainty with both investors and
intermediaries. Once again, this emphasises the importance of investor protection and the
maintenance of systemic stability. Obviously, change brings forth new opportunities and
possibilities and as such it must not be hindered. However, it also brings about elements
of risk and uncertainty and which must be identified and dealt with effectively. It may
therefore be argued that from a legislative point of view, such tokens would probably
undergo extensive scrutiny and the investment in such instrument would have to be highly
regulated. Showing once again that these regulatory objectives are more important than
ever in the STO context.

Therefore, one could argue that the three objectives here above discussed, albeit essential
in all aspects of financial services in general, are particularly significant in the STO space.
It may therefore be argued that this is exclusively a result of the innovative character
which underpins STOs, which is an solely a result of the technological aspects at play, ie.
DLT. Therefore, although innovation cannot be halted and should definitely be promoted
given the vast advantages it brings forth, it is of utmost importance that caution is
exercised and that the relative legislation embodies and promotes these fundamental
objectives to the utmost. One ought to remember that the fundamental principal behind
technology as that of constant improvement, therefore, such technological advancements
should be adequately monitored so that such improvements are not accompanied by
additional problems and conundrums.

29
 CHAPTER 3: THE IMPACT OF STOs TO THE FINANCIAL SERVICES
MARKET

Although for the time being the use of security tokens is limited, the potential arising
from tokenising assets is immense so much so that the OECD reiterated that:

“Asset tokenisation has potential cross-cutting implications for financial market

practices and participants, market infrastructure and regulators across a large range of
financial instruments and asset classes.”92

Therefore, a discussion on the potential impacts and implications brought about by STOs
to the financial services industry, particularly to the financial market pillar is essential. 93

3.1) The Interplay between ICOs, STOs and Public Offerings:

The meteoric rise of ICOs in 2017 sparked incredible interest in blockchain and resulted
in several speculations depicting ICOs as the new and improved IPO. This resulted in a
number of investors choosing to invest their money in ICO projects rather than the capital
markets, thereby shifting away some of the liquidity available to the capital market space.
Subsequently, with the increasing popularity of STOs, there was also a proportionate
decrease in the ICO space. In fact, in the fourth quarter of 2018 alone, circa six hundred
forty two (642) ICOs were issued, in contrast to the approximate one hundred seventy six
(176) issued in the third quarter of 2019.94 Contrastingly, in the first quarter of 2018,
around fourteen (14) STOs were issued, while in the first quarter of 2019, approximately
forty seven (47) STOs were issued. This comparison definitely illustrates an important
change in the market, given the shift towards projects which are actually backed by a real
asset and not just by words and promises.

92 The Tokenisation of Assets and Potential Implications for Financial Markets, OECD Blockchain Policy
Series, (OECD 2020), <www.oecd.org/finance/The-Tokenisation-of-Assets-and-PotentialImplications-
for-Financial-Markets.htm.>.
93 Ibid.
94 'Stats And Facts' (ICObench) <https://icobench.com/stats> accessed 3 April 2020.

30
As a result, STOs took back most of the liquidity attributable to ICOs, thereby resulting
in a more stabilised market, particularly due to the amount of scams associated with ICOs.
However, as discussed in Chapter 2, STOs also expose investors to certain risks
particularly due to the creation of new types of tokens which are now in the process of
being offered to the masses which are most likely not well educated. From an investor
protection perspective, this definitely raises certain questions. Particularly, whether
current investor protection measures, such as limiting the amount which can be invested
by a particular investor class, are enough to fully protect investors, especially
inexperienced ones. Therefore, although STOs seem to have incorporated the best
features of ICOs and traditional public offerings, investors, particularly inexperienced
ones, should do their utmost to educate themselves prior to their involvement in the STO
space by assessing the appropriateness of such investments.

3.2) Creating a Global Public Offering:

As previously discussed, STOs have a global reach, in that they are not limited to any
particular territory. In fact, De Filippi and Wright affirm that through decentralisation and
smart contracts ‘people can sell blockchain-based tokens related to their online projects
to anyone across the globe, in what amounts to a global public offering’.95 Further to this,
some argue that decentralised systems ‘are poised to transform capital markets’.96 Should
this be the case, this could result in an increase in investment capital available to SMEs
and the real economy. Needless to say, this is one of the features which will undoubtedly
disrupt the financial market scene and the financial services sphere as a whole, given the
territorial limitations of most public offerings. This global reach would unlock a multitude
of new potential investors and therefore is likely to increase the efficacy and success of
the relative offering.

The creation of a global capital market would in turn result in an increase of funds being
allocated to the financial market space, which would consequently result in more funds
being available to businesses in need of such funding. As a by-product, this could lead

95Primavera De Filippi and Aaron Wright, Blockchain and the Law: the rule of code (Harvard 2018)
96Aaron Wright, ‘Beyond Bitcoin: Emerging Applications for Blockchain.
Technology’ 4 <https://docs.house.gov/meetings/SY/SY21/20180214/106862/HHRG-115-SY21 Wstate-
WrightA-20180214.pdf>.

31
more businesses to seek funding from the financial markets rather than borrowing funds
from banks, which would consequently impact the banking industry as well. Therefore,
this could also result in a shift of liquidity from the banking industry to the financial
market industry thereby posing negative repercussions on the former. Regardless of the
arguments supporting this potential creation of a global public offering, one should take
into consideration that securities offerings are a regulated activity in several jurisdictions.
Therefore, there are various regulatory, marketing and distribution restrictions which an
STO would need to comply with before being issued as a global public offering.

3.3) Potential Implications for Financial Markets:

3.3.1) Efficiency Gains:

The element of decentralisation, together with the features of automation in regards to

transactions and settlement whereby no trusted intermediary is required as well as the use
of smart contracts, may be one of the most disruptive features of security tokens,
especially due to faster and potentially cheaper transactions, particularly in relation to
corporate actions, such as interest payments, dividend distributions or votes. 97 In addition
to the increased efficiency, the DLT and cryptographic element of security tokens allow
for a more robust and immutable infrastructure, thereby increasing the overall security.
Some of the aforementioned effects where displayed in practice in Nasdaq Linq, a DLT
based platform for the issuance and trading of private company shares. This platform
provides a good use case in which issuers are provided with real-time transparency into
the records and trading activity, which resulted in a drastic decrease in manual ownership
transfers and the consequential costs. 98

Furthermore, DLT allows enhanced transparency in relation to transactional data and

beneficial ownership records which as a result may render the role of registrars obsolete.
This enhanced transparency may further be utilised to automatically enforce regulatory
compliance through the use of smart contracts. Moreover, since in a distributed ledger,
transfers of ownership are almost instantaneous and the ledger is in constant

97 Ibid., (n 92).
98 Ibid.

32
reconciliation, the clearing and settlement process might be heavily impacted, in that
efficiency is likely to be increased and operational risk reduced. 99 All of this can be seen
in practice in the Nivaura ET-denominated bond, which is the first company to launch an
STO in the UK FCA Sandbox. In this use case, the blockchain acted as an autonomous
registrar, thereby removing the traditional registrar. As a result of the enhanced
transparency offered by DLT, it was demonstrated that the technology has the capacity
of creating and maintaining an effective reconciliation and auditing process. In addition,
transactions were made on a peer-to-peer basis with smart contracts used to automate both
the transfer of the tokens and the consequent payments. As a result of such automation,
no paying agent was required, which resulted in a more streamlined and efficient
process.100

3.3.2) Fractional Ownership & its Impact on SMEs:

As aforesaid, asset tokenisation allows for the splitting up of assets, thereby

fractionalising ownership, which in turn permits investors, particularly retail investors, to
gain access to asset classes which were beyond their reach. As such, this would allow
investors to hold a much more diversified portfolio. This notion of fractionalisation may
also enhance access to finance for SMEs, since essentially, any investor type, including
retail ones would be able to invest in SMEs and their respective projects. As a result, this
would lead to a more efficient capital allocation and a more inclusive system for both
investors and entities in search of funding which are unable to access capital markets.
Apart from that, the economy could also benefit from the tokenisation of investment
funds.101 Some real life examples wherein security tokens have been used to fractionalise
assets include, AspenCoin and the Art Token. The former is an STO issued on January
2019 by ST. Regis Aspen Resort, which issued tokens representing the resort itself, which
tokens also gave rise to dividends. This STO reportedly raised $18 million and was the

99 Financial Stability Board, 'Decentralised Financial Technologies Report On Financial Stability,

Regulatory And Governance Implications' (2019) <https://www.fsb.org/wp-
content/uploads/P060619.pdf>.
100 Richard Cohen and others, 'Automation And Blockchain In Securities Issuances' [2018] Butterworths
Journal of International Banking and Financial Law.
101 Ibid., (n 92).

33
first STO project tokenising real estate.102 As for the latter, the Art Token is an STO which
issued tokens representing fractional ownership in fine art, with the art itself being
securely stored in a Swiss-bonded warehouse secured by the Swiss Government which
reportedly raised over $25 million.103

3.3.3) Trading Implications:

As here above discussed, DLT allows for direct transacting and does not require any
intermediary, regulatory restrictions aside, thereby resulting in substantial efficiency
benefits. This was demonstrated in practice in the Bitbond STO, which is the first STO
approved by BaFin, the German regulator for financial services. The Bitbond STO
concerned an issue of tokenised debt securities by Bitbond, a global SME lending
platform, wherein transactions were conducted through the stellar blockchain, a public
and permission-less blockchain. As such, this allowed the token holders to easily trade
the tokens in a peer-to-peer manner.104
Nevertheless, today, there is still an element of intermediation within the DLT space.
Eventually, these might be replaced by technology, but so far this has not been the case.
In this regard, some industry participants argue that brokers are still valuable in
decentralised platforms, particularly in relation to the lack of a single accountable point
and the execution of large-sised orders,105 which begs the question, is a decentralised
system actually necessary?

The complete removal of intermediaries may impact the smooth functioning and risk
redistribution of certain markets, in that, a total lack of an intermediaries which are
capable and prepared to warehouse tokens and provide liquidity in bear markets could
have potential implications on the liquidity of the market. Thus, total disintermediation
may result in a detrimental impact on the markets, particularly in times of stress and
extreme volatility. In addition, well-timed liquidation of large holdings in a short

102 Tim-Fries,-'Aspencoin-Transitions-To-Securitize-After-Raising-$18-Million-In-Security-Token-
Offering'- (The-Tokenist,-2019) <https://thetokenist.io/aspencoin-transitions-to-securitize-after-raising-
18-million-in-security-token-offering/> accessed 6 April 2020.
103 STO List, 'Thearttoken (STO) - Security Token Overview | Stoscope' (STOscope)
<https://stoscope.com/sto/thearttoken> accessed 6 April 2020.
104 (Bitbondsto.com, 2019) <https://www.bitbondsto.com/files/bitbond-sto-prospectus.pdf> accessed 7
April 2020.
105 Ibid., (n 92).

34
timeframe may become cumbersome, especially in less liquid securities. 106
Simultaneously, one ought to remember that the efficiency gains derived from the use of
security tokens is dependent upon several factors, inter alia, the level of decentralisation,
the private/permitted nature of the DLT of a DLT, the validation and verification
procedure, and the use of smart contracts. Therefore, the presence of brokers and dealers
in DLT based markets of tokenised securities may limit the extent of efficiency gains
being derived from the use of such technology.107

3.3.4) Liquidity Implications:

Given that any asset can be tokenised, the use of security tokens will likely increase the
number and diversity of assets being traded on the market, thus increasing the liquidity
of the market. In addition, as referred to in Section 3.3.2, asset tokenisation can also
provide ample liquidity to highly illiquid assets such as real estate and SME equity.108 In
fact, some industry participants estimate that tokenisation could potentially “unlock
trillions of euros currently in illiquid assets, vastly increasing the volumes of trade.”109
However, for such benefits to actually materialise there are a multitude of factors which
must be present. Firstly, there must be an adequate demand for tokens. Secondly, the
potential efficiency gains resulting from a shift to a tokenised market must be substantial,
otherwise such transition would not be economically and logistically viable. Thirdly, the
market must be prepared and willing to accept such a shift. 110

However, problems might arise in relation to the trading of security tokens which
represent “off-chain” assets. “Off-chain” assets is a term which essentially refers to real
world assets existing outside of the DLT platform, such as a plot of land. Risks pertaining
to such tokens are related to the possibility of bifurcation between the on-chain and the
off-chain market. This bifurcation could occur when a particular security is traded both
off and on-chain. An example would be, a security token representing gold which is being

106 Ibid.
107 Ibid.
108 Ibid.
109 The-tokenization-of-assets-is-disrupting-the-financial-industry.-Are-you-ready?-Inside-Magazine-
issue-19, (Deloitte 2018), <https://www2.deloitte.com/lu/en/pages/technology/articles/tokenization-assets-
disrupting-financial-industry.html>.
110 Ibid, (n 92).

35
traded on a particular DLT platform, whilst its underlying asset, the gold, is also being
traded on the conventional markets in the real world. 111 Such parallel trading could
potentially dry up the liquidity present in the off-chain markets, thereby causing a
liquidity mismatch between the token and the underlying asset. Furthermore, this could
also expose security token trading to fragmentation, by creating a pricing mismatch
between the on-chain and off-chain markets, which in turn could give rise to arbitrage
risks and impact market stability. 112 This could be viewed as a similar situation to the
typical pricing mismatch found between the net asset value and the trading prices for
securities.

In addition, there are also strong arguments stating that tokenised securities benefit from
lower “liquidity premium.”113 Basically, the term “liquidity premium” is used to describe
the additional return expected by investors from illiquid investments, due to the fact that
such assets cannot be easily sold. This lower liquidity premium allows for assets to be
traded more closely to their fair value and in turn allows investors to gain greater value
from the underlying asset. This advantage is likely to have a greater impact on highly
illiquid asset classes, such as real estate and equity holdings of private SMEs, given that
these carry the highest liquidity premium. Therefore, through the use of STOs as opposed
to traditional public offerings, asset prices can be adjusted in such a way which reflects
their fair value. Nevertheless, one must keep in mind that this argument might be difficult
to substantiate in practice since liquidity premium are difficult to isolate, quantify and
dissociate from systemic or market risk. 114

3.3.5) Pricing Implications:

As aforementioned in the introduction, one of the fundamental principles behind DLTs,

specifically blockchain, is the principle of transparency. Essentially, this principle
provides that each and every action occurring on the network is effectively stored and
recorded on such network. Therefore, since the efficient market theory provides that the
pricing of listed instruments is a reflection of all information which is publicly

111 Ibid.
112 Ibid., (n 99).
113 Ibid., (n 109).
114 Ibid., (n 92).

36
available, 115 this enhanced transparency is likely to play a vital role with respect to such
pricing, in that, it could potentially reduce information asymmetries and improve price
discovery processes. However, it should be noted that such an increase in transparency
might not appeal to particular market participants which value anonymity and obscurity.
Case in point, fragmented large acquisitions or sales from market participants who would
not like to affect the markets with a large block trade order will not be possible in DLT-
based markets.116

3.3.6) Post-Trade Settlement Implications:

A shift towards a DLT based market could have substantial impacts on clearing and
settlement processes. In a traditional trading scenario, both parties to a trade need to
maintain records relating to such transaction. However, the use of DLT would make away
with such an inefficient system through the creation of a single, shared, immutable
register of records, which is continuously updated and is accessible by all involved
parties. In addition, further efficiency gains could also be achieved with the incorporation
of smart contracts, as these have the capacity to validate ownership, confirm trade
matching and record transactions in an “automated, immutable, transparent and near-
immediate way.” In turn, such level of automation would also reduce the number of
intermediaries involved, thus creating a more streamlined process. Furthermore, DLT
could also increase the efficiency of back-office processes, by decreasing costs as well as
data inconsistencies; thus facilitating faster data reconciliation. 117

Dr. Jens Weidmann, president of the Deutsche Bundesbank, commented that there were
mixed results in the efficiency gains derived from experimental applications of DLTs on
clearing and settlement processes. Case in point, the joint Bundesbank/Deutsche Börse
blockchain project for securities settlement, albeit proving its suitability for high-volume
use, did not outperform current clearing and settlement systems. In fact, in certain
circumstances, settlement took longer and produced moderately high computational
expenses. This clearly demonstrates that there are certain hurdles in the technology’s

115 'Efficient Market Hypothesis (EMH)' (Investopedia)

<https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp> accessed 9 April 2020.
116 Ibid., (n 92).
117 Ibid.

37
development which must be overcome in order for DLT to outperform the systems
currently in place.118

118 Jens Weidmann, “Payment systems and securities settlement in Germany in 2019” (Deutsche
Bundesbank, 2019), <https://www.bundesbank.de/en/press/speeches/prometheus-and-epimetheus-in-the-
digital-age-798160> accessed 8 April 2020.

38
 CHAPTER 4: ADDRESSING REGULATORY PROBLEMS AT THE
NATIONAL LEVEL

Albeit recognising that security tokens, as securities issued on a distributed ledger, should
be regulated by current securities legislation, the author is of the opinion that current
legislation cannot fully cater for such tokens’ technological elements. Therefore certain
deficiencies must be addressed in order for STOs to be used at their full potential.

4.1) Achieving Regulatory Harmonisation:

In the STO context, regulatory harmonisation is key, particularly when addressing the
possibility of issuing a ‘global public offering’ as referred to in Chapters 2 and 3. One of
the main problems in this regard is the classification of certain hybrid tokens which
encompass elements of all three main type of tokens described in the introduction. In this
regard, it is the author’s opinion that Maltese legislation should be as aligned as possible
with EU law. In turn, this would facilitate intra-community offerings and issuers could
enjoy the full benefits of the EU internal market. Moreover, one also ought to think in a
global manner, rather than restrict his thinking solely to the EU. Therefore, in addressing
the regulatory challenges faced by ‘global public offerings’ reference shall be made to
the comparative analysis undertaken in sections 1.3 and 1.4, namely in regards to the
definition of a ‘security’ under USA and Singapore law.

4.1.1) Hybrid Instruments: Securities or Not?

One of the biggest issues surrounding digital assets is the categorisation of innovative
instruments which do not seem to fall in any of the existing categories. Such issue has
been addressed by various regulators, such as the MFSA as discussed in section 1.2.2.1,
as well as by the FCA and the European Commission in their respective consultations. At
EU level and even globally, these instruments are referred to as ‘hybrid tokens’ and as
abovementioned, such instruments encompass a combination of characteristics pertaining
to the three main types of tokens, such as a token which gives only a share of revenue of
a particular investment, without granting ownership or voting rights to the token holder.

39
With the main issue being whether such hybrid tokens should be classified as ‘financial
instruments’ or if a different notion should be adopted.119

Such issue should ultimately be addressed at EU level, which could likely be the case,
given that it was specifically addressed by the European Commission. 120 However,
pending any decision by the EU, it is the author’s opinion that from a Maltese perspective,
such hybrid tokens should ultimately fall outside the remit of MiFID II, insofar as they
do not meet the definition of ‘transferable securities’. Instead, they should fall under the
purview of the VFA Act, and be treated as VFAs, provided that they do not constitute
virtual tokens. In this regard, albeit understanding the MFSA’s reasoning that certain
hybrid tokens which are akin to securities should not fall outside MiFID II simply because
they do not fully conform with the traditional notions of what constitutes a security, such
categorisation would ultimately have a detrimental impact. In particular, this would
disrupt the harmonisation which is currently present within the EU and possibly impact
the internal market, given that if such hybrid tokens were to be treated as securities under
Maltese law, the passporting of the relative offering to another Member State which does
not categorise such hybrid instruments as securities would face several challenges and
implications, which would ultimately negate the benefits arising from the internal market.
It may therefore be argued that although an optimal solution should ultimately be reached
by the EU, such a temporary measure would not disrupt the current degree of
harmonisation present within EU financial legislation and the internal market.
Furthermore, this would simultaneously provide an optimal degree of regulatory
certainty, given that the VFA Act follows the principles enshrined in MiFID II which
renders it a substantially robust piece of legislation.

4.1.2) Extra-Community Offerings – Reaching the East & the West:

Malta has often been described as a European financial hub which is heavily based on
foreign direct investment. Therefore, it is essential to analyse the possibility of extending
such offerings beyond the frontiers of the EU, whilst taking into account the suggested
approach for hybrid token classification. Naturally, this analysis revolves predominantly

119 Ibid., (n 19).

120 Ibid.

40
around the definition of a security of the relative jurisdictions, which definitions have
been included in the table hereunder.

Table 1: The Definition of a ‘Security’: EU vs Singapore vs USA Law

Jurisdiction Definition

European Union ‘Transferable securities’ means those classes of securities which

(MiFID II) are negotiable on the capital market, with the exception of
instruments of payment, such as:

(a) shares in companies and other securities equivalent to shares in

companies, partnerships or other entities, and depositary receipts
in respect of shares;

(b) bonds or other forms of securitised debt, including depositary

receipts in respect of such securities;

(c) any other securities giving the right to acquire or sell any such
transferable securities or giving rise to a cash settlement
determined by reference to transferable securities, currencies,
interest rates or yields, commodities or other indices or measures;

Singapore ‘Securities’ means —

(Securities and
(a) shares, units in a business trust or any instrument conferring or
Futures Act)
representing a legal or beneficial ownership interest in a
corporation, partnership or limited liability partnership;

(b) debentures; or

(c) any other product or class of products as may be prescribed.

USA The term ‘security’ means any:

(Securities Act note, stock, treasury stock, security future, security-based swap,
1993) bond, debenture, evidence of indebtedness, certificate of interest or
participation in any profit-sharing agreement, collateral-trust
certificate, preorganization certificate or subscription, transferable
share, investment contract, voting-trust certificate, certificate of
deposit for a security, fractional undivided interest in oil, gas, or

41
 other mineral rights, any put, call, straddle, option, or privilege on
any security, certificate of deposit, or group or index of securities
(including any interest therein or based on the value thereof), or
any put, call, straddle, option, or privilege entered into on a
national securities exchange relating to foreign currency, or, in
general, any interest or instrument commonly known as a
“security”, or any certificate of interest or participation in,
temporary or interim certificate for, receipt for, guarantee of, or
warrant or right to subscribe to or purchase, any of the foregoing.’

An ‘investment contract’ is defined as:

an investment of money in a common enterprise with the expectation
of profits solely from the efforts of others.

The extension of a Malta issued STO to Singapore would most likely be faced with
minimal problems in regards to token classification, given that the respective EU and
Singapore definitions of the terms ‘transferable securities’ and ‘securities’ as seen in the
table above, are quite similar. Furthermore, should the suggested classification in relation
to hybrid tokens as laid down in section 4.1.1 be adopted, such tokens, which under
Maltese law would be classified as VFAs, should also likely be qualified under Singapore
law as ‘digital payment tokens’ which is the Singapore equivalent to a VFA.

Table 2: The Definition of a ‘digital payment token’ under Singapore Law:

Jurisdiction Definition

Singapore The term ‘digital payment token is defined as:

(Payment Services ‘any digital representation of value (other than an excluded
Act 2019) digital representation of value) that —
(a) is expressed as a unit;
(b) is not denominated in any currency, and is not pegged by
its issuer to any currency; (c) is, or is intended to be, a medium
of exchange accepted by the public, or a section of the public,
as payment for goods or services or for the discharge of a debt;
(d) can be transferred, stored or traded electronically; and

42
 (e) satisfies such other characteristics as the Authority may
prescribe.121

In turn, this would render Singapore a viable market to consider when issuing an STO
from Malta. Which shows that the classification of hybrid tokens as VFAs not only
facilitates intra-community offerings but also unlocks new possibilities outside the EU.

However, certain issues might arise in the context of the USA, given the extensive
definition of the term ‘security’ as well as that of an ‘investment contract’. The extension
of an STO to the USA would prima facie not face any hurdles, given that the USA
definition of a security is wider than that adopted by the EU. Nevertheless, problems
might arise in relation to hybrid tokens, particularly if one is to follow the approach
suggested in section 4.1.1, given that from a USA perspective such tokens would most
probably qualify as a security. In fact, the above mentioned example of a token giving
only a share of revenue of a particular investment, without granting ownership or voting
rights to the token holder would definitely be classified as an investment contract in
accordance with the Howey Test. Therefore, although the suggested classification vis-à-
vis hybrid instruments does not pose any benefits within a USA scenario, one ought to
appreciate that the approach adopted by the USA regulator/s is extensively wide. As such,
trying to align the Maltese approach with that of the USA would ultimately be detrimental
within an EU context.

4.2) Company Law Considerations:

In order to fully incorporate and benefit from the use of DLT, there are certain company
law considerations which must be addressed. As such, this section shall identify the main
provisions of the Companies Act which may pose obstacles to the use of DLT and suggest
possible amendments to cater for such hindrance.

121 Payment Services Act 2019, Article 2(1).

43
Table 1: Companies Act Amendments – The Register of Members and Debenture Holders

Art.123 & 124 – The Registers of Members and Debenture Holders

Provision Summary Every company is required to keep a register of shareholders

and a register of debenture holders which shall be kept at the
company’s registered office. That being said, such registers
may be kept in a dematerialised form or represented in book-
entry form as immobilisation with a CSD.

Issue As per current legislation, the aforementioned registers

cannot be kept in a dematerialised form using DLT.

Suggested Such provisions should be amended so as to allow the register

Amendments of members and the register of debenture holders to be kept
in a dematerialised form using DLT. With such DLT being
duly certified by the MDIA in order to ensure an adequate
level of legal certainty and security.

Additional Remarks Through the incorporation of DLT, the abovementioned

registers would be rendered immutable and would also be
automatically updated upon a transfer / issue of shares or
debentures, as the case may be (insofar as such transactions
take place using DLT).

Table 2: Companies Act Amendments – Instruments in writing for share transfers

Art.118 – Instruments in writing for share transfers

Provision Summary Any transfer of shares or debentures of a company shall be

made in writing, with the exception of shares or debentures
which are kept in a dematerialised form or represented in
book-entry form as immobilisation.

Issue As per current legislation, the exemption from requiring a

written instrument for the transfer of shares or debentures

44
 applicable to dematerialised securities does not cater for
tokenised securities.

Suggested The exemption from requiring a written instrument for

Amendments transfer applicable to dematerialised securities should also be
extended to securities which are recorded on DLT. Instead,
such written instrument could be replaced with a smart
contract duly certified by the MDIA, which would
simultaneously execute the transfer of securities, the transfer
of the relative consideration, if any, as well as update the
register of members or debenture holders accordingly.

Additional Remarks Needless to say, such an amendment would reduce the level
of human intervention, thereby increasing efficiency, as well
as increasing transparency and security through the use of
DLT.

Table 3: Companies Act Amendments – Statutory Notification Forms & Tax Filings

Statutory Notification Forms & Tax Filings

Summary Certain provisions in the Companies Act as well as other

legislative instruments such as the Duty on Documents and
Transfers Act122 and the Capital Gains Rules123 require that
upon a transfer of shares, certain forms need to be filed with
the Malta Business Registry or the Inland Revenue
Department.

Issue As per current legislation, such statutory forms and filings

need to be manually filed with the relative regulators.

Amendment These provisions should be amended in a way which allows

the use of DLT, particularly smart contracts, which are duly

122 Chapter 364 of the Laws of Malta.

123 Capital Gains Rules, S.L. 123.27.

45
 certified by the MDIA for the purposes of filing such forms.
In doing so, upon a transfer of shares, the relative statutory
forms would be automatically recorded (filed) with the
regulator.

Additional Remarks This would probably also require some technological

developments, in that a common permitted DLT system
would probably have to be created, which DLT would be used
by the relative regulators, company service providers and the
companies themselves. However, this is a question of
technological implementation rather than a legal one.

46
 CONCLUSION

This dissertation seeks to study the regulatory framework and legislative concerns
surrounding STOs as well as to analyse the implications brought about by such fund
raising mechanism to the financial services market. The ultimate aim being the creation
of a better system which allows STOs to be used to their full potential whilst
simultaneously ensuring adequate legal certainty.

Firstly, Chapter 1 dealt with the question of “How are STOs currently regulated?”, which
chapter demonstrated that security tokens, being securities recorded on DLT, are subject
to traditional securities legislation. In the EU space, once a security token fulfils the
definition of a ‘transferable security’ it will be subject to various directives and
regulations, principally, MiFID II, the Prospectus Regulation, and the Market Abuse
Directive and Regulation. As for the USA, the definition of a ‘security’ was found to be
much wider than that adopted under EU law, particularly due to the Howey Test. The
definition under Singapore law, was found to be quite similar to that adopted under EU.
From a Maltese perspective, the MFSA has addressed and clarified a number of issues
pertaining to STOs through its feedback statement, wherein the Authority started paving
the way for future STO projects.

After determining the applicable legislation, the author sought to furtherly analyse such
legislation by delving into its underlying rationale. In fact, Chapter 2 addressed the
question “What is the rationale behind STO legislation?”, wherein the three main
regulatory objectives were identified, being; the safeguarding of the financial system’s
stability; investor protection; and the preservation of market integrity. Through an
analysis of key STO peculiar features, the author was able to conclude that such objectives
play a crucial role in the drafting of STO specific legislation. The concept of a global
public offering highlighted the importance of having adequate mechanisms in place for
investor protection and market integrity preservation, given that such offerings could be
issued on a worldwide scale. Furthermore, the objectives of investor protection and
systemic stability were also highlighted in regards to tokenised assets and hybrid tokens.
Particularly due to the limited knowledge and experience of investors in relation to such
instruments, which may be exploited by intermediaries, as well as possible lack of
knowledge and experience on the part of intermediaries themselves. It was further noted

47
that technological developments may be accompanied with certain perils, as such a
cautious approach in regards to such technological advancements was suggested.

Subsequently, the author shifted from a pure regulatory analysis to a more financially
oriented one by analysing the potential impacts of STOs on the financial services sphere.
In fact Chapter 3, addressed the question “What is the impact which STOs can pose on
the financial services market?”. The potential implications of STOs to the financial
services market are plenty. Based on the figures cited in Section 3.1, one can pinpoint a
substantial impact on the market, given the decrease in ICOs and the consequential
increase in STOs. Furthermore, the potential of creating a global public offering clearly
demonstrated that STOs could potentially transform capital markets. As a by-product, it
was noted that this could potentially strip away some of the liquidity available to the
banking industry.

Moreover, the author delved into the efficiency gains which could be derived through the
use of DLT, such as, cheaper and faster transactions, enhanced transparency and a high
degree of disintermediation. With regards to the removal of intermediaries, the author
opined that a certain degree of intermediation is still necessary for the proper functioning
of the financial markets. Therefore, a balance should be found between the efficiency
gains which can be derived through disintermediation and the proper market functioning
which is derived through a certain level of intermediation. As for the enhanced
transparency, it was concluded that this could reduce information asymmetries and
improve price discovery processes, thereby affecting the pricing of listed instruments.
Apart from that, it was ascertained that the use of smart contracts could potentially
automate the clearing and settlement processes. However, Dr. Jens Weidmann
commented that there were mixed results in regards to the efficiency gains derived from
experimental applications of DLTs on such processes.

Additional benefits include enhanced access to finance for SMEs, given that through asset
tokenisation any investor would be able to invest in SMEs and their respective projects.
Tokenisation could also lead to an increase in market liquidity as well as provide ample
liquidity to highly illiquid assets such as real estate, and such assets could also benefit
from lower liquidity premium. However, one should also take note of the possibility of

48
bifurcation which might arise from the trading of security tokens which represent “off-
chain” assets.

Finally, the author felt it necessary to revert back to the regulatory analysis undertaken in
the initial chapters, in order to address relevant amendments which are required at the
Maltese level. In fact Chapter 4 addressed the question “What are the deficiencies of the
Maltese regulatory framework and how can they be amended?”. In this chapter, the
importance of regulatory harmonisation in the STO space was discussed. Hence, it was
suggested that hybrid instruments which do not fall within the MiFID II definition of
‘transferable securities’ should be classified as VFAs. Thereby avoiding discrepancies
vis-à-vis classification at EU level whilst simultaneously ensuring adequate legal
certainty. Furthermore, in adopting such approach, it was also ascertained that the
extension of an STO from Malta to Singapore would be facilitated, given the similar
definitions of what constitutes a security. Conversely, the extension of an offering from
Malta to the USA would encounter certain difficulties in regards to classification, insofar
as the issued unit is a hybrid token, due to the wide definition of what constitutes a security
adopted by the USA.

In the second part of Chapter 4, a number of possible amendments to the Companies Act
were proposed in order to facilitate the adoption of DLT and STOs, thereby rendering
such act more ‘compatible’ with DLT. These amendments concerned three main issues:
the register of members and debenture holders, the requirement of written instruments for
share transfers, and other statutory notification forms and tax filing requirements.

In conclusion, the author has sought to provide a clear view of the concept of STOs from
a legal, technological and financial perspective. However, there is much more research
that can be undertaken, which due to the limited word count and the nature of this
dissertation the author could not delve into. As such the author shall conclude this
dissertation by setting forth some proposals of areas which merit further research.

49
Table: Future Research Areas

Research Area Further Elaboration

The interrelation One could address the CSDR implications arising from the use
between DLT and of DLT as a CSD or as an alternative to a CSD.
CSDs

The Classification of One could delve deeper into the concept of hybrid instruments
Hybrid instruments and possibly come up with a viable solution to be undertaken
at EU level or even just look into the implications arising from
the proposed classification of hybrid instruments as VFAs and
the misaligned MiFID II transposition and interpretation of the
definition of ‘marketable securities’ by EU member states.

The Implications of Whether a security token which is being used in order to

using Security tokens exchange value in a barter like fashion can be treated as an
in Barter like Fashion instrument of payment, thus falling outside the classification of
‘transferable securities’. To answer such a query one would
have to start by differentiating between money and currency.
Subsequently, one could argue that whilst a security token is
not money, if it is accepted as a medium of exchange of value,
then it is currency, and you can have an instrument which is
currency but not necessarily money.

50
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