Luxembourg’s new blockchain boosts distributed ledger technology for securities and introduces a ‹control agent,› offering new possibilities for fund distribution and innovation. Benjamin Schaub of the intas.tech consultancy and Sebastiaan Hooghiemstra at Loyens & Loeff share their insights in the Blockchain IV law and look at the potential impact on Luxembourg investment funds from a German law perspective.
On 24 July 2024, the Luxembourg Ministry of Finance submitted a bill of law to the Luxembourg Parliament (the “Blockchain IV Law”) that proposes amendments to the law of 6 April 2013 on dematerialised securities (the “2013 Law”) that further strengthens the use of distributed ledger technology (“DLT”) for dematerialized securities.
Key changes in the Blockchain Law IV
The Blockchain Law IV has two key changes that are (proposed to be) introduced.
First, besides dematerialised (unlisted) debt securities, it is now also proposed that the scope of the 2013 Law would be expanded with unlisted equity securities (fund units included) for which the use of DLT for the issuance, holding and transfer of dematerialised securities would be opened up.
Second, the Blockchain Law IV proposes to introduce a new actor by means of the concept of the “control agent”. This actor is proposed to serve as an alternative to the role of the central account keeper under the 1993 Law. The Blockchain Law IV proposes to assign the following roles to the “control agent” (which are not central account keepers):
- the maintenance of the securities issuance account;
- the verification of the consistency of the number of securities issued by the issuer and the number of securities registered on the DLT network; and
- the supervision of the securities custody chain from accountholders to investors…
The Blockchain Law IV innovates with the introduction of the “control agent”, as the “control agent” may hold natively issued DLT securities on a securities issuance account and, at the same time, record such DLT securities in securities accounts, thereby effectively eliminating the need for a central account keeper’s top-tier custody layer. Hence, the Blockchain Law IV proposes for “disintermediation”, as it does away with the mandatory two-tiered central account keeper and account keeper (i.e. credit institution) roles.
Implications from a German law perspective
Similar to Germany with the eWpG, Luxembourg proposes to extend its dematerialised securities framework with not only unlisted bonds, but also with unlisted equity securities (including fund units).
Potentially, this is beneficial for furthering retailisation of (Luxembourg) AIFs through digital platforms. Traditionally, the B2B2C (business-to-business-to-consumers) distribution model is predominant in Europe. Most fund managers distribute funds via distributors, such as banks, financial advisers and insurance intermediaries.
However, the Blockchain Law IV also allows investors to directly hold their securities with the “control agent”. Hence, this could further the development of more direct distribution models, in which funds through robo-advisory solutions or through digital marketing platforms are distributed to retail investors. This could also further the development of matchmaking, i.e. secondary market solutions for retail AIFs.
However, when considering the lessons learned in Germany from the eWpG, it is not guaranteed that the introduction of the current fashion of the Blockchain Law IV will be a success. In Germany, the uptake has been limited, in particular, with respect to the issuance of so-called crypto fund units (DLT-registered fund units in Luxembourg) Some research papers suggest that this is due to the fact that only unlisted shares/bonds are covered. Practitioners suggest, however, other reasons for the limited uptake.
Among other requirements, fulfilling the role of a crypto securities registrar (equivalent to the control agent role in Luxembourg) necessitates obtaining a corresponding license from BaFin. Financial institutions are not afforded any exemptions compared to start-ups, both of which are eligible to obtain such a license. The effort required to obtain such a license is significant, and the timeframe for potentially receiving approval remains uncertain. Why the hurdles are set so high, even for credit institutions or other heavily regulated financial institutions, and what added value this license brings is not immediately evident.
Particularly in the area of crypto fund units, German legislation reveals a significant weakness, which will likely result in it to be remaining largely a nationally applied regulation. In the area of crypto fund units, the custodian is legally responsible for maintaining the securities register. However, the custodian can delegate this task to a regulated crypto securities registrar. In practice, this approach has seen limited adoption, partly because many of the provisional crypto securities registrars (under grandfathering provisions) originate from the start-up sector.
The key hurdle, however, lies in the fact that EU operating custodians (with or without branches in Germany) may not obtain a license as crypto securities registrar. Affected institutions would first need to establish a subsidiary in Germany before they could begin the licensing process. In practice, this scenario is virtually non-existent. The Blockchain Law IV seems not to propose such a restriction. On the contrary, it proposes to lay the foundation for offering the services of the control agent cross-border within the EU. Hence, the future for the Luxembourg solution seems to be more appetizing for big institutions in this respect.
Lastly, it is unclear whether the status of “control agent” will be subject to an extensive examination of the CSSF. Albeit, officially speaking, it is only subject to a “registration procedure” the requirements are still (partly) aligned with those under the 1993 Law for central account keepers. This could hamper the uptake of this new alternative.
Benjamin Schaub is managing partner of intas.tech, a blockchain and digital asset consultancy focusing on the strategic assessment of blockchain use cases and the integration of digital assets into existing business models and IT infrastructures. Sebastiaan Hooghiemstra is a senior associate in the investment management practice group of Loyens & Loeff Luxembourg and senior fellow/guest lecturer of the International Center for Financial Law & Governance at the Erasmus University Rotterdam. The law firm is a knowledge partner of Investment Officer.
