Crypto View - April 2023

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Welcome to this month’s Crypto View. We have quite a global mix for you - beginning with a landmark case in Hong Kong, before travelling to Germany where there have been developments in legislation permitting more tokenisation of financial instruments. We then go to Ireland where the CBI looks to be more permissive with investments in digital assets by QIAIFs, the UK where we look at a speech by Sarah Pritchard of the FCA and developments to UK regulation before finishing with an update to MiCA in the EU.

Property in Hong Kong

Earlier this month there was a landmark ruling in Re Gatecoin Limited [2023] HKCFI 914 that puts Hong Kong in line with other common law jurisdictions such as the UK, Canada and Australia, in recognizing cryptocurrencies as “property” and capable of being held on trust.

The judgment involved a Hong Kong-based cryptocurrency exchange platform, Gatecoin, which came into operation from January 2015 and was wound up by the court in March 2019. The joint and several liquidators of Gatecoin applied for directions as to whether the cryptocurrencies held should be regarded as being held on trust for the customers, or whether, if no trust existed, the digital assets should be made available to the general body of creditors.

The court concluded that cryptocurrencies are capable of forming the subject matter of a trust and are property, based on the wide definition of "property" in section 3 of the Interpretation and General Clauses Ordinance (Cap.1) and the reasoning adopted in other common law jurisdictions. However, the court found that a trust had not been established in this case on the basis that Gatecoin's latest terms and conditions made it clear that cryptocurrencies were not held on trust for its customers due to a lack of certainty of intention.

In the end, a fair result was given to the creditors, as all cryptocurrencies in the liquidator’s hands were treated as unsecured claims and distributed pari passu.

Overall, the Gatecoin case is a significant development in the legal recognition of cryptocurrencies and their treatment in insolvency scenarios, while also highlighting the importance of carefully drafted terms and conditions in determining the legal status of digital assets held by cryptocurrency exchanges and other similar platforms. The ruling provides legal clarity to the enforceable rights in relation to assets of a company in a winding-up scenario, and will bring far-reaching implications to the cryptocurrency industry, creditors and other related stakeholders.

Our own Eric Chan and Tom Fyfe were representing the “Group A” customers. Please do reach out if you have any question on this case.

German Future Financing Act

On April 3, 2023, the Federal Ministry of Finance (BMF) and the Federal Ministry of Justice (BMJ) published a Joint Key Points Paper for the Future Financing Act (Zukunftsfinanzierungsgesetz, the “Act”). The Act aims to modernise and digitise the German capital markets, and to make Germany a more attractive financial centre. It could lead to far-reaching positive changes for the German finance landscape, in particular for asset management, the capital market and, in particular, the start-up scene.

What is particularly interesting is the short timeline planned for implementation - the Act is supposed to come into force within the first half of the parliamentary term, which comes to an end in October 2023. It was not a surprise, then, that shortly after the Joint Key Points Paper (12 April), the BMF and the BMJ published a draft bill for an Act implementing the new opportunities. The draft bill includes amendments to corporate laws, tax laws and the act for electronic securities (eWpG). The amendments to the eWpG will continue the journey that the act started in 2021 in relation to electronic securities, with the new amendments adding the possibility of offering tokenised shares to the digitalisation of bearer bonds and fund units that came before.

The amendments provide for the issuance of registered shares as central register securities, and as crypto securities. Furthermore, the issuance of bearer shares in tokenised form will be possible provided they are registered in a central register. However, it is not going to be possible to issue bearer shares as crypto securities on a fully de-centralised basis, as this triggers several complex corporate law questions for which further amendments would be required – these are not able to be implemented within the short time frame. Germany certainly seems to be moving faster than other comparable jurisdictions on this front.

If you would like to discuss these developments further, please get in touch with Jochen Kinderman and Lena Menger.

Ireland

Earlier this month the Central Bank of Ireland (CBI) published an updated Q&A on digital assets for Qualified Investor Alternative Investment Funds (QIAIFs). It outlines a very significant departure from the previous CBI position. Up until now, all QIAIFs with any direct or indirect exposure to crypto needed to go through a pre-submission process with the CBI (i.e. 24 hour approval wasn’t possible). The exception to this was where the investment in crypto was limited to 10% of NAV in cash settled Bitcoin futures listed on the Chicago Mercantile Exchange. Only funds which came within this very specific fact pattern could avail of the 24 hour approval process for QIAIFs – this was far too limited for the majority of fund managers. The pre-submission process was relatively opaque and very off putting for the majority of managers that did not want to be a “guinea pig” with no guarantee of success.

QIAIFs can now have indirect exposure to all types of digital assets, so not just bitcoin, and OTC derivatives can be used to gain that exposure, rather than being limited to cash-settled futures only. The permitted exposures have doubled to 20% for open-ended funds and 5x to 50% for closed-ended or limited liquidity funds. Crucial to all of this is that pre-submissions are not required if the fund can come within these parameters.

If you would like to discuss this further at all, please reach out to my colleague James McKnight.

UK Regulation

On 25 April, Sarah Pritchard, an Executive Director at the FCA gave a speech at City Week 2023 on the regulation of digital assets in the UK.

The speech covered a lot of ground, reflecting on how crypto assets are becoming more mainstream (apparently 1 in 10 UK adults have owned crypto at some point, while in 2022, 42% of US institutional investors and 67% of European institutional investors held crypto). She also noted the risks involved, and how the FCA is limited in their powers while it can only enforce the AML regime.

Interestingly, she suggests that the AML regime doesn't bite on overseas firms who may target UK based consumers - which while generally the case doesn't align with their own registration flow chart or the regulation as drafted, which does bring certain businesses with UK links into scope.

As we noted in February’s Crypto View Special, there is a consultation out from HM Treasury which will go some way to determine the future regulatory landscape for cryptoassets in the UK, and will hand the FCA far more power to oversee the industry. This consultation closes this Sunday, 30 April. We do recommend responding if the proposed changes will impact you.

Another change which she mentions is the upcoming change to the financial promotions regime. And here, we very much agree with Ms. Pritchard - firms should start preparing for this now. The changes will impact firms globally that have marketing that can be accessed by UK customers, including websites.

Finally, Ms Pritchard reiterated her desire to engage further with the industry, looking at further Crypto Policy Sprints and roundtable discussions. It does seem that the FCA are giving the industry opportunities to give its views, though it remains to be seen whether the FCA is listening.

This month in MiCA

On 20 April the European Parliament endorsed both MiCA and the EU funds transfer rules for cryptoassets (the Travel Rule). It is a landmark date in the regulation of cryptoassets, and one that at times felt may never come.

There have not been many substantive changes since the last draft we saw, although the text has changed in terms of how it is written, considerably in places. We will be carrying out another series of webinars on MiCA now that we have the the final text. The legislation still needs to be endorsed by the EU Council and then entered into the official journal, so there isn't a definitive date for implementation yet, but this should be soon. We will keep you updated on this front.

On the Travel Rule, this will require firms carrying out transfers of cryptoassets to include identifying information on the originator and beneficiary, with that information "travelling" with the transaction. In a departure from the similar UK equivalent, the EU Travel Rule also requires firms carrying out a cryptoasset transfer over €1,000 to a self-hosted wallet to confirm that the wallet belongs to the sender, which may present some practical implementation problems, in a real-world context.