The current ‘talk of the town’ for all Blockchain & Crypto-enthusiasts is an innovative test formulated by the Malta Financial Services Authority (MFSA) entitled: the Financial Instrument Test.
This analysis and ‘determination’ will be the mandatory barometer for all forms of enterprises proposing to introduce DLT [Distributed Ledger Technology] Assets into ‘Blockchain island’. Moreover, it will be the prime responsibility of the proposed VFA Agent to ensure that the test is conducted properly whilst having taken into consideration the nature and residual assessment of the proposed DLT Asset.
In this connection, it is worth briefly discussing this pioneering test and how representatives of Dr. Werner & Partner can aid in helping you set up a VFA approved business initiative/project.
To note that Article 47 of the Virtual Financial Assets Act, 2018 specifically states that the MFSA [aptly termed the ‘Competent Authority’] ‘shall introduce a test applicable to issuers, VFA agents and license holders for the purpose of determining whether a DLT asset qualifies as Electronic Money, a Financial Instrument, Virtual Financial Asset (VFA) or a Virtual Token’.
Prima facie, the test is in a way structured into ‘three’ main categories which for the sake of simplicity and coherence will be termed as the Virtual Token Test, the MIFID Test and the Electronic Money (E-Money) Test.
The Virtual Token Test.
When proposing a DLT Asset, it must first be determined whether the ‘asset’ or ‘token’ is a Virtual Token. Virtual Tokens can be defined as pure utility tokens in that they are solely issued for the specific purpose of consumption of services by the issuer of a related entity and have no other purpose. If a DLT Asset qualifies as a Virtual Token, it will fall outside the definition of a Virtual Financial Asset.
To determine if a DLT Asset is a ‘Virtual Token’, one must consider two key elements. 1) Its Exchangeability [Virtual Tokens are usually exchangeable solely within the DLT Platform] and 2) its ‘Purpose’ [as previously stated, the Virtual Token’s utility is restricted solely to the acquisition of goods or services]. If the token hypothetically allows for automatic swapping outside the limited network of the DLT Platform, the asset would not qualify as a Virtual Token.
The MIFID Test.
If the proposed DLT Asset does not qualify as a Virtual Token, the asset will be subject to a second layer of testing i.e. whether the proposed DLT Asset qualifies as a Financial Instrument in terms of the Markets in Financial Instruments Directive (the ‘MIFID test’).
A DLT Asset will be deemed to be a ‘Financial Instrument’ if it primarily qualifies as:
- A Transferable Security.
- Money Market Instrument.
- Is a Unit in a Collective-Investment-Scheme.
- A Financial Derivative
- An emissions allowance under MIFID.
The MFSA’s Guidance note to the Financial Instrument Test provides a very robust and in-depth application of MIFID requirements. What is crucial to understand is that any proposed DLT Asset that has a payments/money exchange functionality will technically speaking fall outside the scope of MIFID. The test in itself ‘by-passes’ MIFID if the DLT Asset would contain features which would therefore be similar to an instrument of payment. This will determination will certainly be crucial in solving the FIT ‘riddle’.
One of the most important considerations will certainly be that pertaining to ‘Transferable Securities’ since tokens might hypothetically have rights akin to normal corporate shares. For Tokens to be classified as ‘Transferable Securities’, they would need to be 1) Exchangeable and negotiated on Capital Markets 2) Have rights which render the DLT Asset similar to a share/bond and 3) would not serve as a medium of exchange. This is why the definition of a transferable security excludes instruments of payments.
In terms of ‘Financial Derivatives’, one must always take into consideration ANY ‘underlying contract’ to determine whether the proposed DLT Asset is actually licensable under MIFID. Four principal requirements would need to be satisfied for any token to qualify as a Derivative i.e. 1) Contract Type (DLT Asset would be the equivalent of an option, future, swap or any other Derivative], 2) DLT Asset would have an underlying asset in terms of MIFID, 3) the DLT Asset would be in accordance with conditions applicable in terms of MIFID [Settlement] and 4) Purpose (the DLT Asset would have an underlying purpose equivalent to a contract of difference).
The E-Money Test.
The final stage of the test would be to determine whether the DLT Asset would qualify as ‘Electronic Money’. (The E-Money test). The European Central Bank notes that Electronic money (e-money) is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to entities other than the e-money issuer. The device acts as a prepaid bearer instrument which does not necessarily involve bank accounts in transactions.
This test can be particularly challenging when tokens might be fully backed by FIAT currencies or if the proposed token has ‘redemption’ facilities. In this connection, in order for a DLT Asset to ‘qualify’ as Electronic Money and henceforth fall outside of the scope of the Virtual Financial Assets Act, 2018, the MFSA has established three main determining criteria:
The first pertains to Issuance and Redemption (i.e. the DLT Asset would need to be issued at par value on the receipt of funds by the issuer and redeemed solely by the issuer), secondly the DLT Asset would need to represent a claim on the issuer and thirdly, the DLT asset should be used for the purpose of making a payment transaction and is accepted by a natural/legal person other than the issuer of the said DLT Asset as a payment.
Since the ‘test’ is inherently a ’negative’ test, it stands to reason that if the proposed DLT Asset ‘fails’ all three tests accordingly, it will be by default satisfy the requirements of a ‘Virtual Financial Asset’ and the new regulation would henceforth be applicable.
Here at Dr. Werner & Partner, our qualified personnel will be more than willing to act as your personal prospective VFA Agent and help you draw up your business plans/proposals as per local legislation.
You can contact us accordingly to discuss any ICO, Token Generation Event or Blockchain-related idea by sending an email to: firstname.lastname@example.org
Disclaimer: The above-mentioned article is simply based on independent research carried out by Dr. Werner and Partner and cannot constitute any form of legal advice. If you would like to meet with up with any of our representatives to seek further information, please contact us for an appointment.
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