The Malta Financial Services Authority (MFSA) has in the past weeks issued for consultation the Financial Instruments Test Guidelines. The purpose of such guidelines relates to Article 47 to the Virtual Financial Assets Act (VFAA or Act) whereby the Act sets out the need for a test, which purpose is to determine whether a DLT Asset qualifies as:
Electronic Money – 3rd Schedule to the Financial Institutions Act;
Financial Instrument – 2nd Schedule to Investment Services Act; or
Virtual Financial Asset or Virtual Token – Act.
Applicability of the test
The Financial Instruments Test shall apply to two main categories:
Issuers of DLT Assets to the public in or from Malta; and
Persons involved in any service as defined in Act, traditional financial services in relation to DLT, DLT Assets which cannot be classified as well as DLT Assets offered outside of Malta.
The Financial Instruments Test classifies DLT Assets into three categories and, depending on the category, one will be able to determine whether the DLT Asset is exempt or requires to adhere to some form of regulation.
How does the Financial Instruments Test work?
The Financial Instruments Test is a two-stage test set, the purpose of which is to determine the regulatory regime to which a DLT asset is subject. The first stage focuses on virtual tokens as defined under the VFAA, while the second stage focuses on the various financial instruments under MiFID.
If, at the first stage, the DLT Asset qualifies as a virtual token under the VFAA, it will fall out of scope of the regulation, since virtual tokens fall outside the definition of VFAs under the Act. Alternatively, if a DLT Asset does not qualify as a virtual token, the DLT Assets will be subject to the second stage of the test – i.e. the identification of which MiFID Instrument, such DLT Asset satisfies.
In terms of MiFID, as well as the Financial Instruments Test, the MiFID Instruments which may be captured are as seen in the below diagram.
If the DLT Asset is not captured by any one of the above, then it does not fall within the scope of MiFID. Moreover, if it does not qualify as electronic money, then that asset will qualify as a Virtual Financial Asset and shall be subject to a principles-based regulation in terms of the VFAA.
Virtual Financial Test –criteria
The Virtual Financial Test guidelines also list a number of criteria which would need to be satisfied in order to conclusively determine the classification of a DLT Asset. For the purpose of today’s piece we shall examine Transferable Securities and Electronic Money.
Transferable Securities
If the Virtual Financial Asset Test determines that the DLT Asset is for example a Transferable Security (TS) then the following criteria needs to be considered:
Exchangeability
First criterion is the negotiability of DLT Asset on capital markets. If it is tradeable then DLT is a TS;
Test considers whether the transferability is restricted solely to the issuer – if yes then considered as non-transferable;
Negotiability shall apply to all assets even if not yet issued, if upon issue they would be deemed to be negotiable.
Rights
DLT assets as TS would need to assess the rights attached to it, i.e. akin to a share, partnership, depositary receipt, or other form of securitised debt, right to buy/ sell any TS or gives right to cash settlement.
It is a two-stage test set, the purpose of which is to determine the regulatory regime to which a DLT asset is subject
Instrument of Payment
Definition under MiFID excludes Instrument of Payment and therefore if DLT asset satisfies this definition it is not deemed to be a Financial Instrument. The Virtual Financial Test determines whether DLT asset falls within the definition of a Tranferable Security it would require satisfying the following criteria:
Maturity at issuance of 397 days;
Not an instrument of payment;
Negotiable on capital markets; and
One or more rights attached.
If a DLT Asset qualifies as an instrument of payment then one needs to determine whether it is Electronic Money.
Electronic Money
If on the other hand the DLT Asset is classified as Electronic Money (EM) in accordance with Article 2(2) of 2009/110/EC the following criteria needs to be considered:
Issuance and redemption
DLT Asset should be issued at par value on receipt of funds by an issuer and redeemable solely by that issuer;
Redemption should be possible at any time, at par value and without any possibility to agreeing a minimum threshold for redemption.
Claim on issuer
DLT Asset should represent a claim on the issuer arising from the funds originally placed against such DLT Assets.
Purpose
DLT Asset should be used for making payments as defined in point 5 to Art. 4 to Directive (EU) 2015/2366; and
It should be accepted by a natural or legal person other than the issuer.
For a DLT Asset to qualify as EM it should not fall under exemption under Art. 3(k) to (EU) 2015/2366 and payment transactions should not fall under the said Article.
The Virtual Financial Assets Test determines whether DLT Assets falls within the definition of an EM if the following criteria are satisfied:
DLT Asset is issued by the issuer on receipt of funds at par value and redeemable at par;
Holder has a claim on the issuer arising from the funds transferred and placed against such DLT Asset; and
DLT Asset is used for payment transactions and is accepted by a natural or legal person other than the issuer.
Conclusion
The purpose of the Financial Instruments Test is to give clarity and determination of the type of DLT Asset to be offered. A VFA Agent shall upon completing the Financial Instruments Test together with the issuer, sign off the declaration and submit the Financial Instruments Test to the MFSA together with the issuer’s signature. The MFSA shall not accept a Financial Instruments Test if it is not endorsed by the VFA Agent, as required by the Rules regulating Virtual Financial Assets. The Financial Instruments Test should not be taken lightly as the MFSA shall rely on the determinations of the Issuer and VFA Agent.
Nicholas Warren is senior manager Financial Services and Blockchain at CSB Group.
This article does not purport to give legal, financial or tax advice. Should you require further information, please do not hesitate to contact me on NWQuestions@gmail.com.