The Malta Financial Services Authority ("MFSA") has issued a Consultation Paper on the proposed introduction of a "Financial Instrument Test" in line with a previous MFSA Discussion Paper issued on 30 November 2017 on Initial Coin Offerings, Virtual Currencies and Related Service Providers.
The proposed Financial Instrument Test will be crucial in determining whether a Distributed Ledger Technology ("DLT") asset, which was previously referred to as "Virtual Currency", will fall within current EU and national financial services legislation and regulatory frameworks, or within the ambit of the proposed Virtual Financial Assets Act ("VFAA") or will otherwise be exempt from regulation.
The MFSA is considering introducing a Financial Instrument Test as a mandatory requirement which will be applicable, both within the context of ICOs (both to issuers of ICOs conducted in or from within Malta) exchanges, as well as during the intermediation of DLT assets by persons undertaking certain activities in relation to DLT assets.
The objective behind the introduction of a proposed Financial Instrument Test is to reach a determination on how a DLT asset should be classified and regulated in terms of local and EU legislation and will essentially be based on the following criteria:
- A) Does the DLT asset fall within the definition of a Virtual Token "VT" (previously referred to as a utility token)? If in the negative, then one will move on to the second question.
- B) Does the DLT asset qualify as a financial instrument in terms of MiFID and in terms of the Investment Services Act (Chapter 370 of the Laws of Malta)?
- C) Should this also result in the negative, then the ultimate stage would be that the DLT asset would qualify as a Virtual Financial Asset in terms of the proposed VFAA.
In order to arrive at the determination of a DLT asset, one must systematically assess the features of the DLT asset with a set of predetermined criteria composed of 12 checklists. Such criteria comprise the following:
- i) To determine whether the DLT assets satisfy the criteria of a VT (i.e. purely utility in nature and has value solely in relation to the DLT platform on which it is created) and is thus exempt from the VFAA. This on the understanding, that VTs are not exchangeable directly for legal tender on such platform or with the issuer of the DLT asset. Should the DLT asset not be classified as a VT, one will need to determine whether the DLT asset qualifies as any of the following MiFID instruments:
- ii) Transferable Securities under MiFID;
- iii) Money Market Instruments under MiFID
- iv) Units in a Collective Investment Scheme;
- v) Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, emission allowances or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash;
- vi) Options, futures, swaps, forwards and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event;
- vii) Options, futures, swaps and any other derivative contracts relating to commodities that can be physically settled provided that they are traded on a regulated market, a Multilateral Trading Facility ("MTF"), or an Organised Trading Facility ("OTF"), except for wholesale energy products traded on an OTF that must be physically settled;
- viii) Options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in point 6 of this section and not being for commercial purposes, which have the characteristics of other derivative financial instruments;
- ix) Derivative instruments for transfer of credit risk;
- x) Financial contracts for difference;
- xi) Options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event, as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market, OTF, or an MTF; and
- xii) Other derivative contracts relating to currencies such as spot contracts.
It is to be noted that two additional instruments included under the Investment Services Act namely: (i) certificates or other instruments which confer property rights in respect of any instrument falling within the Second Schedule to the Investment Services Act and (ii) foreign exchange acquired or held for investment purposes, have been excluded from such a test. This is due to the fact that such instruments are not applicable to DLT assets.
The aim behind the consultation paper is for the MFSA to obtain feedback from the industry on the proposed way forward with respect to the Financial Instrument Test, which feedback period shall be open until 4 May 2018.
The introduction of the proposed VFAA, together with the proposed Financial Instrument Test will provide legal certainty to the industry, market stability and protection to investors.