Germany has introduced a new regulation on crypto fund units (Verordnung über Kryptofondsanteile – KryptoFAV), that allows fund managers to issue fund units on an electronic instead of a physical basis. The new rules come less than one year after the Fund Location Act (Fondsstandortgesetz) allowed institutional investors to invest in crypto assets. With these regulations, Germany has taken a leading role in the EU in the regulation of crypto funds, enabling both fund sponsors and professional investors to leverage modern technology in their investments.
New regulation on crypto fund units
The regulation on crypto fund units allows fund managers to issue units in common funds (Sondervermögen) or individual unit classes also as crypto fund units.
Crypto fund units are defined as electronic fund certificates (elektronische Anteilscheine) that are registered in a crypto securities register (Section 1 Sentence 2 KryptoFAV). Crypto fund units require fewer intermediaries, thus lead to a reduction of transaction costs and time to market. The content of the KryptoFAV, which essentially comprises only three paragraphs, can only be fully grasped by the corresponding application of the Electronic Securities Act (Gesetz über elektronische Wertpapiere. eWpG) (Section 2 KryptoFAV).
A central element of the eWpG is the admission of digital securities, for which the paper document requirement no longer applies. Instead, they are entered into an electronic securities register. A special form of this register is the crypto securities register. It is typically based on the distributed ledger technology and operated by the depositary, or another entity appointed by the depositary with an authorization for crypto securities registry (Kryptowertpapierregisterführung). The draft regulation initially envisaged that only a depositary (with a full licence) would be authorized to keep the register, which provoked fierce criticism from fund practitioners. The final regulation now opens the door for other entities, with an authorization for crypto securities registry (Section 3 KryptoFAV). So far, BaFin has granted only four such authorizations. Hence, there remains great potential for young, innovative companies.
The new opportunities opened up by the KryptoFAV also pose challenges for fund managers. For example, the depositary still has a gatekeeper position. Formally, it decides whether and which entity to appoint as crypto securities registrar. In practice, however, there are ways in which fund managers can influence this decision in advance. Other examples relate to the procedure for obtaining an authorization for crypto securities registry, to the requirements for proper registry management, and to liability issues in the event of a breach of these requirements.
Professional investors and crypto investments
In August 2021, Germany enacted a law to strengthen the nation’s reputation as a location for investment funds (German Fund Location Act). It allows certain domestic special funds — a type of fund vehicle especially used by institutional investors — to invest up to 20% of their assets in crypto assets. The sum available as a result theoretically amounts to up to 350 billion euros. There is another great potential here that has not been nearly tapped so far. In practice, German institutional investors are highly regulated and therefore need time to adapt their internal processes to this new investment opportunity. However, experts in the German fund world expect the new quota to be used in the medium term (over the course of the next five years) to a single-digit percentage. Given the investment volume of German special funds, this is a market with massive growth potential.
Definition of crypto assets
Crypto assets, in the meaning of the German law, are defined as:
- Digital representations of value, that;
- Are not issued or guaranteed by a central bank or a public authority; and
- Do not have the legal status of currency or money; but
- Are accepted by natural or legal persons;
- Based on agreement or actual practice;
- As a means of exchange or payment; or
- Are used for investment purposes; and
- Can be transferred, stored and traded by electronic means.
This definition does not only include the full range of well-known cryptocurrencies (also referred to as payment token) such as bitcoin, ether, XRP, etc., but also so-called security or investment tokens, such as token-based bearer bonds (Inhaberschuldverschreibungen). According to the explanatory memorandum of the German legislator, the definition does not include utility tokens (essentially electronic vouchers for the obtaining of goods and services) “as long as they are not used for investment purposes”. What that means exactly, however, has not yet been conclusively answered. The definition of crypto assets expressively excludes e-money and certain monetary values within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz).
Even if these developments in German law are exceptionally progressive, particularly in comparison with other EU member states, this is by no means the end of the story.
The digitalization of the fund market has only just begun. Another major step is already on the horizon: The European legislator has just reached an agreement on the regulation on markets in crypto assets (MiCAR). MiCAR is intended to create a uniform legal framework for issuing and trading crypto assets. As things stand today, the regulation will also change the definition of crypto assets in Germany.