Germany has introduced new regulations on crypto fund shares (Verordnung über Kryptofondsanteile – KryptoFAV), which allows fund managers to issue fund shares electronically rather than physically. The new rules come less than a year after the law on the localization of funds (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, allowing fund sponsors and professional investors to take advantage of modern technology in their investments.
New regulation on crypto fund shares
The Crypto Fund Shares Regulations allow fund managers to issue mutual fund shares (Sondervermögen) or individual share classes also as crypto fund shares.
Crypto fund shares are defined as electronic fund certificates (Electronic Anteilscheine) that are stored in a cryptographic value ledger (Section 1 Sentence 2 KryptoFAV). Crypto fund units require fewer intermediaries, resulting in reduced transaction costs and time to market. The contents of the KryptoFAV, which essentially consists of only three paragraphs, can only be fully grasped through 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 registered in an electronic securities register. A special form of this register is the register of cryptographic values. It is typically based on distributed ledger technology and operated by the custodian, or another entity designated by the custodian with authorization for the cryptocurrency ledger (Kryptowertpapierregisterführung). The draft regulations initially provided that only a custodian (holder of a full licence) would be allowed to keep the register, which provoked strong criticism from fund professionals. The final settlement now opens the door to other entities, with cryptocurrency registry authorization (Section 3 KryptoFAV). So far, BaFin has granted only four such permits. There is therefore still great potential for young innovative companies.
The new opportunities opened up by the KryptoFAV also pose challenges for fund managers. For example, the Custodian always has a Custodian position. Formally, it decides whether and which entity to appoint as the crypto securities registrar. In practice, however, there are ways fund managers can influence this decision in advance. Other examples relate to the process of obtaining a cryptocurrency ledger license, the requirements of proper ledger management, and issues of liability for breaching these requirements.
Professional investors and crypto investments
In August 2021, Germany enacted a law to strengthen the country’s reputation as a location for investment funds (German Fund Location Law). It allows certain national special funds – a type of fund vehicle particularly used by institutional investors – to invest up to 20% of their assets in crypto assets. The resulting sum available theoretically amounts to 350 billion euros. There is another great potential here that has not been 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 from the German fund world expect the new quota to be used in the medium term (over the next five years) at a single-digit percentage. Given the investment volume of German special funds, this is a market with strong growth potential.
Definition of Crypto Assets
Crypto assets, within the meaning of German law, are defined as:
- Numerical representations of value, that;
- Are not issued or guaranteed by a central bank or public authority; and
- Not having 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; Where
- Are used for investment purposes; and
- Can be transferred, stored and exchanged electronically.
This definition does not only include the full range of well-known cryptocurrencies (also known as payment tokens) 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 obtaining goods and services) “as long as they are not used for investment purposes”. . What exactly this means, however, has yet to be conclusively resolved. The definition of crypto assets expressly excludes electronic money and certain monetary values within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz).
Outlook
Even though these developments in German law are exceptionally progressive, especially when compared to other EU member states, this is by no means the end of the story.
The digitization 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 the crypto-asset markets (MiCAR). MiCAR aims to create a uniform legal framework for issuing and trading crypto assets. As it stands, the regulation will also change the definition of crypto assets in Germany.
