New German legislation on crypto tokens and crypto custodian services
By publishing two drafts of legislative acts dated May and July 2019, Germany has initiated a legislative procedure in order to transpose the Directive (EU) 2018/843 (“Fifth EU AML Directive”) into national law. Both legislative drafts are identical to a large extent and provide for, inter alia, an amendment of the German Banking Act in order to regulate certain crypto-tokens and the provision of crypto custodian services.
This draft legislation clearly goes beyond the scope of regulation requested by the Fifth AML Directive:
1. Extent of the regulation on crypto-tokens
The Fifth EU AML Directive only addresses virtual currencies which are defined as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.
The German draft legislation goes one step further by inserting the new term “Kryptowert” into the German Banking Act (Kreditwesengesetz – KWG), which may be translated as crypto-asset. The definition of this new legal term covers the abovementioned definition of virtual currencies and, additionally, includes tokens for investment purposes, i.e. security or asset tokens. Hence, unlike the EU Directive the scope of the German draft legislation is not limited to currency tokens.
Pursuant to the draft legislation the newly created term crypto-asset shall be part of the KWG’s catalogue of regulated financial instruments. Depending on their design and purpose, a crypto-token can constitute a crypto-asset and one of the other regulated financial instruments at the same time. This was only clarified by the second draft legislative act of July 2019, whereas the first draft still stipulated a subsidiary character of the term crypto-asset.
2. Provision of crypto custodian services subject to particular license
In addition to the introduction of crypto-assets, the draft legislation also provides for a regulation on the provision of crypto custodian services (new German legal term: “Kryptoverwahrgeschäft”). The draft legal definition of the corresponding services is similar to the definition of the “custodian wallet provider” set out in the Fifth EU AML Directive, i.e. “an entity that provides services to safeguard private cryptographic keys on behalf of its customers, to hold, store and transfer virtual currencies”. The German draft legal definition of the provision of crypto custodian services is, however, not limited to virtual currencies but also covers crypto tokens with investment purposes, i.e. security or asset tokens.
Another peculiarity of the German draft legislation is that the provision of crypto custodian services shall be subject to a license. In order to eliminate IT-related risks, such a license will only be granted if the relevant entity has not obtained any other license pursuant to the KWG. That means that not even a fully licensed bank would be allowed to provide crypto custodian services in the future.
This will in particular cause high obstacles for platforms providing for example both exchange services regarding virtual currencies and custodian wallets. Those companies will either have to involve external service providers who are licensed for the provision of crypto custodian services or spin off a separate legal entity for this purpose. The cooperation with white label banks will only work if those institutions themselves spin off separate legal entities for the provision of crypto custodian services.
Another question will be if foreign banks and other companies are permitted to provide custodian wallets to customers living in Germany. If a bank benefits from a so called European Passport it should also be allowed to actively offer crypto custodian services in Germany as long as these services are covered by the license obtained in the bank’s EU country of origin. This should even be the case if the country of origin does not limit licenses the same way as intended in Germany. There are, however, no published decisions by German authorities or courts confirming this view.
All other companies which are not based in Germany would generally be prohibited from providing crypto custodian services to German customers unless they have a subsidiary company or branch based and licensed in Germany which legally provides the relevant services. Other than that, an EU company will probably only be allowed to offer crypto custodian wallets to German customers relying on the principle of the passive free movement of services. That means that customers living in Germany are free to ask for and enjoy services by a company based in another EU member state as long as this company does not actively target their services to customers in Germany. This question is subject to a complex assessment on a case-by-case basis that requires taking into consideration certain aspects set out by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin).