A. INTRODUCTION

By

enacting the Virtual Financial Assets Act (VFAA), the Maltese Government has

regulated the Blockchain / ICO / DLT industry. The law appoints the Malta

Financial Services Authority (MFSA) as the designated authority to oversee this

business.

Since

this industry has elements of the Financial Service Regulations (namely MiFID),

it is important to clearly distinguish one from the other.

In

order to ensure a clear difference, the MFSA has sought to further clarify the

instances under which the new legislation applies. It has done this by

introducing the Financial Instrument Test, which will be analysed below.

B.

PURPOSE OF THE TEST

The

objective of the Financial Instrument Test (hereinafter ‘the Test') is to

determine whether a Distributed Ledger Technology (‘DLT')

asset falls under:

the

existing Financial Services legislation (e.g. MiFID)

the

proposed Virtual Financial Assets Act (‘VFAA') or

is

otherwise exempt.

By

undergoing the Test, the DLT asset will be classified accordingly.

C.    WHEN TO APPLY THE TEST

The

Test will be applied in the following scenarios:

In

an Initial Coin Offering (ICO); and

During

the intermediation of DLT Assets by persons undertaking certain activities in

relation to such DLT Assets (VFA Services).

Being

the designated authority specifically appointed to oversee this business, the

Malta Financial Services Authority (MFSA) is proposing that the Test is

mandatory in the above scenarios.

In

addition, the MFSA has also proposed that the Test is confirmed by an

external reviewer.

D.

DEFINITIONS

It

is important to take into account the below definitions:

Distributed Ledger Technology (DLT) - means a

digital or electronic database or ledger which ordinarily is -

a)

distributed, shared and replicated;

b)

public or private or hybrids;

c)

permissioned or permissionless or hybrids;

d)

protected with cryptography or equivalent

forms of encryption; and

e)

auditable:

Provided that this term shall also include any other

technology that achieves the same ends.

DLT Asset - means -

a)

A

Virtual Token; or

b)

A

Virtual Financial Asset; or

c)

A

Financial Instrument

That

is intrinsically dependent on, or utilises, DLT.

Virtual Financial Asset - a

VFA is any form of digital medium recordation that is used as a digital medium

of exchange, unit of account, or store of value and that is not one of the

following as defined below:

a)

Electronic

Money;

b)

Financial

Instrument; and

c)

Virtual

Token.

Legal definitions of the above are analysed in our

brochures:

➢

Malta

- ICOs - The New Legislation

➢

Malta

- Virtual Financial Asset Services - The New Legislation

E.

METHODOLOGY OF THE TEST

In

a nutshell, the Test shall consist of a number of checklists. The aim of the

Test is that the DLT Asset

is analysed against a set of instruments in a prescribed order.

If

the asset falls to be classified under any of these instruments, then by

default it does not qualify as a Virtual Financial Asset under the new laws,

and hence the latter shall not apply. It is important to keep in mind that this

Test is to be used during both ICOs as well as when offering any of the VFA

Services as regulated by law.

In

brief, the following instruments will need to be analysed in the following

order mentioned below. First there is a focus on Virtual Tokens and then the

Test progresses to analyse various financial instruments under MiFID.

F.

ANALYSIS OF THE VARIOUS

INSTRUMENTS

It

is now important to analyse the details of the Test by analysing the proposals

of the MFSA:

1.

Does

the DLT Asset qualify as a Virtual Token under the VFAA?

The proposed definition of a Virtual Token is a DLT

asset that:

a.

Has

no utility, value or application outside of the DLT platform on which it was

issued; and

b.

That

cannot be exchanged for funds or legal tender on such platform or with the

issuer of such DLT asset.

If

the DLT Asset qualifies as such under the proposed regulations,

then it should be exempt under the new laws, and hence the VFAA

is not applicable.

If

it does not qualify under the definition of a Virtual Token, one has to proceed

to the next point below.

2.

Does

the DLT Asset qualify as a Transferable Security under MiFID?

The

definition of "transferable security" refers to those classes of securities

which are negotiable on the capital market, (except instruments of payment),

such as:

a.

shares

in companies or other entities, and depositary receipts in respect of shares;

b.

bonds

or other forms of securitised debt, including depositary receipts;

c.

any

other securities giving the right to acquire or sell any such transferable

securities or giving rise to a cash settlement.

The

main characteristics in order for a DLT Asset to be

classified as a Transferable Security hence are the following:

The

DLT Asset is negotiable on the capital market; And

The

DLT Asset confers rights analogous to those of shares in company or other

entities such as:

▪

Participation

in the capital of the issuer;

▪

Right

to receive proceeds from liquidation of issuer;

▪

Entry

in the register of shareholders;

▪

Right

to acquire or sell transferable securities -

▪

Right

to voting;

▪

Right

to dividends or other proceeds from company assets.

▪

Rights

to periodical inco/ proceeds derived from

Or confers rights analogous to bonds such as:

▪

Principal

amount due of fixed sum with fixed / variable maturity; or

▪

Entry

in the register of debenture holder

▪

Right

to sell or acquire

Is

not an instrument of payment.

If

the DLT Asset

falls under any of the above definitions, the applicable regulatory regime is

the MiFID, and not the VFAA. Hence, the new legislation will not

apply in this case.

If

it does not qualify under the definition of Transferable Security, one has to

proceed to the next point below.

3.

Does

the DLT Asset qualify as a Money Market Instrument under MiFID?

These

are defined as instruments which are normally dealt in on the money market,

such as treasury bills, certificates of deposits and commercial papers and

exclude instrument of payment.

The

main features of a Money Market Instruments are the following:

Have

a valued that can be determined at any point in time;

Are

not derivatives; and

Have

a maturity at issuance of 397 days or less; and

Have

features substantively equivalent to treasury bills, certificates of deposits

or commercial papers.

If

the DLT Asset

falls under any of the above definitions, the applicable regulatory regime is

the MiFID, and not the VFAA. Hence, the new legislation will not

apply in this case.

If

it does not qualify under the definition of Money Market Instrument, one has to

proceed to the next point below.

4.

Does

the DLT Asset qualify as a Unit in a Collective Investment Scheme?

A

Collective Investment Scheme is defined as a scheme that has the following

legally-defined characteristics:

Objective

of the issue is the collective investment of capital

The

scheme operates according to the principle of risk spreading; and either

The

contributions of the participants and the profits or income out of which

payments are to be made to them are pooled; or

At

the request of the holders, units are or are to be repurchased or redeemed out

of the assets of the scheme or arrangement, continuously or in blocks at short

intervals; or

Units

are, or have been, or will be issued continuously or in blocks at short

intervals.

If

the DLT Asset

falls under any of the above definitions, the applicable regulatory regime is

the MiFID, and not the VFAA. Hence, the new legislation will not

apply in this case.

If

it does not qualify under the definition of a Unit in a Collective Investment

Scheme, one has to proceed to the next point below.

5.

Does

the DLT Asset qualify as a Financial Derivative under MiFID?

The MiFID gives a detailed definition of ‘derivatives'

as follows:

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;

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;

Options,

futures, swaps, and any other derivative contract relating to commodities that

can be physically settled provided that they are traded on a regulated market,

a MTF, or an OTF, except for wholesale energy products traded on an OTF that

must be physically settled;

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;

Derivative

instruments for transfer of credit risk;

Financial

contracts for differences;

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.

If

the DLT Asset

falls under any of the above definitions, the applicable regulatory regime is

the MiFID, and not the VFAA. Hence, the new legislation will not

apply in this case.

If

it does not qualify under the definition of a Financial Derivative Instrument,

one has to proceed to the next point below.

6.

Does

the DLT Asset qualify as an Emissions Allowance?

Emission

Allowance Financial Instruments relate to units recognized for compliance with

the Emissions Trading Scheme Directive. Emission Allowance is an allowance to

emit one tonne of Carbon Dioxide or other greenhouse gases (as defined) during

a specified period, which unit shall be transferable in accordance to the

Directive.

In

order for the DLT asset to qualify as an emissions allowance, it should be

issued within the national competent authority in accordance to the directive.

If

the DLT Asset

falls under any of the above definitions, the applicable regulatory regime is

the MiFID, and not the VFAA. Hence, the new legislation will not

apply in this case.

If

it does not qualify under the definition of an Emissions Allowance, then the

new laws will apply.

H.

CONCLUSIONS

By introducing the Financial Instrument Test, the MFSA has ensured a clear

distinction between the current Financial Services Laws (MiFID) and the new

Virtual Financial Asset Act.

The

Test will be rendered mandatory and will have to be confirmed by an independent

verifier. This confirms the importance of the test, as it will have a material

bearing on which regulatory regime to apply.

Hence,

one has to proceed with great caution before embarking on any ICO / DLT

project, as there might be various laws that might need to be taken into

consideration. A detailed analysis of the intended project is thus necessary in

order to ensure legal compliance and avoid severe legal consequences.

To

this effect, it is highly advisable that all ICO / Blockchain intended issuers

seek proper legal advice and guidance at all stages of their project.