In its efforts to adapt the Swiss legal framework to take into account business activities that rely on Distributed Ledger Technology (DLT), the Federal Council recently published the draft blanket ordinance in the area of blockchain. The purpose of this article is to highlight some of the most salient features of the proposed provisions, focusing on topics that may be of relevance for DLT-based capital market related activities.

By Stefan Kramer / Sandrine Chabbey (Reference: CapLaw-2021-18)

1) Introduction

With the aim of fostering innovation, Swiss lawmakers recently adopted an act whose aim is to adapt existing regulations to better account for business models based on Distributed Ledger Technology (DLT). On 19 October 2020, less than a month after the regulation on the adaptation of federal law to developments in distributed ledger technology (DLT Law) has been accepted by parliament, the Federal council published a draft ordinance setting out the changes it proposes to introduce at the ordinance level to prepare for the entry into force of the new legal provisions (blanket ordinance in the area of Blockchain, hereinafter referred to as the Draft DLT Ordinance). The consultation period for the published draft lapsed on 2 February 2021. Rather than offering a comprehensive analysis of the implementing provisions proposed by the Federal Council, this article focuses on certain key aspects that are or may be of relevance for DLT-based capital market related activities as well as certain views expressed by participants in the consultation process.

As a reminder, instead of creating a comprehensive new act on DLT, Swiss lawmakers opted to amend existing regulations to accommodate business models relying on the new technology. While part of the DLT Law, in particular modifications to securities law, including notably changes to the Code of Obligations, Intermediated Securities Act and Private International Law Act, already entered into force on 1 February 2021, the Draft DLT Ordinance relates to provisions of the new legislation which are set to enter into force on 1 August 2021 and consist, for the most part, of modification of existing financial market regulations.

2) Draft Blanket Ordinance in the Area of Blockchain – Certain Key Aspects

a) Proposed Specifications for DLT Based Trading Systems

One of the novelties introduced by the DLT Law is a new category of authorizations pursuant to the Financial Market Infrastructure Act (FMIA), namely the authorization for DLT based trading systems. The Draft DLT Ordinance therefore amends the Financial Market Infrastructure Ordinance (FMIO) to account for this new entity and specifies, where required, the applicable regulatory framework.

Overall, the contemplated new provisions closely mirror those applicable to traditional trading venues and central depositories, with accommodations where needed to reflect the particularities of the new systems, such as the fact that unlike their more traditional counterparties, DLT-based systems may accept private clients as participants.

The draft FMIO provisions notably define the relevant thresholds for the activity of DLT-based trading systems to be carried out on a professional basis (Gewerbsmässigkeit), and therefore in scope of the new licensing regime. Specifically, the activity of such trading systems is deemed as being undertaken on a professional basis if it either (a) generates a total gross income of more than CHF 50,000 during a calendar year, (b) if the relevant trading systems maintains a durable business relationship with at least one securities firm or other regulated participants under the new article 73c (1) (b)-(d) FMIA or, alternatively, with more than 20 participants in total, or (c) may at any time freely dispose of third party DLT-based securities in excess of CHF 5 million. The contemplated provisions further allow those trading systems whose activity remains under specific thresholds, and may therefore be considered as small, to rely on a lighter regulatory regime. Concretely, under draft article 58k FMIO, a DLT-based trading system is deemed as small, provided that (a) trading volume in DLT-based securities remains below CHF 250 million per year; (b) volume of DLT-based securities held remains lower than CHF 100 million; and (c) settlement volume for DLT-based securities includes transactions with a value of less than CHF 250 million per year.

Another striking feature of the published draft is the decision to exclude derivatives designed as DLT-based securities (DLT-Effekten ausgestaltete Derivate) from trading on these new authorized financial market infrastructure. According to the Federal Department of Finance (FDF), this decision is essentially justified by the fact that the market for such products is still in its infancy and it is preferable to wait and see how it develops before admitting it to trading. This choice has been criticized by many participants to the consultation procedure, who emphasize that derivatives are one of the product categories with the greatest potential for efficiency gains through the use of DLT.

b) Proposed Clarifications for the Acceptance of Crypto Assets by Banks and other Custodians

As the Banking Act (BA) will be updated to account for business-models reliant on the custody of crypto assets, the Draft DLT Ordinance envisions introducing in the Banking Ordinance (BO) a definition of the assets whose acceptance may trigger licensing obligations as well as update the definition of activity carried out on a professional basis under the BA.

According to draft article 5a BO, references to crypto assets in the law generally covers all those deposited assets (pursuant to the new article 16 (1bis)(b) BA) which are generally destined to be used/are effectively mainly used as a mean of payment for the acquisition of goods and services or for the transmission of money or other value. Many position statements have criticized this definition, which they generally consider as too vague and potentially covering assets that should not be subject to the BA.

The draft ordinance further suggests modifying article 6 BO to account for the fact that the acceptance of crypto assets, if carried out on a professional basis, may also constitute an activity subject to licensing obligation. The Federal Council proposes to apply the same thresholds to determine whether acceptance of crypto assets may be deemed as an activity carried out on a professional basis as those already relevant to the acceptance of other bank deposits. Many participants to the consultation procedure find this solution unsatisfactory and argue that it would be more appropriate, in particular in light of the related risks, to refer to the more permissive definition applicable to asset managers (see notably article 19 of the Financial Institutions Ordinance).

c) Proposed Modifications of the Anti-money Laundering Framework

The Draft DLT Ordinance further introduces changes to the Anti-Money Laundering Ordinance (AMLO). Among others, the published draft contemplates qualifying all payment services by any service provider who facilitates the transfer of virtual currencies if it maintains a durable business relationship with counterparties. The FDF justifies the decision to refer to the lasting relationship instead of the more commonly used criteria of control over the assets in question by the fact that, in relation to virtual currencies, transfer schemes are increasingly decentralized and financial intermediaries no longer automatically have the ability to dispose of the assets. Hence, it is of the view that the criteria of the durable business relationship better accounts for the different modi operandi of intermediaries dealing with virtual currencies.

The approach chosen in the draft provisions has been widely criticized. In particular, it has been deemed as too broad and potentially covering a whole array of ancillary activities, such as IT, hence subjecting to the Anti-Money Laundering Act (AMLA) entities who cannot comply with its requirements (or solely in a very limited manner). Even though the stated goal of the contemplated rules is to facilitate the application to anti-money laundering regulation, many argue that the change to the new rule would most likely create insecurity and make it difficult for market participants to determine whether the law applies to them or not. Furthermore, to the extent that the approach is not in line with international practice, it has been argued that the contemplated regulation may hurt the competitiveness of Swiss financial markets.

3) Outlook

The consultation period for the Draft DLT Ordinance ended on 2 February 2021. We can therefore expect a final version to be published relatively soon, in order to allow for an entry into force with the relevant legal provisions on 1 August 2021.

Based on the position statements that are publicly available, there appear to be a certain consensus among relevant organizations and market participants on the general appreciation of the published ordinance and the points that still need to be refined. It therefore remains to be seen whether – and how – the Federal council will amend its proposal to address the concerns raised.

Stefan Kramer (stefan.kramer@homburger.ch)
Sandrine Chabbey (sandrine.chabbey@homburger.ch)