Germany: New regulations for Digital Asset Custodians

15 Nov, 2019

From January 1, 2020, ALL exchanges & custodians (no matter where they are based) will need a license from the German authorities when addressing the German market!

 

Commentary on the new Money Laundering Act in Germany, which in particular contains regulations concerning the safekeeping of digital assets such as Bitcoin and Ethereum, but also the so-called security tokens, i.e. digital securities.

  • The regulation applies to any Exchange or Custodian actively involved in the German market (e.g. operates a German-language website) and is at any time in possession of its clients’ digital assets. This applies regardless of where the entity is based; i. e. if you are domiciled in Hong Kong, you still have to comply with the rules.
  • Using a licensed sub-custodian might be a remedy as setting up an own regulated entity appears cumbersome and cost-intensive.

The Finance Committee’s decision recommendation provides clarity on some issues that have been discussed since the publication of the speakers’ and government drafts. The Committee is in favor of deleting the much-discussed “separation requirement” that crypto custody and other regulated banking or financial services could not be offered from the same legal entity. With the announcement of the Federal Government to make electronic securities possible, the question had arisen whether their safekeeping under a roof with other Digital Assets such as Bitcoin would be possible. With the proposed adjustments, the separation of the custody of securities (custody business) from the cryptographic custody business would no longer be legally mandatory.

Nevertheless, depending on the business model, there may still be reasons for separating various regulated services: As has often been called for in recent months, the Finance Committee recommends that service providers offering only crypto custody services be granted extensive relief from the CRR’s capital adequacy requirements. This does not apply to the required initial capital of EUR 125,000, but to the additional capital resources which, according to the CRR, would increase with the value of the assets held in safe custody and the associated risks.

Despite the proposed adjustments, the separation of the custody of securities into custody business and other crypto values can be advantageous not only for reasons of liability but also economically. Although the organizational effort involved in outsourcing to another legal entity will increase, the exemption of the crypto custody business from the CRR requirements will reduce the overall amount of capital tied up. The adjustment recommendations of the Finance Committee are supplemented by exemptions from separate institution reporting obligations and the regulations on institution remuneration.

Besides, the transitional period has been extended: The license is deemed to have been granted provisionally if the intention to apply for such a license is notified to the Federal Financial Supervisory Authority (BaFin — the German regulatory watchdog) in writing by March 31, 2020, and a complete application is submitted by November 30, 2020.

Contractually tied agents who already hold cryptographic values for third parties before the Act comes into force are exempt from the licensing requirement until November 30, 2020. It is, therefore, open to them to also use the transitional period to apply for a license or to stop storing crypto assets by the end of November. Such a transitional phase would also be desirable for other financial service providers (e.g. asset managers) who store cryptographs for their customers. These service providers must either acquire the license themselves or announce an application for a license or find a crypto custodian before January 1, 2020, to take over this task for them. They are denied the opportunity to observe the market over the coming months and to take developments into account when selecting a suitable custodian.

With its first-mover approach, the German regulator is playing a pioneering role in regulating digital asset companies. And thus contributes to investor protection, although this step contradicts the efforts of establishing a “European Single Market”. It could prove to be an advantage to be forced to comply with special German regulatory rules when doing business with Germans. This is because we assume that the German license will be “passable” if other jurisdictions follow.

The DLC Distributed Ledger Consulting GmbH will offer services in getting this license when you wish to obtain this on your own. They are also considering the possibility of offering a “license as service” product; if you do not want to apply for a license, but still want to comply with the German regulations, this might be an option.

If this is of interest for you, please get in contact at info@distributed-ledger-consulting.de

 

Find the Finance Committee’s decision recommendation here (available only in German).

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