Crypto-securities and applicable law: is there a situs?
Sara Sánchez Fernández - IE Law School-IE University (Spain)
--The progressive implementation of distributed ledger technologies (DLT) in finance has reached a large number of areas, including the registration of securities. Although limited to non-listed corporations, DLT has become in some jurisdictions an alternative to the traditional securities registration in physical certificates or book-entry form (e.g. Ordonnance n° 2017-1674 du 8 décembre 2017 relative à l'utilisation d'un dispositif d'enregistrement électronique partagé pour la représentation et la transmission de titres financiers in France or Del. Code Ann. tit. 8, § 224 (2017) in Delaware). Blockchain evangelists predict that this will soon expand to listed securities and become a new “plumbing system”, thus replacing current registration in CSD and clearing and settlement processes. In addition, new instruments are being issued in ICOs –hence registered in tokenized form-, which may also qualify as securities under the applicable regulatory rules.
Be that as it may, legal systems are struggling to accommodate the different dimensions of DLT in the substantive-law level. Possibly the most controversial area is the rights in rem over such crypto-securities. Unsurprisingly, whether or not the crypto holders have a proprietary claim becomes key in a number of situations. While referred to Bitcoins (a cryptocurrency) and not to crypto-securities, Mt Gox is a case in point. The Tokyo-based cryptocurrency exchange, which held the private keys on behalf of the bitcoin investors in a “hot” wallet, became insolvent after being hacked. Given that private keys grant exclusive control over crypto-assets, the crucial question was whether investors had a restitutionary claim or not. The answer varies largely across jurisdictions and indeed is yet unclear in most of them (see Koji Takahashi, K “Implications of the Blockchain Technology for the UNICTRAL Works”). This makes the question of the law applicable particularly relevant. In my recent presentation at the Machine Lawyering Conference I addressed various conflict of laws issues in relation to crypto-securities, including the above mentioned in rem aspects.
If we accept a proprietary characterization of the these claims, the choice of law rule, widely recognized in comparative law, is lex rei sitae, i.e. the law applicable is the law of the place where the crypto-asset is located. Of course, the application of such rule is problematic with any intangible, as shown with the case of securities registered in book-entry form and held with an intermediary. In the EU, harmonized conflict-of-laws rules on book-entry securities solved the problem by following the so-called PRIMA approach (place of the relevant intermediary account, i.e. a conto sitae rule) (see e.g. Directive 2002/47/EC on financial collateral arrangements). The 2006 Hague Securities Convention addressed similar issues with a slightly different approach. It establishes a primary rule based on the law chosen for the account agreement, if the relevant intermediary has, at the time of the agreement, an office in that State. As the 2006 Hague Securities Convention shows, in the case of choice of law rules for proprietary aspects in intangible assets (intermediated securities) it is accepted to depart from the situs as connecting factor.
The location problem is further exacerbated in the case of crypto-securities. On the one hand, DLT replaces central registers with a ledger which is entirely distributed among all nodes. On the other hand, the network is disintermediated. Thus the PRIMA rule is no longer of use. I argue that, although there is no perfect solution, probably the best approach is to draw an analogy with choice of law rules for non-intermediated securities, instead of looking for a parallel with securities held with intermediaries. Such analogy is consistent with the principle of technology neutrality: if securities are held directly, the technology deployed should not in principle alter the analysis.
In the EU, the European Insolvency Regulation (2015/848) establishes a number of rules for the location of assets, including securities. In spite of the Regulation’s limited scope of application, which merely provides for rules in cross-border insolvency scenarios, it has been argued that such rules may be the seed for a future more general instrument for choice of law in proprietary issues and currently sheds some light in the absence of other applicable rules. According to it, the situs of non-intermediated registered shares is the issuer’s registered office and the law applicable would be the lex societatis. Where securities are not equity but debt securities, the law applicable would be, by analogy, the law applicable to the issuance. This will lead to the coincidence between the law governing the proprietary rights over the securities and the law governing the exercise of the rights deriving from the securities vis à vis the issuer. In addition, it would mitigate legal uncertainty by establishing a connecting factor unrelated to the platform and thus avoiding the problems of its a-nationality.
Certainly, this interpretation poses problems, especially in relation to non-equity securities, as the unrestricted choice of law for in rem aspects is not commonly accepted. There are however precedents for this. With all its limitations, the analogy with choice of law rules for non-intermediated securities has relevant practical advantages and lacks a feasible alternative for crypto-securities registered in different kinds of platforms, hence it is an approach worth being further explored.