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Article by Codrina Constantinescu, Partner, Investment Funds, Céline Moille, Counsel – Lawyer / Financial Services, and Lauréline Decottignies, Intern, at Goodwin, as published in Insight/Out magazine #33.
On 19 December 2024, the Luxembourg Parliament once again reinforced the national’s leading position as a hub for secure electronic registration mechanisms, including distributed electronic registers or databases commonly referred as distributed ledger technology (DLT) by adopting a law (Blockchain IV) amending the following laws:
- the law of 6 April 2013 on dematerialized securities[1].
- the law of 5 April 1993 on the financial sector, and
- the law of 23 December 1998 establishing a financial sector supervisory commission.
This landmark legislative measure completes the existing DLT legal framework consisting of the following laws: Blockchain Law I[2] adopted in 2019, Blockchain Law II[3], in 2021 and Blockchain Law III[4], adopted in 2023, that together permitted the secure registration, issuance, and transfer of dematerialised financial instruments
Blockchain IV completes the legislative framework and introduces new opportunities for issuers, including Luxembourg investment funds.
A. The DLT legal provisions relevant to investment funds
Traditionally, under the Luxembourg companies law, certain forms of companies (such as stock companies) are allowed to issue shares or securities in registered, bearer or dematerialized form. Investments funds structured themselves as stock companies tend to issue registered or dematerialized shares and securities depending on the product laws’ provisions applicable to them being noted that the registered form is probably the most frequently used.
With the successive Blockchain Laws, the issuance and transfer of dematerialized securities via DLT has been brought in focus for companies and investment funds.
Dematerialized shares or securities are registered by an inscription (i.e., a record) in a securities account in the name of the account holder. Such securities account is held at a settlement institution, a central account keeper, a national accounts’ keeper, or a foreign accounts’ keeper within the EU. Transfers of such shares or securities are carried out by way of book entry.
Blockchain Law II introduced the concept of securities issuance account (that is different from a securities account) that should be used to register all the dematerialized securities of the same type (i.e., same class of shares, same currency for securities other than capital securities) of an issuer whether they are listed or unlisted.
The securities issuance account will indicate the number and type of securities that have been issued and will allow a reconciliation between this information and the number and type of securities in circulation in securities accounts.
Both securities accounts and securities issuance accounts may be operated through DLT. This is a significant advantage introduced by Blockchain II that allows to maintain records related to the issuance and transfer of dematerialized securities via DLT and recognizes that successive registrations of securities using DLT have the same effect as transfers between securities accounts.
Blockchain IV went a step further and introduced the concept of control agent.
B. Introduction of the Control Agent: A New Option for Issuers
The control agent (“agent de contrôle”) holds the securities issuance account while the securities accounts remain with settlement organizations, central account keepers or account keepers.
Within or through DLT, the control agent is inter alia in charge of (i) maintaining and updating the securities issuance account, (ii) tracking of the securities’ ownership chain and (iii) reconcile the amount of each issuance registered in a securities issuance account against the sum of securities registered in the securities accounts.
The role of the control agent could be played by (i) a settlement organization or (ii) a Luxembourg or other EU credit institution or investment firm. The categories mentioned under (ii) are particularly interesting for investment funds.
Funds – as issuers – may appoint a control agent that can be an investment firm, e.g., a portfolio manager or investment advisor. If the alternative fund manager or the management company of the fund has a license to act as portfolio manager or investment advisor under MiFID or an entity affiliated with it has such license, then the fund may appoint any of these entities as its control agent.
Funds may also appoint the depositary bank as their control agent. In this case, the depositary will be entrusted with real-time oversight and reconciliation of transactions.
In this regard, issuers must notify the Commission de Surveillance du Secteur Financier (CSSF) of the appointment of the control agent at least two months prior to the agent’s commencement of activities. The CSSF will verify that the control agent has adequate professional experience, as well as a solid internal governance system, and in particular if it complies with the requirement to have appropriate IT systems.
It results that, with Blockchain IV, the number of intermediaries involved in the operation of a fund may be significantly reduced, operating efficiency further increased, and costs reduced.
This new function presents another advantage for Luxembourg and can allow the country to take a significant place in the DLT ecosystem and attract new talents who are specialized in this area.
C. Unlisted equity securities issued by funds in the scope of the new DLT framework
Since the adoption of Blockchain IV, the concept of securities covers both equity (shares, profit units, subscription rights and units of common funds) as well as debt securities (that qualify as financial instruments and instruments representing public debt) whether they are listed or unlisted. The addition of unlisted equity securities by Blockchain IV is particularly important for investment funds in order to tokenize funds units (i.e., converting funds shares and units into digital tokens that can be traded on a blockchain).
In this regard, Blockchain IV authorizes the digital management of unlisted equity securities issued by funds. This expansion strengthens Luxembourg’s ability to attract investors interested in the increased liquidity and accessibility provided by tokenized instruments. For fund managers, tokenization offers a new avenue for raising capital.
D. The use of DLT in light of the regulatory requirements applicable to funds
In addition to reducing the number of intermediaries, the use of DLT ensures adequate regulatory oversight.
On one hand, it facilitates the AML/KYC checks both for the professionals subject to the AML/CFT obligations as well as customers (including investors) required to be identified. Customer identification checks can be performed by authorized entities (such as control agents) and the verified customers’ digital identity can be shared with other professionals thereby avoiding duplication of data collection and verification efforts. Indeed, the transparent and immutable nature of blockchain’s decentralized ledgers empowers fund managers, control agents and regulators to access real-time transaction data, thereby ensuring adherence to regulatory requirements. This reduces the risk of non-compliance and enhances the overall integrity of the financial system.
On the other hand, it allows to verify the regulatory status of investors either directly by the control agent or via the use of distribution platforms. The investor will again be authenticated though cryptographic means when subscribing for tokenized fund shares.
The new regulation also simplifies payment processes within the DLT framework, particularly for settling financial obligations such as dividends and interest. Through smart contracts, payments can be made immediately and without intermediaries after the transfer of the relevant amounts, automating otherwise lengthy and complex processes.
[1] Law of 6 April 2013 on dematerialized securities.
[2] Law of 1 March 2019 amending the law of 1 August. 2001 on the circulation of securities.
[3] Law of 22 January 2021 amending both the law of 5 April 1993 on the financial sector and the law of 6 April 2013.
[4] Law of 15 March 2023, implementing the EU Regulation 2022/858 on a pilot regime for market infrastructures based on DLT, amending law of 5 April 1993, law of 5 August 2005 on financial collateral arrangements and law of 30 May 2008 relating to markets in financial instruments.
Copyright: D.R.
