News focus: Clock is ticking for legal clarity on digital securities

Sir Geoffrey Vos’s ambition is bold: to establish England and Wales as the jurisdiction of choice for the global crypto-economy just as, in the 18th century, Lord Mansfield established it for the joint stock company. A first step, according to the master of the rolls (pictured, inset), is to set out what the law actually says today. On that foundation, the thinking goes, parties will increasingly opt for English law, trusting in its inherent adaptability – to accommodate blockchains, distributed ledgers and other novelties.

The UK Jurisdiction Taskforce, which Vos chairs, has already published one such statement, on the status of cryptoassets and smart contracts. However its next project, an attempt to set out the legal position on digital securities, could prove more tricky if discussions at a London event this week are any guide.

The government-funded LawtechUK initiative held the event to encourage submissions to a consultation on the question ‘Does English private law support the issuance and transfer of equity or debt securities using a system deploying blockchain or DLT [distributed ledger technology]?’ A statement is expected to be published in January. It is unlikely, however, to deliver the green light sought by enthusiasts for ‘dematerialised’ financial markets.

Speaking at the event, taskforce member David Quest KC predicted that current law might be applicable to the ‘debt’ category of digital securities, such as bonds. This is because debt transactions are ‘essentially contractual in nature’ and lend themselves to ‘drafting around the issues’.

The handling of equity securities, such as company shares, would be ‘potentially more complicated’ because of statutory requirements, however.

A 25 page submission to the consultation by the City of London Law Society (CLLS) sets out some of these clashes in detail. A fundamental problem is that the very attractions of blockchain-based systems – their distributed nature and potential for anonymity – sit uneasily with statutory requirements covering the registration and possession of equity-based securities.  

'Much of the excitement about the use of blockchain and DLT is their potential for making it impossible to identify either a physical asset or specific person against whom any right or claim can be exercised or enforced'

City of London Law Society

For example, English law requires the existence of a ‘proper instrument of transfer’ for the sale of securities held outside the CREST securities settlement system. The form, content and any rules, protocols and systems used to generate and process such an instrument must be acceptable to HMRC/the Stamp Office and be compatible with the HMRC/Stamp Office’s own systems, it notes.

Another problem is the familiar one of ownership of a stream of digital data. This is being resolved in the very specific cases of bills of lading and other shipping documents in the Electronic Trade Documents Bill currently before the House of Lords.

Meanwhile, the distributed nature of DLT systems creates the risk of a conflict in laws.

A basic problem, as the CLLS points out, is that much of the excitement about the use of blockchain and DLT is their potential for making it impossible to identify either a physical asset or specific person against whom any right or claim can be exercised or enforced. This sits uneasily with the idea of digital assets as securities on which a charge can be placed.

Quest said that the forthcoming statement on digital securities will need to consider:

• The need for a register for such assets;
• How to create a legally compliant instrument of transfer in the crypto world – for example, could it exist as code, or would it need to be set out in natural language?
• How stamp duty could be paid in a blockchain environment.

Of course this discussion is taking place at a time of extreme nervousness about the whole blockchain economy, following the highly publicised collapse of crypto exchange FTX. But such disasters do not mean that the underlying technologies will not find a place. The CLLS submission suggests that, as blockchain and DLT-based systems become mainstream, ‘their technological, operational and resilience benefits mean that they are likely to be used more widely in the financial, capital and other markets’.

But this will not happen without a strong legal underpinning. As the master of the rolls pointed out this week, scandals such as the collapse of FTX underline the need for legal certainty.

England and Wales is not the only jurisdiction trying to provide this. This week’s LawtechUK event heard that competing jurisdictions such as France and Germany had already passed statutes covering cryptoassets. Vos said he was confident that a flexible common law approach will continue to prove more suited to fast-changing technologies. However ,the event heard that the clock is definitely ticking.

The UK Jurisdiction Taskforce’s consultation closes on 30 November.