UAE Security token regulation ushers new era for capital markets

In June 2021 UAE Investment freezone DIFC ( Dubai International Financial Center) presented a consultation paper for the regulation of security tokens. In October 2021 the proposed legislative changes based on the Consultation Paper No 138 were published. The DFSA Board after due consideration of consulted comments made amendments to the DFSA rulebook to provide for a  regulatory framework for security tokens in UAE based DIFC.

KARM Legal, a leading tech law firm, has analyzed and explained these amendments. First The amendments include the inclusion of the word 'Token' in the GEN Rulebook, where now investments can be structured as 'investment token, security token, derivative token or others where such tokens imply that it is  an investment or a  particular type of investment.

The amendments mark the start of a new technological and economic  era  in  the  capital  markets  where  bonds,  options, shares   and   futures   can   be   tokenized  via  blockchain  or distributed ledger technology. The regulatory framework for security  tokens  will   spur  economic  growth  and  future development of the financial markets in the UAE  and abroad.

Key Takeaways from Security token regulations

• Provides a regulatory framework for tokenization of regulated financial instruments.
• Introduces regulations for tokenization of shares, derivatives, options, futures, units of a fund or investments deemed security as tokens.
• The regulations provide new rules for financial promotion in relation to tokenized securities.
• Introduces the concept of Alternative Trading System where the Authoriseded Firm holds Client assets under Category 4.

How security token regulations will change the status Quo

The amendments to the legislation and the rulebooks are groundbreaking and provide new  economic  opportunities  in  the  UAE. KARM Legal has summarized  the  major takeaways herewith below:

The new regulations enable the tokenization of shares, units, derivatives, bonds, futures, and options. Such financial instruments shall be referred to as share token, units token, derivatives tokens, bond token, futures token, and options token.

The regulations provide for the definition of a  security token or a  derivative token in the form of a cryptographically secured digital representation of rights and obligations  that  is   issued, transferred  and  stored  using  DLT  or  other  similar technology.

The regulations specify that a person who carries on certain activities relating to investment tokens  will  require  DFSA approval  or  authorisation.  Such  activities include carrying out financial services, financial promotion,  offer to the public or applying for a security token to be admitted to the official list of securities.

A person making or approving a  financial promotion that refers to an investment token or a  security token must ensure that the communications are clear, fair and not misleading.

The regulations now include the provision for an Alternative Trading System (ATS), where the ATS may hold or control client investments that are investment tokens or provide custody in relation to investment tokens after complying with application requirements as laid down in the regulations.

The capital requirements for the regulated activities at large have remained  the same; however, under Category 4,  the base capital requirement  for ATS, if  it holds Client assets, has been introduced to $140,000.

A new era of tokenization from tokenized Funds to regulated markets

The regulations provide for a regulatory framework for tokenization, listing and trading of fund units or fund interests issued by a fund from the DIFC. KARM Legal has summarized the major takeaways for the readers on fund tokenization and market rules herewith below:

According to the DFSA regulations, where units of a fund that are security tokens are admitted to trading on an ATS but are not admitted to trading on an Authorized Market Institution (AMI) or a Regulated Exchange (RE),  such a fund is defined as an ATS Traded Fund.

All  Securities in a  class of security tokens admitted  to trading on an ATS, including those specified under regulations, must be traded on an ATS, an AMI or a Regulated Exchange.

According to the regulations, inside information relating directly or indirectly to a security token may include matters arising due to the use of DLT that are capable of having a significant effect on the price of the security token. Such matters may, for example, include an interruption due to the creation of a ‘fork’ on the DLT or it becomes the target of a  cyber-attack. A reporting entity for a  security token must ensure that its systems and controls for identifying, controlling and handling inside information are adequate and will  operate effectively should such matters arise, including through appropriate market disclosure.

The  security token  regulations start a  new  era  for  the  financial markets  in UAE Based DIFC. DFSA is  one  of the  first regulators from  a  major  financial free  zone  to  bring  regulations in  regards to  security tokens that  may  be changing the history of the financial markets for at least the next 100 years.

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