The UK Jurisdiction Taskforce of the Lawtech UK Panel (UKJT) has recently issued a legal statement on digital securities, reflecting on the results of a lengthy consultation process. This explores the question of whether English law currently supports the issue and transfer of equity and debt securities on blockchain and distributed ledged technology (DLT) based systems.
The UKJT describes securities as ‘unitised, transferable interests in, or obligations of, an issuer that are issued and transferred to investors as a means of raising capital' and notes that the precise meaning of a security will depend on the context but seeks to focus on three types of securities within its statement:
- bonds (debts and other contractual securities);
- proprietary securitisation of assets; and
- equity securities (essentially shares in companies)
Some of the key points from the statement are summarised below:
1. Issuance of digital securities
The UKJT acknowledges that in principle, there is no reason why equity and debt securities cannot be issued and / or transferred using blockchains or DLT based systems under English Law.
The UKJT recognises that the features of ‘traditional’ securities (being paper based or registered) can be replicated using appropriate legal structuring techniques and any formalities / requirements on UK companies can generally be met through electronic means.
2. Legal form of digital securities
The UKJT explores the form that digital securities may take and looks more specifically at the concept of ‘stapling’. Stapling refers to a ‘legal mechanism whereby the holder of a legal right/interest is identified by reference to a crypto asset, or to another digital object of property or a ledger record that is not in itself an object of property.’
Stapling a security to a digital object would allow the security to pass with control of the object (rather than by way of an update to the register).
The UKJT notes that there is no reason why a contractual security may not be stapled to a digital token and recognises that there are mechanisms under English Law to facilitate this.
When it comes to equity securities, the UKJT does note that shares in a UK company would probably have to be issued in the traditional registered form or in accordance with the Uncertificated Securities Regulations 2001, which already sets out a regime for transferring securities by electronic means due to existing requirements under the Companies Act 2006 (the Act).
3. Register of digital securities
In relation to the question of whether blockchains or DLT based systems may be used as registers of digital securities, the UKJT notes that as a database, a blockchain could in theory be used as a register of members.
There is nothing in the Act which prevents a company from opting for an electronic register. However, a company would need to ensure that it is able to produce a hard copy of the data (in order to satisfy requirements contained in s.1135(2) of the Act).
There is also information that is to be stored in a register of members which some companies may prefer to be ‘off-chain’ (such as the names and addresses of shareholders).
The UKJT further recognises that UK companies are not simply under an obligation to store a register but also maintain it, meaning that it would probably not be possible for a UK company to opt for a fully decentralised and permission-less ledger.
4. Transfer of equity securities
In relation to the transfer of equity securities, the UKJT notes that so long as the system is capable of producing a ‘proper instrument of transfer’ (for the purposes of satisfying s770 of the Act) that can be submitted to HM Revenue and Customs (HMRC), there is again no reason why a DLT based system could not be utilised for the purposes of transferring equity securities.
However, given that there would still be a need to produce a form that could be submitted to HMRC, it is questionable whether this would deliver any real tangible benefits to companies (in terms of reducing formality and simplifying the transfer process).
The above notes highlight some of the key points discussed within the legal statement, and are not a comprehensive summary.
But what they illustrate, and the general thrust of the report also shows, is the inherent degree of inherent flexibility in English company and commercial law. Although there are a limited number of existing legal provisions which would block the full use of DLT and blockchain technology for dealing with the issue and transfer of shares, it would not require a complete overhaul to address this, but some more minor adjustments. English securities law has adapted in the relatively recent past to uncertificated securities and electronic transfers without this upsetting established principles of company law and corporate governance.
The question is perhaps what the tangible benefits of doing this would be, and whether there is sufficient enthusiasm or perceived necessity to drive these type of changes. For SME owner managed businesses it is difficult to see any particular attraction. Shares in larger PLCs already exist in an almost entirely dematerialised form.
And, for those growth companies who participate in fundraisings where there are large numbers of individual investors with relatively smallholdings, platforms such as Crowdcube and Seedrs already exist with nominee arrangements in place (and secondary markets) that facilitate dematerialised share ownership.
The current issue is not so much whether it is feasible, both legally and practically, for DLT and blockchain technology to support the issue and transfer of securities. It is, albeit some change in the law would be required. The bigger challenge is demonstrating the potential advantages to such a degree that they are perceived to outweigh the difficulties of a departure from the current system, and the relative leap into the unknown that would involve.