DFSA’s New Regulatory Framework for Investment Tokens
The Dubai Financial Services Authority (DFSA) officially announced in October 2021 the governing Framework for Investment Tokens. It is the latest financial body in a regulatory capacity in the region to regulate investment tokens. Dubai has been at the forefront in the adoption of digital assets and blockchain technology. In September 2021, UAE’s financial regulator, SCA or the Securities and Commodities Authority, and the DWTCA or the Dubai World Trade Centre Authority have reached an official consensus to support trading in digital assets. DFSA’s recent Investment Token regulatory framework attempts to help mobilize the adoption of Distributed Ledger Technology (DLT). DFSA’s Framework will ensure that digital assets are issued, listed, and supported in a regulated ecosystem.
The Framework reflects the aspects mentioned in the Consultation Paper 138 released in March 2021. With the launch of the Framework, it is DFSA’s Digital Assets regime’s first phase.
What does the Regulatory for Investment Tokens say?
- An investment token as per the Framework can be a Derivative Token or a Security Token.
- The Framework has been designed to protect consumer and investor needs.
- The regulations aim to address integrity risks and Counter-Terrorism Financing risks.
- These also were formed to handle Anti-money laundering (AML).
The regulations have been introduced due to the positive moves in the investment market. For example, the sales of tokens touched $200 million in 2020, and there are rising demands for investment tokens. And, within the DIFC, several companies are interested in issuing and trading with investment tokens.
Understanding the terms
A token is a cryptographic secured digital representation of the obligations that get stored, issued, and transferred with the aid of DLT. It could also be transferred using similar technology.
An investment token is a tokenized security or a derivative permit. The rights and responsibilities provided by traditional securities or financial products are the same as those offered by the tokenized security or derivative. The same rights and liabilities are conferred or have a similar purpose.
More and more companies are now ready to raise capital by tokenization rather than bearing the costs associated with IPO or Initial Public offerings.
The Framework was created to encompass persons, entities, and authorized businesses involved in the issue, trading, marketing, or ownership of investment tokens within the DIFC and is eager to begin financial services relating to investment tokens.
Risks associated with investment tokens
There are four major risks with investment tokens.
- The very nature of the transactions is pseudo-anonymous. Therefore, there are higher risks of illegal activities like money laundering, etc.
- Investment tokens are liable for higher speculation levels and suffer from lower transparency.
- Most sellers of tokens do not have a credible track record.
- Tracing the operator’s authenticity can be challenging if the token seller or scheme operator is located outside the UAE.
DFSA’s new Framework for Investment Tokens
Most experts feel that DFSA’s new Framework is going to be suitable for the industry. Here are the reasons why financial specialists in the MENA region are optimistic about the new Framework.
- The new Framework allows businesses interested in conducting financial transactions with tokens to determine whether it’s an investment token and, if so, what type it is.
- Assist with the inclusion of investment tokens on DFSA-regulated exchanges. Additionally, offer the necessary support for multilateral trade.
- The Framework defines the different requirements for systems and controls for trading venue service providers. It also emphasizes technology audit by an independent body.
- The new laws specify allowing trading venues immediate access, a departure from the previous intermediated trading paradigm. It also includes retail clientele.
- Digital wallet providers that hold investment tokens have been given additional requirements to meet.
- The disclosure of marketing and legal documents like prospectus needs to be disclosed appropriately.
- All financial operators that participate in token-related operations, particularly asset management, must fulfill stringent standards.
Furthermore,
- Under the Framework announced, DFSA has given DWCA the rights to approve and provide licenses to entities related to crypto-assets. DWCA oversees any financial activity related to cryptocurrency.
- In the current Framework, DFSA covers security tokens and derivative tokens. Security tokens are instruments like shares tokens, and derivative tokens are Options or Futures.
- DFSA is now involved in tokenization proposals that are not covered under the current Investment Tokens regulatory framework.
- The organization will now gradually cover the three distinct types of investment tokens –
- Utility tokens – it is used for accessing a service or buying a good.
- Asset-backed tokens or stable coins – these are also commonly known as flat-backed tokens or e-money tokens.
- Exchange tokens or cryptocurrencies – are something issued by cryptocurrency exchanges as a fundraising method.
The work of framing regulations for investment tokens is happening in phases and gradually – an aspect that the finance community in Dubai has welcomed. The second paper is expected to be released in 2022, in line with the first one during the next quarter. Rather than including every aspect in one go, DFSA is going step-by-step. It is beneficial due to the nature of the security token sector, which has been plagued by false starts in recent years.
What must corporate entities or individuals do if they want to trade in investment tokens in the UAE?
- The first stage is to prepare a thorough presentation that provides insight into corporate activity.
- The same information must be provided to the DFSA.
- The DFSA will review the strategy to see whether it fits their regulatory standards and if so, will permit the firm to trade in investment tokens.
Endnote
The reason behind devising the Regulatory Framework, as per Mr. Peter Smith, the Managing Director and Head of Strategy, Policy and Risk, DFSA, is to provide start-ups and innovative businesses with a friendly ecosystem. Their strategy is in sync with the UAE Government. They have conducted exhaustive studies and consultation on investment tokenization, and the regulations have been framed thereof. As the organization studies the landscape further, they are expected to develop more rules that have a far-reaching impact on creating a progressive ecosystem.
