DLT and securities registration

Sukuk and DLT

The question arises as to whether, beyond traditional registration in certificate or book-entry form, a sukuk can be registered, alternatively, in tokenized or digital form in DLT. From the Sharia law perspective, there seems to be no reason why the registration in one or another form would be relevant. The reference to the term ‘certificate’ in the AAOIFI definition of sukuk, rather than mandating that specific registration form, highlights that among sukuk's core features is the fact that they are freely tradable. As explained above, the use of the term ‘certificate’ seems only to reflect the most common practice in the market to obtain such transferability (see the FAB Sukuk Company Limited example). Indeed, the ‘device’ deployed by the law for that purpose (certificate, book-entry form, tokenized form) should be irrelevant for Sharia compliance.

Rather, from the Sharia law perspective, the use of blockchain for registration and subsequent transfers of sukuks may be even positive (Elasrag 2019). Certain blockchain’s key attributes justify this assertion; the record is based on the idea of ‘trust’ among participants, which cooperate with each other, instead of being based on the participation of intermediaries and a central authority. In addition, the ledger keeps a record of all past transactions (each of the blocks is a past group of transactions), thus making the system more transparent and improving accountability.

The problematic question, thus, is not whether such registration is possible under Sharia law but whether it is possible from the perspective of secular law. At a national level, there are already some examples of jurisdictions that are regulating registration in digital or tokenized form, but in all cases for non-listed securities. For example, France has regulated such a new possibility in the Ordonnance du 8 décembre 2017.6 The Ordonnance equates the registration of securities in a ‘shared electronic recording device’ - referring to a DLT platform - to registration in book-entry form -dematerialized securities. Therefore, the application of the same rules to registration and transfer of securities, regardless of the underpinning technology, is ensured (Vauplane 2018). Another example of the same is Delaware law, which allows for DLT registration of non-listed securities (title 8 Delaware Code).7

Given that, to the extent of my knowledge, registration of securities in tokenized form is, currently, only allowed for non-listed securities, the question still pertains - mainly - to the realm of corporate law, rather than to regulatory requirements of capital markets law. As explained above, access to EU-regulated markets and multilateral trading facilities (e.g. London Stock Exchange in the UK, AIAF in Spain) require registration in book-entry form in a CSD (e.g. Euroclear, Iberclear). Thus, listed sukuks in such markets cannot be registered in tokenized form. The traditional S/?ana-compliant capital-raising activity by way of sukuk issuance, i.e. sukuks issued by governments and large corporations, which are typically admitted to trading on regulated markets and target large investors, will still be based on the registration, clearing and settlement in CSD in book-entry form. For the time being, DLT is not relevant for the industry.

Conversely, capital-raising through the issuance of sukuks in tokenized form in a DLT (i.e. swhzfo’ ICOs) is attractive for small and medium-size issuers (Elasrag 2019), in need for lower amounts of capital, for which conventional markets are too complex and costly (S&P 2020) and which do not need to request admission on regulated markets but instead aim at other trading venues. The capital raised in exchange for the cryptosecurities may be either in hat currency or in cryptocurrencies, e.g. bitcoin or ether; the latter option triggers additional Sharia compliance questions, which are covered by another contribution in this book (ALAM 2021).

This kind of capital-raising, alternative to crowdfunding, takes place entirely online, which may prove to be particularly helpful in times of lockdown, as in the current coronavirus pandemic. The platforms in which issuance and subsequent transfers take place may be: (i) permissioned blockchains, where access is granted only to authorized participants and transactions can only be validated by certain nodes; or (ii) permissionless blockchains, e.g. Ethereum, where participation is not restricted and any node may validate transactions (for information on the kinds of blockchain platforms see Finck 2019). In both cases, no intervention of intermediaries is needed, thus lowering transaction costs, and any investor with internet access can acquire tokenized sukuks. This should contribute to increase the investor base and favour retail investors’ participation in sukuk capital-raising; nonetheless, investors undeniably need to be somewhat tech savvy which, in turn, limits such growth. In addition, many cryptosecurities are traded on DLT secondary markets (in 2019 between one third and one fourth, according to ESMA 2019), enhancing investor liquidity and hence making the investment more attractive.

One example, known to be the first sukuk issuance in the blockchain, was launched in 2019 via Blossom Finance’s SmartSukuk platform, built over Ethereum as a public blockchain. The issuer was Baitul Maal wat Tamweel (‘BMT’), a community-based microfinance in Indonesia, and the underlying structure was a sukuk al-nnidarabah, for which, however, there was no secondary market (Blossom n.d.).

Corporations issuing sukuk registered in the blockchain must consider, prior to launching the ICO, whether they need to comply with regulatory requirements or not. Although the answer depends on the relevant jurisdiction, generally speaking ICOs of tokens that qualify as securities are bound by regulatory requirements. Some jurisdictions, however, have even established a ban, e.g. China and South Kore (Lord Hodge 2018).

In the EU, the fact that a sukuk is registered in tokenized form, instead of certificate or book-entry form, does not modify its transferable security nature for the purposes of MIFID II and therefore an offering of cryptosukuks to the public triggers the same regulatory requirements as one of sukuks in certificate or bookentry form: to draw up, obtain approval and publish a prospectus. Indeed, ICOs very often do qualify as public offerings, which are defined as communications ‘to persons in any form and by any means, presenting sufficient information on the terms of the offer and the securities to be offered, so as to enable an investor to decide to purchase or subscribe for those securities’ under article 2d of the Prospectus Regulation. Similar prospectus requirements apply in other jurisdictions, for instance in the US, pursuant to Section 5 of the Securities Act 1933.

The above is particularly relevant, given that issuers frequently (and often wrongly) turn to ICOs as being, if not unregulated, at least less cumbersome from the regulatory perspective than traditional issuances. Yet, as discussed above, if the offer is made to the public and unless an exception applies, the same prospectus obligations stand. The lack of regulatory compliance triggers the application of liability rules, both in terms of administrative fines and private law rules (damages). Issuers should be aware of that.

This being said, it is tme that some regulatory exceptions in prospectus rules may be more relevant for issuers in the context of ICOs than they are in traditional IPOs. For instance, where total consideration of the issuance is less than EUR 8,000,000 (article 3.2 Prospectus Regulation, but see also article 1.4j), there is no

DLT and capital-raising in Islamic Finance 85 prospectus obligation. Insofar as the issuer’s needs for capital are lower, the issuance falls under the exception, thus reducing costs associated to capital-raising.

 
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