Tokenisation is the creation of the digital representation of an asset on a blockchain.
The tokenisation process involves the registration of an asset and its rights on a digital token which is then recorded on a shared electronic recording device like blockchain.
The respective project leaders are the only ones who can decide on the asset they want to integrate into their security token. Like utility tokens, whose utility and economy must be carefully designed, it is necessary to create a security token that refers to an underlying asset.
Real estate tokenisation is an essential subject that affects a huge global market. Indeed, the real estate investment market is generating several trillion dollars each year and more than half of every asset held by individuals consists of at least one real estate asset.
It is therefore not surprising that many players, institutional or otherwise, offer services related to the tokenisation of real estate assets, such as "Tokenestate", which offers the creation of investment vehicles that are able to issue "real estate tokens", or “Blockstone”, which has created a real estate investment platform that enables investors of all sizes to own shares of institutional quality real estate assets.
It is therefore necessary to appreciate the assets that can be tokenised and in particular real estate assets (I).
Actors may also decide to tokenise assets such as financial securities for the purpose of selling to the public in order to raise funds by initiating a Security Token Offering ("STO") operation.
It is therefore appropriate to review the currently favourable French regime for implementing such STO (II) operations.
I. ASSET TOKENISATION - FOCUS ON REAL ESTATE ASSETS
Many traditional assets are likely to be tokenised; a process that makes these assets, especially the most illiquid ones, much more easily exchangeable.
Real estate financing, in its broadest sense, is increasingly involving the financing and management of real estate through the blockchain as well as the process of tokenisation of real estate assets.
Indeed, providing a system for transferring real estate assets through the blockchain would eliminate the risks and uncertainties associated with the simple use of paper while retaining the properties and characteristics of the transferred real estate asset.
This article analyses the different real estate assets that could be subject to tokenisation (1.) and specify its advantages (2.).
- Real estate assets that may be tokenised
Tokenising a real estate asset implies associating a digital token registered on a blockchain with a real estate property.
More specifically, real estate tokenisation is the process of representing with a token the property or part of it in a real estate property. It is thus important to distinguish clearly what the token represents.
The possibilities are so numerous that it would be inappropriate to draw up an exhaustive inventory, but, for example, a token could represent:
- ownership of the underlying real estate asset (1.1.);
- the right to receive land incomes generated by a real estate asset (1.2.); or
- ownership of a share of real estate funds, i.e. of the structure that itself owns the real estate assets (1.3.).
1.1. The tokenisation of the ownership of a real estate property or a portion of it
It is quite possible to tokenise the ownership of a property or a portion of it. Thus, the total value of any tokens would consist of a representation of the total value of the property. The amount of tokens could then be determined by the number of square metres or square millimetres of the property.
For example, the ownership of a building valued at 10 million Euros for 10,000 square meters, or 10 million square millimetres, would be represented on a blockchain by 10 million tokens each representing 1 square millimetre of the property for a value of 1 Euro per token.
The sale of these tokens representing part of the property would be similar to an Initial Coin Offering ("ICO") provided that the tokens are not tied to financial securities.
Thus, the sale of these tokens to thousands of participants would not be intended to finance or support a native blockchain project, for example, but to fund an identified real estate asset.
It is understood that the holder of such a project should, where applicable, comply with the rules applicable to collective investments and in particular to alternative investment funds ("AIFs") when it comes to buying real estate. Indeed, without involving securities, AIFs are intended to raise capital from a certain number of investors in order to invest them, in the interest of these investors, in accordance with an investment policy that these AIFs or their management companies define.
This hypothesis must be distinguished from a simple sale of tokens on a property already acquired. In this case, the financing through the sale of the tokens would not concern the purchase of the property, but its management.
Finally, this hypothesis, without falling into the tokenisation of real estate financing, would consist in a tokenisation of the right of ownership itself, i.e. of a real property right.
In some jurisdictions, such as the United States, the sale of a property entirely through a blockchain process has already been carried out by the American company, Propy. On the other hand, in France, tokenising such a real property right is much more complicated because of the French administrative land registry (through cadastral registration) and the necessary intervention of a notary.
It seems much more realistic to tokenise land incomes such as future rental incomes or the share of the sale price of a property.
1.2. Land incomes tokenisation
The token that represents a share of ownership of a property becomes a more practical tool because all the rights and revenues attached to ownership of the property could be attached to this token.
Through the use of so-called smart contracts, the owners of the tokens, which represent part of the ownership of the property, could be directly distributed the income from the exploitation of the property up to their share.
It is therefore a tokenisation of land income. These land revenues come from the ownership of a building or more precisely from the use made of the building by a third party or by its owner. They are defined as the income from the building through current or future rents generated by the operation of the building in comparison to the expenses that must be borne for its acquisition and conservation.
However, a distinction must be made between two hypotheses:
1) Either it is a matter of issuing a digital token as a mirror of a property right and in this case, except in the case of securitisation, it is necessary to dismember/share the property because the holder of the token is necessarily the owner or co-owner of the real estate asset.
In this case, the digital token has no reason to be considered as a financial security since the holder of the digital token is the direct holder of the underlying real right.
2) Either it is a matter of issuing a digital token which is not the exact mirror of the property right and corresponds rather to land income or to a securitisation of the underlying right.
In this case, depending on the characteristics of the transaction, the digital token should either be considered as a derivative product or comply with French Intermediaries in Miscellaneous Properties regulations.
1.3. "Real estate development" tokenisation or investment fund shares tokenisation
Most real estate financing is provided through investment funds that allow investors to make investments together for one or more specific properties. These funds, which belong to banks, financing organisations or individuals, make it possible to pool investors' capital and pool costs.
Some of these funds are intended for real estate such as Société Civiles de Placement Immobilier ("SCPI"), which are intended for rental investment and consist of at least 90% of real estate assets or collective investment schemes dedicated to real estate ("OPCI"). Some of these funds may also be listed on the stock exchange.
The tokenisation of shares in real estate funds refers mainly to the tokenisation of securities and financing through a Security Token Offering, i.e. by issuing tokens representing securities (see II. below).
A digital token from a tokenisation of fund shares can be the perfect mirror of the fund share with all the financial and political rights attached to it. Moreover, the advantage of tokenising shares in real estate funds, in addition to the practical modalities, is that this digital token could also be provided with financial rights alone, and without granting political rights.
A digital token could also be created and issued as part of a real estate development operation, similar to the systems developed in real estate crowdlending, which consist of participatory financing in the form of credit (loan contracts, mini-bonds or bond issues).
In such a case, a building (purchase or construction) would be financed through the loan and the digital token would represent the debt portion. The token holder would thus have his debt repaid with interest when the building is sold.
It should be noted that, with regard to the secondary market for these tokens, OTC exchange is entirely open and does not require any specific regulation. On the other hand, once these tokens are exchanged on a multilateral platform, they should be exchanged through a multilateral trading facility.
Projects to establish multilateral trading facilities for the exchange of security tokens are currently under development.
2. The benefits of real estate asset tokenisation
Real estate asset tokenisation would have many advantages.
The first is the wider inclusion of investors in the real estate world, as digital tokens have greater flexibility than traditional investments, and allow for smaller amounts of investment. The real estate investment market would therefore open up to a larger number of investors, whereas it is now rather reserved for institutional investors.
The tokenisation of real estate assets would lead to disintermediation of the sector and therefore lower many barriers to entry. Real estate funds, or any company holding real estate, could free themselves from costly IPOs and issue tokens sold directly, without going through investment banks or brokers.
This tokenisation of real estate assets would also allow greater flexibility and easier trade, which would certainly lead to a wider opening of the market to third countries.
A significant advantage is to make the real estate market much more liquid. Traditionally, illiquid assets such as buildings can be split into smaller pieces and can be traded under very restrictive practical terms. Tokens, however, would be tradable on regulated platforms that operate 24 hours a day, 7 days a week.
An overarching advantage exists in all systems organized through a blockchain, which offers greater transparency and security. Smart contract technology also makes it possible to reduce costs and save time by automating certain movements.
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II. THE POSITIVE FRENCH REGULATORY CONTEXT - SECURITIES TOKENISATION AND ASSOCIATED FUNDRAISING
A financial security always refers to a specific kind of asset with a monetary value. This asset may represent the ownership of a portion of a company's shares or a debt obligation to the company in the form of an (obligation), or an ownership interest represented by an option.
A Security Token Offering ("STO") consists of an issue of financial securities in the form of tokens and must follow specific steps in its execution (3.).
The current French regulatory context is very favourable to financial securities issuance operations following two concomitant reforms: the exemption of a prospectus for public offerings of less than €8 million (1.) and the entry into force of the "blockchain" decree (2.)
- Public offers of less than €8 million that are exempt from prospectus requirements
Since July 2018, Article 211-2 of the Autorité des Marchés Financiers ("AMF") General Regulations (RGAMF) has been amended and now stipulates that the offer of financial securities for which the total amount in the European Union is less than €8 million, or the equivalent value of this amount in foreign currency, does not constitute an offer to the public subject to a prospectus approved by the AMF.
The total amount of this offer is calculated over a period of twelve months following the date of the first offer.
For these public offerings of less than €8 million, the issuer benefits from a simplified procedure and may limit itself to providing investors, prior to any subscription, with a summary information document, the "document d’information synthétique", or ‘DIS’, in accordance with Article 212-44 of the RGAMF.
The summary information document must include in particular:
- a description of the issuer's business and project, including the latest existing financial statements, business forecasts and an organisation chart of the management team and shareholders;
- information on the level of participation to which the issuer's managers have committed themselves in the context of the proposed offer;
- exhaustive information on all the rights (voting rights, financial rights and information rights) attached to the securities offered but also all the rights attached to the securities not offered in the context of the proposed offer;
- a description of the provisions contained in the articles of association or in an agreement, and organising the liquidity of the shares or the explicit mention of the absence of such provisions;
- the conditions under which copies of entries in investors' individual accounts in the issuer's books, evidencing ownership of their investment, will be issued;
- or a description of the risks specific to the issuer's business and project.
This summary information document, as well as promotional communications relating to the offer, regardless of their form or method of communication, are sent to the AMF.
It should be noted that, as such documents are not subject to an AMF visa as a prospectus would be, the issuer may not publicly report any review or verification by the AMF.
In addition, with regard to promotional communications, the AMF may require that they include a warning about certain exceptional characteristics presented by the issuer.
The following are excluded from this scheme:
- offers offered through a participatory financing website (crowdfunding); and
- offers relating to securities admitted or applied for trading on a regulated market or multilateral trading facility.
2. The decree of December 24th, 2018 implementing the Blockchain Ordinance of December 8th, 2017
These two texts allow the use of a blockchain system for the representation and transmission of financial securities.
It is now possible to register securities issued in France and not admitted to trading by a central depositary in a shared electronic registration device (or blockchain). Such an entry shall be deemed to be an entry in an account pursuant to Article L. 211-3 of the French Monetary and Financial Code.
In this context, the electronic device must provide guarantees, in particular with regard to authentication, at least equivalent to those provided by a book entry. Thus, the electronic device must be designed and implemented in such a way as to ensure the registration and integrity of registrations and to allow, directly or indirectly, the identification of the owners of the securities, the nature and number of securities held.
Owners of securities registered in such a system must also be able to have their own transaction records.
All these new rules do not create a new obligation, nor do they lighten existing guarantees relating to the representation and transmission of the securities concerned. The provisions within the Monetary and Financial Code and the Commercial Code relating to financial securities are simply adjusted to allow such a system to be used.
To conclude, the current French legal system allows financial securities to be issued and registered on a blockchain system, an issue of securities that can be opened to the public without the obligation to have a prospectus endorsed, as long as it is less than €8 million, an amount assessed over twelve months and throughout the EU.
This regulatory context opens up a very favourable path for tokenised financial securities offers, i.e. Security Token Offering operations.
3. The security token offering process
There are several main steps to understand how an STO operation works.
➢ The first step is to identify the asset that will be tokenised
As explained above, an STO consists of an issue of financial securities in the form of tokens registered on a blockchain so that all financial securities can be the subject of such a transaction, namely equity securities, debt securities and securities of collective investment undertakings.
Starting from the asset subject to tokenisation, consisting of the asset underlying each token, the value of each token issued can then be determined.
The exercise will then consist of determining:
- the income associated with each token: investors will only invest if they believe that the underlying asset will earn value and/or generate income. The issuer must therefore explain in its documentation in which form the income generated by the underlying assets will be generated and then distributed, including how often;
- the rights associated with each token: if the tokens represent shares, all rights associated with the shares are associated with the tokens. Additional rights may be granted to token holders such as information rights. All these rights must be detailed in the legal documentation of the offer.
Some of these rights may be expressed directly on the blockchain if the issuer uses an appropriate identification system for investors, for example, voting may take place on the blockchain.
➢ The second step is to ensure good compliance of the STO's operation
In order to ensure that the STO transaction complies with the obligations in force in a jurisdiction, the issuer must choose a country of issue. In the event that the issue is made from France, the issuer would benefit from the above-mentioned favourable regulations and could be exempted from the requirement to draw up a prospectus for a public offering of less than €8 million.
In addition to the financial regulations relating to the issuance of tokenised financial securities, all applicable rules on investor identification (or "Know Your Customer - KYC") and the fight against money laundering and terrorist financing (known as "AML/CFT") must be applied and respected. In this context, it is necessary to put in place concrete and operational procedures.
➢ The third step is to choose an appropriate ecosystem
Finally, it is important to identify serious and credible actors and stakeholders to develop and support the STO operation: legal advice, placement, development, etc.
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Thibault VERBIEST Diane RICHEBOURG
Partner at DS Avocats Associate Lawyer at DS Avocats