Last week the International Securities Lending Association (ISLA) published a whitepaper highlighting the legal issues of digital assets used in securities lending.
When we reported that ISLA contracted lawyers Ashurst to work on the topic, crypto lender Celsius had recently entered into bankruptcy. Shortly before its bankruptcy, Celsius agreed to let stablecoin issuer Tether liquidate collateral against a loan it could not repay. But there are legal question marks over whether Tether had the right to the collateral. In legal lingo, did Tether ‘perfect its security interest’ in the collateral?
That usually involves one or two formalities. In the United States, many of these transactions are legally governed by the Uniform Commercial Code (UCC), which is adopted by all states, at least in part. In May, new UCC rules covering digital assets were agreed. However, until each state adopts the new rules, perfecting a security of interest in the digital assets is not straight forward.
ISLA wants to ensure the existing framework for securities lending – the Global Master Securities Lending Agreement (GMSLA) – is sufficiently flexible to support digital assets. Although debt and equity securities are its priority, ISLA is keen to be agnostic as to the nature of a digital asset, so it could also be a cryptocurrency or an NFT.
The whitepaper primarily explores the transfer of title and security interest but also looks at other topics such as early termination, netting, agency and collateral management.
There’s potential for a legal minefield, and this is where ISLA wants to create at least some clarity. It gives the example of a GMSLA (governed by English law) entered into between a German lender and a French borrower for a digital bond issued by an Irish issuer and held at a Spanish custodian.
So the first issue regarding the transfer of title is the conflict of laws. A court in one jurisdiction might not agree with the applicable law assessed by another jurisdiction. Either way, the law often uses the asset’s location to decide jurisdiction. But that can get a bit trickier with a decentralized network. After all, the network on which the digital asset ‘lives’ might be distributed across multiple jurisdictions.
If a custodian holds an asset, the location is easier to pin down. But digital assets can also be self custodied which can make that trickier. If the digital asset specifies a governing law that can help enormously and for equities and bonds is more likely.
Given that digital assets tend to be borderless, these cross border issues are likely to become more common. While the initial ISLA focus is more on equity and bonds, the laws of perfecting security interest for crypto-assets are getting tested with the bankruptcies of Celsius, Voyager, FTX and yesterday, another crypto lender BlockFi.
Meanwhile, EquiLend is starting work on a blockchain solution for securities lending, and the Tel Aviv Stock Exchange launched a network two years ago.
