Tokenization of Financial Instruments: The Future of Finance? 

Crypto-assets are one of the main applications of distributed ledger technology (in this article, we will use the simplified term “blockchain”) in the financial sector. The so-called “tokenization” of financial instruments can be defined as the digital representation of financial instruments on blockchains or the issuance of traditional asset classes in tokenized form to enable them to be issued, stored and transferred on a blockchain. The legal development in this area will have a major impact on the future market. In this article, we examine tokenization of financial instruments with a focus on company shares. Our aim is to bring the reader an overview of the legal aspects and provide an outlook on future legislation.

Tokenization in blockchain: Reinventing an old concept using new technology

In the context of property rights, tokenization is the process of “replacing” a physical or digital asset or right by a token –making the token a representation of the asset or right. Ownership or other property rights would typically either be claimed by the holder of the token or by another person or entity noted in a register. In terms of Swedish property law, generally such claimant would likely stipulate strong evidence of being the owner or rightsholder of the asset or right – depending on the applicable legal framework.

The type of tokenization we will focus on in this article is tokenization in a blockchain context and its applications for the financial industry. Although this kind of “tokenization” has become a recent buzzword, the act of letting an object represent or symbolize another – thus providing strong evidence for property rights – is in actual fact nothing new at all. Without wandering too far into the annals of Swedish property law, or indeed creditor protection concepts and the Swedish doctrine of traditio, etc., we’ll provide a few high-level examples, which are very common in our day-to-day lives:

• Legally speaking, a promissory note (sw. skuldebrev) is a document (physical or digital) representing the right to collect a debt and receive (future) payment.
• In terms of real property, registration in the land registry provides strong evidence of ownership, even stronger if combined with an agreement stating the purchase of the real property (i.e., the contract of sale (sw. köpekontrakt), and/or the bill of sale (sw. köpebrev)).
• Financial instruments in the form of company shares represents a unit of ownership interest in a company as well as stockholder voting rights on matters that affect the company. According to Swedish corporate law, the ownership of a company share is (generally) represented by registration (a note) in the company’s share register (sw. aktiebok). The purpose of the share register is to constitute a basis for exercise of shareholders’ rights vis-à-vis the company; and to provide the company, shareholders and others with information in order to assess the ownership structure of the company. Additionally, any holder of a physical share certificate (sw. aktiebrev) is presumed to have a strong claim of being the rightful owner of the share(s), i.e., representing (a fractionalized) ownership of a company.

Utilizing blockchain technology in the financial sector: Use cases

So, what is then tokenization in the context of blockchain and how does it differ from the above?

The blockchain use cases have evolved from the blockchain being solely a facilitator of cryptocurrency transactions – to the emergence of market platforms for trading and issuance of different kind of tokens. This development is providing for enhanced utilization of blockchain in the finance sector and for fintech-solutions.

Using company shares as an example, at least two types of tokenization is emerging on the European market;

1. Utilizing blockchain as the underlying technology for a company’s share register, making it possible to (i) issue the share certificate as a token, or (ii) let the share certificate be represented by a token, facilitating the transfer of the share certificate upon change of ownership; and,
2. Where the share itself is issued as a token on a blockchain, facilitating the transfer of the share upon change of ownership.

The commonality between the two different types of tokenization related to shares described above is that both types utilize the blockchain as a recordkeeper of the ownership of the company. However, in the context of law, there are a number of differences to be aware of.

Legal aspects of “share ledgers” and tokenized share certificates

Under Swedish law, a company’s share register may be maintained using automated processing. Thus, there is no obstacle from a perspective of corporate law of using blockchain as the underlying technology as the “share ledger”.

As regards digital copies of, or tokenized share certificates, the legal aspects give rise to a number of issues. Firstly, the Swedish Companies Act[1] prohibits issuance of digital share certificates (see chapter 6 para. 3). This means that a share certificate issued by a company in the form of a token would be invalid. And secondly, digital copies or representations of a share certificate in the form of a token would on the one hand indicate ownership of the share, but the current paper-based system for share certificates raises problems in terms of “evidence”. A physical share certificate may thus trump its “(non)-equal” of a tokenized share certificate.

Legal aspects of tokenized shares

While Swedish legislation is rather low-key on the notion of tokenized shares, a lot is happening in this area of law in other parts of Europe – introducing legislation streamlined for tokenized assets. For example, Liechtenstein’s “Blockchain Act”, providing for the tokenization of “everything”, took effect in January 2020.[2] Switzerland introduced the concept of tokenized securities by passing its respective act which entered into force in August 2021.[3]

On the EU side, there is a vast legislative work in progress in order to regulate the crypto market, introducing, e.g., the Markets in Crypto-Assets Regulation[4] (the “MiCA-regulation”) and the DLT Pilot Regime (as defined below).[5] The MiCA-regulation creates clarity on the notion of tokenized financial instruments by actively bringing it outside its scope;  instead referring to well-established EU regulatory frameworks for the financial sector, e.g., the Markets in Financial Instruments Directive (MiFID II).

The regulatory sandbox: An insight into future legislation

Another “legislative project” from the EU is the DLT Pilot Regime[7] which introduces a union-wide legislation which provides the opportunity of operating DLT market infrastructures subject to temporary exemption from some specific requirements of EU financial services legislation. The overall goal of letting players in the market operate “freely” is for the purpose of testing and letting the EU legislators gain valuable experience regarding tokenized financial instruments and their underlying technologies. The aim is to develop the trading and settlement for tokenized financial instruments and insights to be gained are supposed to be helpful in the identification of possible practical proposals for appropriate regulatory frameworks. The focus is on regulatory proposals for the issuance, safekeeping and asset servicing, trading, and settlement of tokenized financial instruments.[8]

Three types of “DLT market infrastructures” are introduced by the DLT Pilot Regime (somewhat simplified in the below description):

• DLT multilateral trading facilities (“DLT MTFs”): multilateral systems operated by an investment firm or market operator approved under MiFID II — which only admits to trading tokenized financial instruments.
• DLT settlement systems (“DLT SS”): a system that settles transactions in tokenized financial instruments against payment or against delivery and that allows the initial recording of or the provision of safekeeping services in relation to tokenized financial instruments.
• DLT trading and settlement systems (“DLT TSS”): a DLT MTF or DLT SS that combines services performed by a DLT MTF and a DLT SS.

Furthermore, the specific kind of tokenized financial instruments which are enumerated in the regulation are (i) shares, (ii) bonds, and (iii) units in collective investment undertakings.

The European Securities and Markets Authority (“ESMA”) is responsible for providing a report to the EU Commission on 26 March 2026, stemming from this Pilot Regime-project evaluating a number of different aspects. The ESMA report shall serve as a basis for the final evaluation report to be presented by the EU Commission to the European Parliament and the Council. This final report shall include a cost-benefit analysis on whether the Pilot Regime should be extended, if it should also include other kinds of financial instruments, or whether it should generally be amended, be made permanent or be terminated. ESMA will also provide interim reports annually in order to, e.g., provide the market participants with information on the functioning of the markets, address incorrect behavior of operators of DLT market infrastructures, provide clarifications on the application of the regulation and update previous indications based on the evolution of blockchain technology.

Are tokenized financial instruments the future of finance?

One thing is for sure, and that is that entrepreneurs and companies are eager to follow the legislative development in the EU – as future legislation forms the framework for tokenization of financial instruments and its impact on the market. Setterwalls will continue to monitor the development and application in the blockchain area to fully prepare clients for legal developments in this exciting and rapidly developing field.

[1] The Companies Act (SFS (Swedish Code of Statutes) 2005:551).

[2] The Token and Trusted Technology Service Provider Act (TVTG).

[3] the Federal Act on the Adaptation of Federal Law to Developments in Distributed Electronic Register Technology and the associated blanket ordinance.

[4] Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets and amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937.

[5] Setterwalls examines the MiCA-regulation in several articles. For more information, see:

The MiCA regulation – ten steps for crypto companies to consider – SetterwallsThe upcoming EU Crypto Asset Regulation (MiCA)– are NFTs to be regulated like crypto? – Setterwalls The new EU Crypto-asset legislation (“MiCA”) – are the Wild West days of Crypto about to end? – Setterwalls

[6] Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU.

[7] The “DLT Pilot Regime”: regulation (EU) 2022/858 on a pilot regime for market infrastructures based on distributed ledger technology entered into force on 23 March 2023. The DLT Pilot Regime is part of the EU Digital Finance Package, among the MiCA Regulation and the Digital Operations Resilience Act.

[8] Setterwalls examines the DLT Pilot Regime in this article: Blockchain Regulation in the Spotlight: Key Takeaways from the EU DLT Pilot Regime – Setterwalls