Last week, the International Securities Lending Association (ISLA) published a white paper highlighting the legal issues of digital assets used in securities lending.

As we reported that ISLA hired Ashurst lawyers to work on the issue, crypto lender Celsius recently filed for bankruptcy. Shortly before his bankruptcy, Celsius agreed to allow the issuer of the stablecoin, Tether, to liquidate collateral on a loan that he could not repay. But there are legal questions about whether Tether was entitled to the collateral. In legalese, has Tether ‘perfected its security interest’ in 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 guarantee of interest in digital assets is not easy.

ISLA wants to ensure that the existing framework for securities lending, the Global Master Securities Lending Agreement (GMSLA), is flexible enough to support digital assets. Although debt and equity securities are its priority, ISLA wishes 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 title transfer and security interest, but also discusses other topics such as early termination, compensation, agency, and security management.

There is potential for a legal minefield, and this is where ISLA wants to create at least some clarity. He 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 by a Spanish custodian.

So the first issue regarding title transfer is conflict of laws. A court in one jurisdiction may not agree with the applicable law assessed by another jurisdiction. Either way, the law often uses the location of the asset to decide jurisdiction. But that can be a bit trickier with a decentralized network. After all, the network in which the digital asset “lives” may be spread across multiple jurisdictions.

If a custodian has an asset, the location is easier to pin down. But digital assets can also be self-custodial, which can complicate matters. If the digital asset specifies an applicable law that can help tremendously and is more likely for stocks and bonds.

Since digital assets tend to be borderless, these cross-border issues are likely to become more common. While ISLA’s initial focus is more on stocks and bonds, the perfecting security interest laws for crypto assets are being 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.