// Financial Law Update
FINMA Issues Guidelines on Initial Coin Offerings
In the last few years Switzerland became one of the world’s leading hubs for initial coin offerings. This raised questions on how ICOs shall be treated from a Swiss regulatory standpoint. In an attempt to address such concerns the Swiss Financial Market Supervisory Authority FINMA recently issued a series of publications aimed at providing transparency regarding its approach to this new way of fundraising. Most importantly, this February FINMA issued guidelines for enquiries regarding the regulatory framework for initial coin offerings (the “Guidelines”).
In the recent past, business models based on distributed ledger and blockchain technologies successfully attracted the crowd’s as well as seasoned investors’ attention. And own experience as well as various studies show that Switzerland plays a dominant role when it comes to fundraising by means of ICOs. This is due to different factors such as “home-grown” DLT and blockchain based business ideas that have emerged from local universities, a traditional Swiss affinity for the financial sector open for and evaluating alternative service models as well as progressive, partially government supported initiatives embracing DLT and blockchain technologies. Further, Switzerland’s liberal and business friendly regulatory environment also helped convincing foreign players to launch ICOs in Switzerland.
Liberal does not mean libertarian and of course there are rules to be observed when performing an ICO. Given the vibrant Swiss ICO market, FINMA was increasingly confronted with enquiries in this regard. In order to inform the public about its perception of the legal implications of ICOs, FINMA on February 16, 2018 issued respective Guidelines which were presented on the occasion of roundtables held in various cities. The Guidelines contain an Appendix stating the minimum information to be submitted to FINMA in order to obtain the regulator’s assessment of a planned ICO.
2. Principle based approach
When qualifying ICOs, FINMA follows a principle based approach, i.e. a qualification occurs based on existing financial markets regulation. So far, there are no specific rules governing ICOs and it is currently not expected that ICOs will be specifically addressed by the Swiss law maker.
An ICO may be defined as a project financing by the issuance of tokens against payment predominantly in the form of cryptocurrencies, i.e. digital payment means using cryptographic techniques not issued by state authorities but generated (“mined”) by private persons for proofs of work or stake. Tokens may be described as digital data stored on a block (forming part of a chain) conferring a certain promise in the widest sense. ICOs usually occur at an early stage of a company’s or a project’s lifecycle and thus often serve as substitute for traditional venture capital A-financings, which typically follow so-called S(eed)-financing rounds. Unlike VC-financings, though, ICOs are often directed at a broader public requiring each investor to accept identical, non-negotiable terms. In this respect, ICOs resemble crowdfunding projects.
Due to this combination (fund raising / identical terms / direction at public) ICOs in various ways “collide” with Swiss financial market regulations. Particularly, the Banking Act, the Act on Stock Exchanges and Securities Trading, the Financial Market Infrastructure Act, the Collective Investment Schemes Act, the Act on Combating Money Laundering and Terrorist Financing as well as prospectus rules of the Swiss Code of Obligations may be affected. As of 2019, ICOs will have to be compliant with the Swiss Financial Services Act which is expected to pass parliament this summer.
3. Token typology
An ICO is a token generating event. The legal qualification of an ICO to a large extent depends on the nature of the token, i.e. the “promise” digitally embedded in the token. The Guidelines identify three types of tokens:
- – Payment tokens (i.e. cryptocurrencies), to be used to acquire goods or services or as a means for money or value transfer; they do not confer claims against the issuer.
- – Utility tokens provide digital access to an application or service via a blockchain based infrastructure.
- – Asset tokens represent assets such as debt or equity claims against the issuer (or an affiliate). Economically, asset tokens may confer analogous rights as equities, bonds or derivatives. As the Guidelines further state, “tokens which enable physical assets to be traded on the blockchain also fall into this category.”
There are hybrid tokens for instance combining elements of asset or utility tokens with those of payment tokens. Tokens may also entitle their holders to at a later stage acquire tokens with different properties (so called “pre-sale” tokens). In addition, fund raising may also occur for financing the development of tokens which is referred to as token “pre-financing”.
4. Legal classifications
Token as security
The legal consequences of an ICO partly depend on whether a token is to be classified as a security in the sense of the Financial Market Infrastructure Act (“FMIA”). Securities encompass standardized certificated (Wertpapiere) or uncertificated (Wertrechte) securities, derivatives (Derivate) and intermediated securities (Bucheffekten) which are suitable for mass standardized trading, i.e. they are publicly offered for sale in the same structure and denomination or are placed with more than 20 clients, insofar as they have not been created especially for individual counterparties (art. 2 (1) FMI-Ordinance).
According to the Guidelines, FINMA does not qualify payment tokens as securities. The same holds true for pure utility tokens conferring digital access to an application or service in which case a connection to the capital markets being “a typical feature of securities, is missing” (Guidelines, p. 5). Utility tokens with an investment purpose will, however, be treated as asset tokens. Depending on their features, asset tokens are qualified by FINMA as securities in the sense of uncertificated securities (Wertrechte) or derivatives (Derivate) if they are suitable for mass standardized trading.
Uncertificated securities are identical rights (like membership rights or financial claims) based on a common legal basis such as a company’s articles of association or issuance conditions and which are entered by the issuers into a specific ledger (Wertrechtebuch, art. 973c (3) of the Swiss Code of Obligations); such ledger may be digitally kept on a blockchain. Derivatives are financial contracts that derive their valuation from an underlying such as shares or bonds.
The qualification of a token as a security may have the following legal implications:
- – According to the Stock Exchanges and Securities Trading Ordinance (“SESTO”), only the self-issuance of derivatives, not of other securities, including uncertificated securities, requires the issuer to be regulated and supervised by FINMA as securities dealer (art. 3 (3) SESTO).
- – A FINMA license as securities dealer is required for persons who in a professional capacity either underwrite and publicly offer third party tokens qualifying as (any kind of) securities (art. 3 (2) SESTO). Further, trading in securities in a professional capacity for the account of clients or for own account may also require a securities dealer license (art. 3 (1), (4) and (5) SESTO).
- – The FMIA stipulates specific license requirements for stock exchanges or multilateral trading venues and organized trading facilities on which securities are traded.
In Switzerland, the acceptance of deposits from the public on a professional basis is generally reserved for FINMA licensed banks. Tokens which confer upon the investor a claim against the issuer for repayment may be qualified as deposits. Accordingly, the issuance of such tokens needs to be analysed under the Banking Act and its exemptions (pls. also see our article on the “Liberalization of the rules relating to acceptance of deposits from the public”).
Act on Combating Money Laundering and Terrorist Financing (“AMLA”)
The provision of payment services as well as the issuance or management of payment means is subject to anti-money laundering legislation (art. 2 (3) (b) AMLA). As FINMA pointed out, a means of payment may be assumed if it facilitates the transfer of assets by a third party in the context of a payment system, even if the payment system may only be accessed by a limited number of users.
Therefore, the issuance of payment tokens is subject to the AMLA if such tokens – pursuant to FINMA – may “be transferred technically on a blockchain infrastructure” (Guidelines, p. 6). The issuance of utility tokens is not considered a financial intermediary activity pursuant to the anti-money laundering law if the main reason for their issuance is to provide access rights to a non-financial application of blockchain technology and a potential payment function is therefore to be considered an “accessory service” (art. 2 (2) (a) no. 3 AML-Ordinance). Issuing asset tokens is generally out of AMLA’s scope.
The AMLA imposes various obligations of diligence and reporting on the person being regarded as financial intermediary as well as a duty to affiliate with a self-regulatory body or become directly supervised by FINMA for anti-money laundering purposes. In the case of an ICO, the entity receiving the proceeds is considered the financial intermediary. Consequently, the organizer of the token generating event needs to comply with the anti-money laundering duties, unless a financial intermediary already subject to the AMLA will act as recipient of the proceeds in which case only such intermediary will be subject to the AMLA (Guidelines, p. 7).
Collective Investment Schemes Act (“CISA”)
The CISA defines collective investment schemes as “assets which are raised from investors for the purpose of collective investment and which are managed for the account of such investors”. There might be situations in which an ICO bears reference to a collective investment (or a structured product also – at least partly – governed by the CISA), for instance if the ICO proceeds are pooled in order to carry out a specific investment strategy and the issued asset tokens represent correlative performance driven financial claims.
In case new shares or debentures are publicly offered for subscription, the issuing company needs to prepare a prospectus complying with art. 652a (shares) or art. 1156 (debentures) of the Swiss Code of Obligations (“CO”). The issuance of asset tokens qualifying as equities or debentures may, therefore, lead to prospectus requirements under the CO.
Since the CO is private and not supervisory law, the safeguarding of compliance with prospectus requirements is currently not within FINMA’s scope. Under the Financial Services Act, though, which is expected to enter into force in 2019, the public issuance of securities and the prospectus requirements entailed therewith will become part of Swiss supervisory law.
The Guidelines provide a solid overview on the regulatory framework governing ICOs. They serve as initial orientation aid when evaluating the regulatory pros and cons of launching an ICO in Switzerland and, by means of their Appendix stating the “Minimum information requirements for ICO enquiries”, help structuring the process in view of obtaining a regulatory assessment by FINMA.
As FINMA points out, though, there is not “one” token generating event. They all deviate from each other, depending on the structure of the ICO, the players involved and the promises attached to the tokens. Consequently, every ICO must be individually analysed and thoroughly assessed from a legal point of view which goes beyond the Guidelines.
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