Initial coin offerings
Focus on key jurisdictions
14 May 2018
While no jurisdiction has yet implemented a regulatory framework specific to ICOs and/or tokens, regulators globally are increasingly focused on them and a number have issued announcements, guidance or comments. The general regulatory theme is that activities around ICOs and/or tokens may constitute regulated activities in the relevant jurisdiction under the existing local regulatory regime depending on the facts of the case, and regulators are closely watching this space. Some highlights of the international regulatory framework and some recent examples of regulator engagement globally are set out below.
In an interview in June 2017, the Australian Securities and Investments Commission (ASIC) Chairman Greg Medcraft broadly noted that the question of how ICOs are/should be regulated remains unsettled given that ICOs can lack characteristics associated with traditional securities. Chairman Medcraft noted that ICOs that meet the more traditional concept of a security would not be treated any differently to other financial instruments by ASIC. In particular, Chairman Medcraft mentioned that he would take a technology–neutral approach to such an ICO and focus instead on disclosure, both in respect of the issuer and the associated risks of the issuance. Chairman Medcraft cautioned against undertaking any premature regulation of such offerings without first having a comprehensive understanding of the value proposition, underlying technology and the benefits and risks posed to both investors and the market generally.
The German Federal Financial Supervisory Authority (BaFin) has published a guidance note on virtual currencies on its website. BaFin qualifies virtual currencies as units of account (Rechnungseinheiten), which generally qualify as financial instruments within the scope of the German Banking Act, regardless of what software or encryption technologies have been used. Tokens issued under an ICO are likely to be classified as virtual currencies for this purpose.
In BaFin’s view, virtual currencies are not legal tender and so are neither currencies nor foreign notes or coins. Virtual currencies also do not usually qualify as e-money within the meaning of the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz) – in BaFin’s view they do not represent any claims on an issuer, as in most cases there is no issuer of coins. However, BaFin takes a different view for digital payments with virtual currencies which are backed by a central entity that issues and manages the units, which may be the case with certain ICO issuances.
The simple use of virtual currencies as a substitute for cash or deposit money, to participate in exchange transactions as part of the economic cycle does not in BaFin’s view trigger a licencing requirement in Germany. The “mining”, purchase or sale of virtual currencies would also not trigger a licencing requirement. However, in certain additional circumstances, commercial handling of virtual currencies may trigger a licencing requirement under the German Banking Act. In this respect, every ICO would need to be assessed on a case by case basis.
The regulators in Hong Kong have adopted a technology–neutral regulatory approach and are seeking to develop and implement a regulatory framework and requirements based on the intrinsic characteristics of the relevant activities or transactions and the risks arising from them. The Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) have not yet issued any formal publication on their views regarding the regulatory treatment of ICOs. In this respect the HKMA has previously reiterated that Bitcoin is not a legal tender but a virtual “commodity”. While one may equate tokens with Bitcoin and thus assume that they should possess the same legal status as a virtual commodity, as discussed in this paper there are broader regulatory implications to consider with ICOs and tokens.
Following amendments becoming effective in April 2017, cryptocurrencies are defined in Japan’s Payment Services Act (PSA) as “Virtual Currencies”. Sale and purchase of, and exchanging, Virtual Currencies (or acting as an intermediary in respect of such activities) are regulated and require registration with the Financial Services Agency of Japan. Since no comprehensive rules or guidelines specifically regarding ICOs have yet been issued in Japan, it is advisable to consider carefully whether activities taken in respect of any individual ICO could be categorised as regulated business under, among others, the PSA, traditional securities regulations and/or other financial regulations.
People’s Republic of China
China has not developed a comprehensive regulatory regime for ICOs or cryptocurrencies. In 5 December 2013, the People’s Bank of China (PBoC), the China Banking Regulatory Commission, the China Securities Regulatory Commission and other relevant Chinese regulators jointly issued the Circular on Guarding against the Risks of Bitcoin, which may inform the approach in respect of ICOs. According to the Circular, from a regulatory perspective in China, Bitcoin is not viewed as a type of currency but rather virtual goods. Chinese investors may engage in the trading of Bitcoin at their discretion but Chinese financial institutions and payment institutions may not engage in any activity or provide any services related to Bitcoin. Risks associated with the usage of Bitcoin (for example, money laundering, circumvention of foreign exchange restrictions) are also highly emphasised by the PRC regulators.
Recently, the relevant Chinese regulators (in particular, PBoC) have taken a number of regulatory actions in this respect including conducting on-site inspections of domestic Bitcoin trading platforms, summoning the senior management in charge of the relevant trading platforms for meetings, and urging these platforms to arrange self-surveys and take rectifying measures accordingly. These demonstrate the Chinese regulators’ stance of increased supervision and oversight in this area.
No law, regulation or guidance specific to ICOs has been implemented or issued in Poland. In July 2017, the Polish Financial Supervision Authority (Komisja Nadzoru Finansowego, the KNF) and the National Bank of Poland (Narodowy Bank Polski, the NBP) issued a circular dedicated to virtual currencies. While the circular notes that dealing in virtual currencies does not breach Polish law, it warns against the risks associated with purchases of, and investing funds in, virtual currencies. The circular points out that holding virtual currencies involves risks not only for the users but also for financial institutions. The NBP and the KNF consider that the purchase, holding and sale of virtual currencies by institutions supervised by the KNF would carry a high risk and would not ensure stable and prudential management of a financial institution. Pursuant to the circular, financial institutions should exercise special caution when cooperating with entities trading in virtual currencies, in particular with regard to the risk of those entities being used to launder money and finance terrorism.
While the initial attitude of the Russian Government to cryptocurrencies was fairly cautious (with some officials even suggesting it would be a criminal offence to use cryptocurrencies), over the last 18 months there has been a considerable shift in mindset. Although Russia has not issued any specific regulations on cryptocurrencies yet, the issue is widely debated both by the Government and in the business community, with more and more businesses expressing interest in ICOs and a willingness to accept payments in cryptocurrencies. Accordingly, in June 2017 the Central Bank of Russia has together with the Ministry of Finance announced that draft legislation is being developed to define the legal and tax status of cryptocurrencies, and although limited information is available at this stage, it appears that the intention is to treat cryptocurrencies as “quasi-commodities”.
In the wake of an increase in the number of ICO offerings in Singapore, MAS issued a clarification on 1 August 2017 that the offer/issue of digital tokens in Singapore would be regulated if the digital tokens constitute products regulated under existing legislation such as the Securities and Futures Act (SFA). MAS had previously stated in March 2014 that virtual currencies are not regulated, however, MAS has clarified that they view a virtual currency (functioning as a medium of exchange, a unit of account or a store of value) as only one particular type of digital token. Where digital tokens represent ownership or a ‘security’ interest over an issuer’s assets or property, for example, such tokens may be considered an offer of shares or units in a collective investment scheme under the SFA. Digital tokens may also represent a debt owed by an issuer and so be considered a debenture under the SFA. As such, the regulatory treatment of any token and, if applicable, the related ICO offering would need to be analysed carefully against existing regulation based on the terms of the token and the ICO and the activities and role of the various players using the framework discussed above.
MAS had also stated in March 2014 that intermediaries in virtual currencies would be regulated for money laundering and terrorist financing risks, and more recently in 2016 published a statement that it is working on proposed regulations to be introduced for virtual currency intermediaries operating in Singapore. MAS also stated in its 1 August 2017 clarification that it is currently assessing how to regulate money laundering and terrorist financing risks associated with activities involving digital tokens that do not function solely as virtual currencies. In a related development, MAS issued a policy consultation paper in August 2016 proposing wide-ranging changes to the regulatory regime for payments in Singapore, including the introduction of an activity-based payments regulatory framework.
While the Bank of Spain has publicly stated the importance of providing an appropriate legal framework for virtual currencies, no comprehensive rules or guidelines regarding ICOs have yet been published. Accordingly, any ICO related activity in Spain requires careful consideration of payment services and anti-money laundering regulations (within the context of the EU Directives) as well as other general financial regulations.
United Arab Emirates
In the UAE, the leading sector for fintech innovation in the Middle East, ICOs are currently being undertaken without specific regulation but subject to certain licensing requirements where the units offer a right in an underlying commodity in which trading does require a licence (gold being the example applied to date in the UAE). However, there has been some controversy regarding whether the UAE Central Bank intends to regulate “virtual currencies”.
In January 2017, the Central Bank published a new licensing framework for stored value facilities offering certain digital payment services, due to be implemented by 1 January 2018. This framework states “All Virtual Currencies (and transactions thereof) are prohibited”. The definition of Virtual Currencies captures any type of digital unit used as a medium of exchange, a unit of account, or a form of stored value (expressly excluding loyalty or rewards programs).
Following confusion in the market, with several ICOs having already been publicised, the Governor of the Central Bank, issued a statement to the press in February 2017 regarding its regulations, including that they “do not cover Virtual Currency” and “do not apply to Bitcoin or other cryptocurrencies, currency exchanges, or underlying technology such as blockchain”. It was further noted that new regulations will be issued as appropriate. No action has been taken in respect of subsequent unlicensed ICOs.
It is now therefore expected that a more thorough regulation covering cryptocurrencies will be issued in the near future by the Central Bank, perhaps as part of the implementing measures for the 2017 licensing framework expected later this year. In addition, in November 2016, the Supreme Legislation Committee for the Government of Dubai announced discussions on future legislation related to cryptocurrencies in cooperation with the Dubai Electronic Security Center. This could result in regulations specific to the Emirate of Dubai, in addition those of the Central Bank (which would be at a Federal level across the UAE).
The Financial Conduct Authority (FCA) has been uncharacteristically quiet on the topic of ICOs so far, given its reputation as one of the more technology-cognisant regulators. The only evidence that the FCA has ICOs on its radar is found in the FCA’s consultation from April 2017 on the potential for the future development of distributed ledger technology in regulated markets. In this consultation, the FCA briefly noted in respect of ICOs that “depending on how they are structured, they may, therefore, fall into the regulatory perimeter”. On this, there are a number of regulated activities that issuers and participants in ICOs would need to consider and navigate, including deposit-taking and e-money issuance, CFDs and derivatives as well as the broad definition of what constitutes a collective investment scheme and applicable anti-money laundering regulations.
In the United States, an ICO is potentially subject to numerous laws and regulations, depending on: (i) the location of the issuer, (ii) the entities or persons to whom it is marketed and (iii) the type of services provided or proposed to be provided. Generally, an offer and sale of tokens may be subject to U.S. securities laws if an investment of money is made with an expectation of profits arising from a common enterprise that depends solely on the efforts of a promoter or third party.
On July 25, 2017, the U.S. Securities and Exchange Commission (SEC) issued a report summarising its conclusion that tokens sold by The DAO were securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. If a token is a security, then its offer and sale must be registered or exempt from registration and the offer and sale may be subject to disclosure liability. The SEC in its report did not comment on the status of The DAO under the Investment Company Act of 1940, nor the status of the promoters of The DAO under the Investment Advisers Act of 1940, nor did it offer any guidance as to the securities offering safe harbours that would have been most applicable to The DAO ICO.
In addition, exchanges on which tokens classified as securities are traded may need to register with the SEC as alternative trading systems, and broker/dealers that engage in trading of security-tokens would likewise need to be registered with the SEC and other regulatory bodies. Other federal regulatory agencies, including the Commodity Futures Trading Commission, may respond to ICOs and other fintech innovations with new regulations.
A patchwork of state regulations can also apply to borderless ICOs, including investor suitability guidelines and financial services licensing requirements. The precise nature of a token can also have significant relevance under state corporate law: for example, if an ICO is deemed to be an offer and sale of general partnership units, participants might be surprised to find that they are liable for the actions of the issuer.
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