In the first of my 3-part series on Initial Coin Offerings (ICOs), I touched on the characteristics, types, risks, benefits and examples of ICOs. In this second part, I will be covering the current regulation of ICOs in various jurisdictions.
By and large, most financial regulatory authorities around the world have stated that initial coin offerings (“ICOs”) will be regulated under their respective existing laws and regulations. However, there are anomalies, with countries such as China and South Korea choosing to ban ICOs completely, while Gibraltar has announced its intention to introduce new legal frameworks specifically to regulate ICOs.
The jurisdictional comparison below is arranged according to how welcoming the regulations are to ICOs.
|Country||Status of Regulation||Description|
|Australia||Allowed, regulated||On 28 September 2017, the Australian Securities and Investment Commission (ASIC) issued an information sheet regarding the potential application of the Australian Consumer and Corporations laws to companies planning to raise funds through an ICO. In a nutshell, the legal status of an ICO depends on the structure and operation of the ICO, and the rights attached to the tokens.
Therefore, simply describing a token as a utility token or a digital currency would be insufficient for the token to be considered not a financial product. For example, if a token carries rights with regards to ownership in, or entitlement to future profits of the issuing company, it would well fall within the definition of a share (i.e. financial product), and therefore the ICO would constitute an offer of shares that is governed by the Australian Corporations Act. As such, the company conducting the ICO would be required to comply with disclosure requirements of the Australian Corporation Act such as the preparation of a prospectus.
Furthermore, regardless of whether a token is classified as a financial product or not a financial product, the general laws of Australia would apply to them equally. The distinction between a token which is classified as a financial product and one that is not, is relevant to the extent that the Australian Corporations Act would apply to the former, and the Australian Consumer law would apply to the latter. In addition, issuing companies have been cautioned that any communications in relation to ICOs should not mislead or deceive potential consumers. Misleading and deceptive conduct include the use of social media to generate the appearance of a greater level of public interest in an ICO, undertaking or arranging for a group to engage in trading strategies to generate the appearance of a greater level of buying and selling activity for an ICO or a crypto-asset, or suggesting that the ICO is a regulated product or the regulator has approved the ICO when that is not the case.
|Estonia||Allowed, regulated||The Estonian Financial Supervision Authority (EFSA) has stated that depending on the structure of an ICO, the issued token may be classified as a security as defined under their existing regulations, namely the Securities Market Act (SMA) and the Law of Obligations Act (LOA). In determining if the existing regulations apply to an ICO, the EFSA would take a substance over form approach to the respective offering. For example, a token that provides investors rights in the issuing company or in the future profits are likely to be considered securities under the SMA. In such an event, the ICO may constitute an issue of securities and be governed by the regulations in relation to public offerings (i.e. requirement of prospectus).
Moreover, the entities hosting such ICOs or facilitating the secondary trading of such tokens may be classified as providing investment services. If an entity provides loans in its own name/account, and the source of financing of these loans are the repayable funds raised through an ICO, it could be possible for the ICO to be governed by the Credit Institutions Act (CIA).
|Gibraltar||Unregulated, but legislation upcoming||Although ICOs are currently unregulated in Gibraltar, the government of Gibraltar and the Gibraltar Financial Services Commission (GFSC) have recently announced that they are in the process of drafting legislation to govern ICOs.
The proposed token legislation is said to regulate “the promotion, sale and distribution of tokens", secondary markets relating to tokens and the provision of investment advice relating to token investment. An interesting concept that is to be introduced by the proposed token regulation is the regime for the authorisation and supervision of token sale sponsors, i.e. authorised sponsors.
It has been proposed that an authorised sponsor will have to be appointed for every ICO that is promoted, sold or distributed in or from Gibraltar, and will be responsible for compliance with the proposed token legislation.
The proposed token regulation will be in addition to the Digital Ledger Technology (DLT) Regulations that came into effect on 1 January 2018 in Gibraltar. The DLT Regulations do not extend to ICOs. Instead, they govern intermediaries using DLT “for storing or transmitting value belong to others” (crypto exchanges for example), and require them to be licensed. Licensed intermediaries will be subject to ongoing obligations including compliance with regulatory principles such as honesty, integrity and maintenance of adequate financial and non-financial resources.
|New Zealand||Allowed, regulated||Similar to their Australian counterpart, the Financial Markets Authority of New Zealand (FMA) published an article outlining the various financial products that tokens issued by ICOs could constitute as. These financial products include tokens being offered as debt securities, equity securities, managed investment products as well as derivatives which are all regulated under the Financial Markets Conduct Act 2013 (FMC).
Tokens that are not considered financial products are not regulated by the FMA. Nonetheless, the FMA may still choose to “designate tokens issued as part of an ICO to be a particular financial product if, based on their economic substance, this is necessary to promote fair and efficient financial markets in New Zealand or any of the other purposes of the FMC Act”. Further, even if tokens issued in ICOs are not financial products, FMA has clarified that the general consumer protection laws that prohibit deceptive conduct and fraud will still apply to them
|Singapore||Allowed, regulated||See below|
|Switzerland||Allowed, regulated||The Swiss Financial Market Supervisory Authority (FINMA) has released two guidance papers in relation to its position on ICOs. In the first paper published on 29 September 2017, FINMA stated that while there may be no specific regulations governing ICOs, depending on the structure of an ICO existing financial market regulations may still apply. These include provisions on combating money laundering and the financing of terrorist, banking law, securities trading and collective investment schemes.
In the second paper published on 16 February 2018, FINMA went into further details and provided guidelines as to how it intends to treat enquiries from issuers. In relation to the categorisation of a token issued in an ICO, FINMA shall focus on the underlying economic function of the token. Accordingly, it has classified tokens into three categories (while acknowledging hybrids are possible) as set out below:
1. Payment tokens: These are synonymous with cryptocurrencies and have no further functions or links to other development projects. Tokens may in some cases only develop the necessary functionality and become accepted as a means of payment over a period of time.
2. Utility tokens: Tokens which are intended to provide digital access to an application or service.
3. Asset tokens: Tokens which represent assets such as participations in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, the tokens are analogous to equities, bonds or derivatives.
In relation to relevancy of existing regulations to ICOs, FINMA has stated that money laundering and securities regulations are the most relevant of the financial market regulations. FINMA has categorised ICOs and advised on the application of respective regulations as follows:
1. Payment ICOs: Where the token is intended to function as a means of payment and can already be transferred, compliance with anti-money laundering regulations will be required. Token will not be treated as a security.
2. Utility ICOs: Utility tokens do not qualify as securities only if their sole purpose is to confer digital access rights to an application or service and if the utility token can already be used in this way at the point of issue. If a utility token functions solely or partially as an investment, it will be treated as securities (i.e. in the same way as asset tokens).
3. Asset ICOs: Asset tokens are securities. There are securities law requirements for trading in such tokens, as well as civil law requirements under the Swiss Code of Obligations (e.g. prospectus requirements).
|Country||Status of Regulation||Description|
|Japan||Allowed, regulated||According to the Financial Services Agency of Japan (FSA), ICOs in Japan may be regulated under the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA).
The FSA has advised that tokens issued in an ICO may be categorised as “virtual currency”. Under the PSA, "virtual currency" is defined as a proprietary value that (a) as between unspecified persons (i) can be used to settle payments for goods and/or services and exchanged with legal currency; or (ii) can be exchanged with another virtual currency; (b) can be transferred using an electronic data processing system and (c) is not denominated in Japanese Yen or any foreign legal currency.
In the event an issued token meets the aforesaid definition, entities providing exchange services of said token will be required to be registered with the relevant authorities.
The Financial Instruments and Exchange Act regulates collective investment schemes and securities. Collective investment schemes are broadly defined by the FIEA and covers any arrangement under which cash/cash equivalent is collected from investors and in which investors are entitled to receive dividends or distributions of assets. The FSA has clarified that if an ICO has the characteristics of an investment and the purchase of the token issued in the ICO is via a virtual currency, the ICO would be subject to the FIEA. This clarification is consistent with the official recognition in the PSA of the use of certain virtual currencies such as Bitcoin.
|United Kingdom||Allowed, regulated||The Financial Conduct Authority (FCA) of the United Kingdom has stated that whether an ICO falls within its existing financial markets regulations would be assessed on a case by case basis. In this regard, the FCA would look at the structure of an ICO to determine if it may involve regulated investments. Moreover, the firms involved in ICOs may also be conducting regulated activities.
The FCA has also stated that “some ICOs feature parallels with Initial Public Offerings (IPOs), private placement of securities, crowdfunding or even collective investment schemes. Some tokens may also constitute transferable securities and therefore may fall within the prospectus regime”.
|United States||Allowed, heavily regulated||The United States Securities and Exchange Commission (SEC) clarified its position on ICOs in its report subsequent to its investigation into the ICO conducted by the company DAO (Decentralised Autonomous Organization). The SEC’s involvement in the ICO came after hackers made off with almost $50 million of the funds raised. The SEC stated that “whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances. […] issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies.”
The term “security” is broadly defined in the Securities Act of 1933 and the Securities Exchange Act of 1934. The term includes investment instruments such as shares, bonds and investment contracts. In determining if an offering is a security, the SEC employs the “Howey Test”. Under this test, an offering would be classified as a security if it is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. The drawing of distinction between an investment that is a security and one that is not is critical as the former requires regulatory compliance such as registration with the SEC and disclosure obligations.
Essentially, the position in the United States in relation to ICOs is that federal securities laws would apply to any entity offering and selling securities in the United States regardless of whether (a) the issuing entity is a traditional company or a decentralized autonomous organization, (b) the offered securities are purchased via U.S. dollars or virtual currencies, and (c) the offered securities are distributed in certificated form or through distributed ledger technology.
|Country||Status of Regulation||Description|
|South Korea||Banned, but ban may be lifted in the future||South Korea’s ban on ICOs came within weeks of China’s blanket ban. Despite ICOs being banned domestically, South Koreans were still allowed to invest in foreign ICOs. However, nearly 7 months after the ban, a report from The Korean Times dated 8 March 2018 has suggested that the ban may be lifted should token sales meet conditions that are yet to be revealed. Perhaps, the consideration to reverse the ban on ICOs may be in part due to the fact that South Korean startups have found a way to circumvent the ban by conducting their ICOs in foreign jurisdictions and then listing their tokens on South Korean crypto exchanges.|
|Country||Status of Regulation||Description|
|China||Banned||In September 2017, the first move of its kind, the Chinese government moved to put an immediate ban on ICOs, stating that digital coin fundraisers have “seriously disrupted the economic and financial order”. The Chinese government also cited concerns over scams and fraudulent ICOs due to lack of regulation.
The ban required companies which completed ICOs to return the funds raised back to their investors. Although, Hu Bing, a researcher at China’s Institute of Finance and Banking, had previously stated that China’s ban on ICOs was only temporary until regulatory frameworks were ready to be implemented, China has yet to show any willingness to relax its ban thus far.
Status of ICOs in Singapore
Having examined the various jurisdictions above, we now turn to the status of ICOs in Singapore. Following its August 2017 media release, in which the Monetary Authority of Singapore (MAS) clarified that the offer or issue of digital tokens in Singapore will be regulated by MAS if the digital token constitutes a product regulated under the Securities and Futures Act (Cap. 289) (SFA), MAS has published a 13 page guidance on digital token offerings.
In the November 2017 guidance on digital token offerings, MAS provided more details and clarifications as to which types of tokens would fall within the ambit of the SFA. In determining if a digital token would constitute a type of capital market product under the SFA, MAS has stated that it will examine the structure, characteristics and rights attached to the said token. If the token is considered a capital markets product (e.g. securities, futures contracts and contracts or arrangements for purposes of leveraged foreign exchange trading), it may be regulated by MAS.
MAS also affirmed that offers of digital tokens that constitute a security or unit in a collective investment scheme will be subject to disclosure obligations under the SFA such as the requirement of the offering to be accompanied by a prospectus registered with MAS. Such an offer may be exempted from the prospectus requirement if:
- It is a small offer that does not exceed S$5 million (or its equivalent in a foreign currency); or
- It is a private placement made to no more than 50 persons within any 12-month period, or
- It is made to accredited investors under certain conditions or to institutional investors.
When could an ICO be an offer of securities?
Under the SFA, the definition of securities includes shares, units of shares, debentures, units of debentures, contract for differences and such other products or class of product as MAS may prescribe.
#1 . Offer of Shares
‘Shares’ are defined in section 2(1) of the SFA as having the same meaning as in section 4(1) of the Companies Act (Cap. 50). Accordingly, a ‘share’ means a share in the share capital of a corporation, and generally includes stock.
Shares in a company entitle its holders to a set of rights, ranging from ownership in the company, voting rights, entitlement to future profits through dividends and a claim on the residual assets of the company in the event the company is wound up.
If a token issued in an ICO has rights similar to that of rights attached to conventional shares, then it is very likely that the token would be considered a share. Accordingly, the issuer of the token would be making an offer of shares and be subject to the prospectus requirement prescribed by the SFA.
#2 . Offer of debentures
Under section 239 of the SFA, ‘debentures’ includes:
- debenture stock, bonds, notes and any other debt securities issued by a corporation or entity, whether or not constituting a charge on the assets of the issuer;
- any document that is issued or intended or required to be issued by an entity acknowledging or evidencing or constituting an acknowledgment of the indebtedness of the entity in respect of any money that is or may be deposited with or lent to the entity in response to such an invitation; and
- any invitation to a person to deposit money with or to lend money to an entity
Essentially, in the context of an ICO a digital token may constitute a debenture “if its constitutes or evidences the indebtedness of the issuer of the digital token in respect of any money that is or may be lent to the issuer”.
When could an ICO be an offer in a unit of a collective investment scheme?
Under section 2(1) of the SFA, a collective investment scheme (CIS) means
- “an arrangement in respect of any property
- (i) under which the participants do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management, and the property is managed as a whole by or on behalf of a manager;
- (ii) under which the contributions of the participants and the profits or income from which payments are to be made to them are pooled; and
- (iii) the purpose or effect of which is to enable the participants (whether by acquiring any right, interest, title or benefit in the property or any part of the property or otherwise) to participate in or receive profits, income, or other payments or returns arising from the acquisition, holding, management or disposal of, the exercise of, the redemption of, or the expiry of, any right, interest, title or benefit in the property or any part of the property or to receive sums paid out of such profits, income, or other payments or returns” or
- “an arrangement which is an arrangement, or is of a class or description of arrangements, specified by MAS as a collective investment scheme”.
Further, a “unit”, in relation to a collective investment scheme, means “a right or interest (however described) in a collective investment scheme (whether or not constituted as an entity), and includes an option to acquire any such right or interest in the collective investment scheme.
Hence, a digital token which represents a right or interest in a CIS, or an option to acquire a right or interest in a CIS may be categorized as a unit in a CIS.
Facilitation of initial coin offerings
A person who operates such a platform with regards to tokens which constitute any type of capital markets products, may be carrying on business in one or more regulated activities under the SFA, and would be required to hold a capital markets licence for that regulated activity unless otherwise exempted.
In addition, any persons who provides financial advice regarding such digital tokens must be authorised under the Financial Advisers Act (FAA).
Intervention by MAS
Recently, MAS issued a warning to eight digital token exchanges in Singapore that if a digital token constitutes a security or a futures contract, the exchanges are not allowed to trade in the digital token. Additionally, if the exchanges were already trading they had to immediately cease trading until they receive the authorisation of MAS as an approved exchange or recognised market operator.
MAS has also directed an ICO issuer to stop offering its digital token to Singapore-based investors as the offer breached the SFA. This was because the token represented ownership in the company, thus classifying as a security under the SFA. Accordingly, the issuer had to register a prospectus with MAS prior to the offering, which it had failed to do so. The issuer stopped its offering and also returned all monies received from Singapore-based investors.
An overview to Singapore’s approach to ICOs
Singapore’s approach to ICOs is very similar to the approach taken by countries like Australia, New Zealand and Estonia. In a nutshell, the status of an ICO is dependent on the circumstances of the ICO. These include the manner in which the ICO is structured and operated, and the rights that are being attached to the digital token being offered through the ICO.
It is imperative that companies seeking to hold an ICO in Singapore are cognisant of how the SFA applies to their offering. Companies should carefully analyse the objective of their offering and structure their offering in a manner that best suits their requirements.
- If your virtual tokens are to be strictly used as virtual currencies on their blockchain networks, and do not represent ownership in the company or entitle holders to any monetary rewards, your offering would not constitute a security or futures contract.
- Alternatively, in the event that your digital token falls within the ambit of the SFA, you should ensure compliance with the provisions of the SFA such as the registration of an offering prospectus.
In the third part of this series, I will be examining the framework and process of conducting an ICO. Stay tuned!
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This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to a practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.