First published in Asia Business Law Journal
With flexible and commercially minded legislation, an innovative approach to anti-money laundering (AML) compliance, political stability and an internationally recognised securities regulatory regime, the British Virgin Islands (BVI) has established itself as the jurisdiction of choice for a number of initial coin offerings (ICOs).
The ongoing "crypto Winter" has seen a shift of investor focus away from crowd-funded platforms offering utility tokens towards security tokens that seek to provide greater value stability and more predictable investment returns. The BVI was well suited for the first wave of digital assets, and remains well placed to take advantage of the shift to securitising and digitalising common assets when the "Crypto Spring" arrives.
Utility tokens, in their purest form, provide a means of access to a technology platform or service, and derive their value from the demand for that access, rather than from the value of any underlying asset or share in the profits of the venture.
In contrast, the value of security tokens is derived from the underlying asset. The nature of that asset is limited only to its ability to be tied to a token, but could include equity, fractional entitlements to a pool of investments, profit shares, bonds and other debts, real estate, commodities, and even collectible assets such as art or fine wines. By attributing a digital token to an otherwise illiquid asset, the token can give the asset a tradable quality, an irrefutable record of transfer, the possibility of rapid and 24-hour transaction settlement, and the removal of costly middlemen.
Unlike other offshore jurisdictions, the BVI has not yet expressed an interest in implementing an overarching framework to govern digital assets. Instead, the primary legislation governing securities in the BVI is the Securities and Investment Business Act 2010 (SIBA). In this fast-moving sector, where the technology is always running ahead of the law, this watch-and-wait approach helps the BVI adapt quickly.
The SIBA sets out an exhaustive list of financial instruments that constitute investments (similar to securities under comparable legislation), and requires that those who carry on, or hold themselves out as carrying on, an investment business obtain a licence from the BVI Financial Services Commission (FSC), subject to certain safe harbours.
Investments include: (1) shares and partnership or fund interests; (2) debentures and other instruments creating or acknowledging indebtedness; (3) instruments giving entitlements to any of the above-mentioned; (4) certificates representing investments held by others; (5) options to acquire or dispose of certain assets; (6) futures; (7) contracts for difference; (8) long-term insurance contracts; and (9) rights to and interests in any of the above-mentioned.
Investment business includes: (1) dealing or arranging deals in investments; (2) managing investments; (3) providing investment advice; (4) providing custodial or administration services with respect to investments; and (5) operating an investment exchange. Among other safe harbours, an entity issuing its own shares, partnership interests, debt instruments or instruments giving entitlements to any of the above-mentioned will not be deemed to be carrying out an investment business and will not require a licence. While every token is different and requires a full regulatory review, pure utility tokens would not generally be deemed to be investments and therefore would not trigger licensing requirements under the SIBA. Consequently, issuers, dealers, custodians and exchanges of pure utility tokens do not generally require licensing in the BVI.
Conversely, most security tokens would be expected to fall within the SIBA. However, as a result of the act's more prescriptive approach to defining investments (in particular when compared to more generalised tests such as the US Howey Test), certain tokens deemed generally as security tokens may, in fact, not fall within the SIBA's ambit.
Where licensing is required under the act, the BVI provides a clear framework for obtaining such a licence, and a commercial list of post-licensing obligations. At the start of 2019, the BVI had more than 600 licensed investment businesses. Applications can usually be handled within four weeks of submission to the FSC, although additional time may be required for more complex projects.
Tokenised equity and debt
As the bear market for ICOs continues, many digital asset businesses have reverted to traditional debt and equity raising. In Asia, the authors have noticed increasing interest in tokenising such debt and equity.
BVI's principal company legislation, the BVI Business Companies Act 2004 (BCA), allows for commercial flexibility, and lends itself well to tokenised equity. Where issuers are looking to attract a wide range of investors through debt or equity, we anticipate the tokenisation of depository receipts, rather than securities. In such cases, the issuer would issue securities to a licensed custodian to hold the assets on trust for token holders.
For smaller enterprises looking to attract fewer investors, direct tokenisation of equity interests may remain feasible. The BCA allows flexibility for BVI companies to determine the manner of passing shareholder resolutions and hosting shareholder meetings, both of which can be conducted electronically, and instruments of transfer can be completed digitally by virtue of the BVI Electronic Transactions Act 2001.
While the SIBA does include approval and prospectus requirements for public equity offerings in the BVI, these provisions are not yet in force. Consequently, no prospectus would be required for offers of tokenised securities by BVI entities inside or outside the BVI, provided securities laws of investors' jurisdictions are complied with. We anticipate that most security token offerings will be carried out by private placement.
Regulatory concerns over anti-money laundering (AML), know your customer (KYC) and jurisdictional restrictions can be alleviated in part through programming checks and restrictions upon a token, or through the exchanges upon which a token is listed. Such restrictions may, for example, prevent onward transfer of a token until the transferee has been whitelisted by a third-party KYC provider. Recent and welcome amendments to the BVI's AML regulations permitting digital verification of identities, the receipt of electronic copies of documents instead of traditional "wet ink" paper-based processes, and the use of third-party providers offer greater flexibility in satisfying AML compliance obligations.
Interest has also increased in the formation of tokenised funds, where fund interests are represented by tokens as opposed to shares, units or other interests offered to investors, as expected from a more traditional fund structure.
There is no separate regulatory framework for tokenised funds in the BVI. Only open-ended funds (those in which investors are entitled to redeem their interests at a sum calculated with reference to the fund's net asset value) are regulated in the BVI.
The SIBA offers a range of regulated options for open-ended funds, from highly regulated public funds, to professional funds (permitting only professional investors with minimum investment thresholds), and private funds (with no more than 50 investors), to less-regulated approved funds (aimed at private offerings to a small number of investors), and incubator funds (for start-up funds), the latter two of which benefit from a fast-tracked approval process. Close-ended funds are not regulated in the BVI.
Security token exchanges
Notwithstanding their increasing popularity, liquidity remains elusive for security tokens. Few security token exchanges have commenced operations, and those that have remain in their infancy. The BVI is home to a number of utility token and cryptocurrency exchanges. While at the time of writing no security exchanges are licensed in the BVI, the SIBA provides a regulatory regime for obtaining a licence to operate an investment exchange that follows the same, oft-used path as other investment businesses.
Further guidance is expected from the FSC, but no indication has been given that it would look to restrict such applications. Following approval, BVI-based security token exchanges would benefit from the amendments to the BVI's AML regulations and a pragmatic investment business regulatory regime.
The tokenisation of assets represents the next shift in the blockchain revolution. To date, the BVI has been a popular jurisdiction for projects raising funds through an ICO. As this fundraising model changes, the BVI's corporate and regulatory regimes remain well suited and will continue to be at the forefront in assisting businesses looking to launch the next generation of digital assets.
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