Following a sharp increase in the number of initial coin offerings (ICOs) taking place in Switzerland and a growing interest in cryptocurrencies, on February 16th the Swiss Financial Market Supervisory Authority (FINMA) published a series of guidelines that integrate the FINMA Guidance 04/2017, issued earlier last year. FINMA has also been organising a series of roundtables in Zug, Geneva and Lugano to explain and analyze the recently issued guidelines, in light of the existing financial market regulation.
According to the guidelines, ICOs need to be assessed case-by-case to evaluate whether they comply with the requirements of the financial market regulation, in particular with the securities rules and the Anti-Money Laundering Act. The compliance with those rules, however, depends on the kind of tokens and ICO under consideration.
Function of the tokens
When assessing the ICOs, FINMA will consider the function of the tokens and whether they are already tradeable or transferable. FINMA categorises tokens into three different groups:
- Payment tokens, in other words, cryptocurrencies. They are intended to be used as a way of payment for acquiring goods or services, in lieu of money or as a value transfer.
- Utility tokens – tokens which "are intended to provide digital access to an application or service" through a blockchain based infrastructure.
- Asset tokens represent assets such as a debt, equity or other claims on the issuer, for instance, participations in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments. In this sense, asset tokens are analogous to equities, bonds or derivatives.
FINMA also specifies that tokens may fall into more than one category and that the function of a token and its classification may change over time.
On the basis of the classification highlighted above, FINMA's Guidelines consider each kind of token under different terms.
For ICOs where the token is intended to function as a mean of payment and can already be transferred, FINMA will require compliance with the anti-money laundering regulation. The aim of anti-money laundering rules is to protect the financial system from money laundering and financing terrorism. On the other hand, FINMA will not treat such tokens as securities, unless payment tokens were to be classified as securities by the new case law or legislation.
Compliance with the Anti-Money Laundering Act implies a series of duties upon the organisers. They have to carry out a due diligence assessment upon the ICOs, comply with a series of organizational measures, ensuring the identity of the owners of the assets and file a report to the Swiss Money Laundering Reporting Office, should suspicions of money laundering arise.
The FINMA further specifies that, if in the pre-financing and pre-sale phase the tokens do not yet exist but their claims are already tradeable, then those claims should be treated as securities rather than as a mean of payment.
Utility tokens are not considered securities 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. On the other hand, if a utility token functions solely or partially as an investment in economic terms, FINMA will treat such tokens as securities – exactly as if they were asset tokens.
Similarly, anti-money laundering regulation is not applicable as long as the main reason for issuing the tokens is to provide access rights to a nonfinancial application of blockchain technology. In other words: if the payment function of the utility tokens is just an "accessory service", such tokens are not to be considered a method of payment. A service is considered accessory if a series of conditions occur; mainly if the accessory service is of subordinate importance to the primary service and the provision of the primary service would not be possible without the token.
FINMA generally considers asset tokens as securities. This implies that trading in these tokens needs to comply with the securities law requirements and the civil law requirements under the Swiss Code of Obligations. Legislation concerning securities is mainly aimed at ensuring that prospective investors can base their decisions on a transparent, reliable and comprehensive set of information.
More in detail, when do ICOs need to comply with securities regulation?
Securities ("Effekten") are defined as: standardised certificated ("Wertpapiere") and uncertificated securities ("Wertrechte"), derivatives and intermediated securities ("Bucheffekten"), which are suitable for mass trading (Art. 2 let. B FMIA [FinfraG]).
Securities suitable for mass standardised trading include certificated and uncertificated securities, derivatives, and intermediated securities which are publicly offered for sale in the same structure and denomination or are placed with more than 20 clients, as long as they have not been created especially for individual counterparties (Art. 2 para. 1 FMIO [FinfraV]).
Considering asset tokens as securities entails a series of duties for the ICO's organisers and for the financial intermediaries. Organisers need to ensure that ICOs adhere to the prospectus requirements which entails an adequate disclosure of information to investors.
As for financial intermediaries, offering asset tokens is to be considered a licensed activity and specific licensing requirements are needed for trading venues.
Asset tokens may also be subject to the Banking Act. Generally, when ICO organisers issue asset tokens, they do not guarantee the repayment of the money invested. However, should they guarantee a return of the capital invested, the Banking Act would apply.
FINMA also admits that ICOs may exist in hybrid forms – for instance, if utility tokens can be used as a form of payment, the ICO would need to comply with anti-laundering regulations.
It appears that FINMA is particularly concerned about the compliance of certain types of ICOs with the Anti-Money Laundering Act. In a blockchain system, financial risks may be particularly relevant, as transfers can take place anonymously and without relying on regulated intermediaries.
The focus is also on securities regulation – particularly on the obligation to provide investors with transparent and reliable information, not least because tokens acquired in the context of an ICO are likely to be subject to high price volatility.
The Guidelines confirm the interest of FINMA in the innovative potential of blockchain – and the necessity of a balanced -but firm- approach in regulating this new phenomenon. FINMA stated that its aim is to remove all unnecessary obstacles to innovative business models while ensuring transparency and legal clarity. As reported by Goldblum earlier this year, FINMA is also part of the Blockchain/ICO Working Group – formed by the (SIF) State Secretariat for International Financial Matters in January 2018 to overlook the legality and operational framework of ICO and blockchain. Establishing Switzerland as a leader in the FinTech market, while ensuring the country remains an attractive base for foreign investments, is definitely one of the main priorities for the Swiss Government.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.