In its guidance published today, the Swiss Financial Market Supervisory Authority (FINMA) outlines how it will deal with filing requests for initial coin offers based on existing financial market law. FINMA defines the minimum information it requires to process such requests and the principles it will use to answer them. FINMA thus creates transparency for interested market participants.
FINMA saw and is confronted with numerous requests for immigration in the light of a marked increase in initial coin offers (ICOs) implemented or planned in Switzerland. With an ICO, digital capital is used to procure capital for corporate purposes on the basis of blockchain technology. With the guidance published today, FINMA announces in addition to the supervisory report 04/2017 how it deals with the lodging requests of ICO organizers in the light of a legal situation requiring interpretation. This transparency about its approach seems important and appropriate for FINMA against the background of the special market dynamics and the high demand in this area.
Individual case analysis is crucial
Not all ICOs are subject to financial market law and have a duty of subordination – this is because ICOs are designed very differently. In each case, the circumstances must be taken into account in each individual case. As explained in Supervising Communication 04/2017, there are various points of contact between ICOs and applicable general financial market law. However, specific regulatory requirements for ICOs do not yet exist. So far, there is neither relevant case law nor a consistent legal doctrine.
FINMA principles focus on the functionality and portability of tokens
In its prudential assessment of ICOs, FINMA follows an approach that focuses on the economic function and purpose of the tokens, ie the blockchain-based units issued by the ICO organizer. Central to this is the classification of the tokens and the question of whether these tokens are tradable or transferable right from the beginning of the ICO. There is currently no generally accepted classification of tokens in Switzerland or internationally. Functionally, FINMA differentiates between three types, whereby mixed forms can also occur:
Payment tokens are synonymous with pure “cryptocurrencies” without being linked to any other functionality or projects. In some cases, tokens can only develop the necessary functionality and acceptance as a means of payment over time.
Usage tokens are tokens intended to provide access to a digital use or service.
Investment tokens represent assets such as shares in real assets, companies, income or entitlement to dividends or interest payments. The token is therefore to be valued in terms of its economic function, such as a share, bond or a derivative financial instrument.
Rules on money laundering and securities trading are at the center
In its analysis, FINMA has determined that ICOs are the most frequent points of contact with the financial market laws in the area of money laundering and securities trading. Applications that would require submission to the Banking Act or the Collective Investment Schemes Act are not typical.
The Money Laundering Act provides for obligations on financial intermediaries such as the determination of beneficial owners. The aim of the law is to protect the financial system from money laundering or terrorist financing. In a decentralized system based on blockchain, in which assets can be transferred anonymously, money laundering risks are particularly high.
Securities trading rules aim to ensure that market participants can make their decisions on investments such as equities or bonds on the basis of reliable minimum figures. In addition, it should be ensured that trading is fair, reliable and efficient.
On the basis of the aforementioned criteria of functionality and transferability, FINMA comes to the following prudential assessment of ICOs.
Payment ICOs: For ICOs whose tokens have the economic function of being a means of payment and are already transferable, FINMA considers that they are covered by the anti-money laundering regulations. However, FINMA will not treat such tokens as securities.
Usage ICOs: Usage tokens do not qualify as securities if the token exclusively provides a right of access to a digital use or service and the use token is useable at the time of issue in this sense. In all cases in which only or even the economic function exists as an investment, FINMA treats them as effects (such as investment tokens).
Investment ICOs: FINMA sees investment tokens as securities with corresponding financial market consequences in terms of trading. This approach usually includes corresponding obligations under ICSs (such as prospectus obligations).
ICOs can also form hybrid forms of these categories. For example, a subordination under the Money Laundering Act can also exist if a usage token is also widely used as a means of payment or should be widely used.
Blockchain technology offers innovation potential
FINMA reserves the right to publish the interpretation of the applicable financial market laws regarding ICOs in a circular letter after further intensification of its supervisory practice in specific cases.
FINMA recognizes the innovation potential of blockchain technology. It therefore supports and participates in the Federal Government’s Blockchain / ICO working group on this topic. Clarity on the civil law framework will be a crucial prerequisite for the sustainable and successful establishment of this technology in Switzerland.
Mark Branson, Director of FINMA, said: “Blockchain technology offers innovation potential for financial markets and beyond: Blockchain projects, which work in a similar way to activities requiring a license, must not bypass the proven regulatory framework.Our Balanced Approach, ICO Projects and Handling inquiries allows reputable innovators to navigate the regulatory landscape and launch their projects in a way that respects existing laws, protecting both investors and the integrity of the financial center.
Information for investors
FINMA has on several occasions referred to the risks to investors associated with ICOs. The tokens acquired under an ICO are usually subject to high price volatility. Due to the early stages of many ICOs, there are many uncertainties about the ICO projects to be financed and implemented. In addition, under applicable law, there are uncertainties regarding the civil transferability and enforceability of claims that may or may not be linked to tokens.
Clarifications in the field of ICO continue
As communicated in September 2017, FINMA is making clarifications in several cases of ICOs. If FINMA receives indications that ICO business models violate supervisory law, circumvent supervisory laws or even have been set up fraudulently, it will initiate enforcement proceedings.