In guidelines published last week, the Swiss Financial Market Supervisory Authority – FINMA – set out ICO guidelines. These describe how it intends to apply financial market legislation in handling enquiries from ICO (initial coin offerings) organisers. The guidelines also define the information FINMA requires to deal with such enquiries and the principles upon which it will base its responses, creating clarity for market participants.
The key to this is FINMA’s experience of a sharp increase in the number of (ICOs) planned or executed in Switzerland and a corresponding increase in the number of enquiries about the applicability of regulation. ICOs are a digital blockchain-based form of public fund-raising for entrepreneurial purposes.
FINMA CEO, Mark Branson comments: “The application of blockchain technology has innovative potential within and far beyond the financial markets. However, blockchain-based projects conducted analogously to regulated activities cannot simply circumvent the tried and tested regulatory framework. Our balanced approach to handling ICO projects and enquiries allows legitimate innovators to navigate the regulatory landscape and so launch their projects in a way consistent with our laws protecting investors and the integrity of the financial system.”
Not all ICO’s are equal, according to FINMA
Given a legal and regulatory framework with partially unclear applicability, FINMA’s guidelines complement its earlier ‘FINMA Guidance 04/2017’. These set out how it intends to treat enquiries from ICO organisers.
Creating transparency is important given the dynamic market and the high level of demand. Yet FINMA assures that each case must be decided on its individual merits. For example, financial market law and regulation are not applicable to all ICOs.
Depending how one designs an ICO, it may not be subject to regulatory requirements. Circumstances must be considered individually. As set out in FINMA Guidance 04/2017, there are several areas in which financial market regulation can impact ICOs. Thus far there is no ICO-specific regulation, nor is there relevant case law or consistent legal doctrine.
FINMA’s principles assess the function and transferability of tokens
In assessing ICOs, FINMA will focus on the economic function and purpose of the tokens (the blockchain-based units) issued by each ICO organiser. The key factors are:
- the underlying purpose of the tokens
- whether they are already tradeable or transferable.
At present, there is no generally recognised terminology for the classification of tokens. This is true both in Switzerland and internationally. Given this, FINMA proposes to categorise tokens into three main types (though hybrid forms may occur):
- payment tokens 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.
- utility tokens are tokens intended to provide digital access to an application or service
- asset tokens 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.
FINMA’s analysis indicates that money laundering and securities regulation are the most relevant to ICOs. Projects which would fall under the Banking Act (governing deposit-taking) or the Collective Investment Schemes Act (governing investment fund products) are atypical.
The Anti-Money Laundering (AML) Act contains requirements for financial intermediaries including, for example, the need to establish the identity of beneficial owners. Swiss law aims to protect the financial system against the risks of money laundering and the financing of terrorism. Money laundering risks are especially high in a decentralised blockchain-based system, where ownership of assets can transfer anonymously and without regulated intermediaries.
Securities regulation seeks to ensure market participants can base their decisions about investments on a reliable minimum set of information. In addition, FINMA seeks to ensure trading should be fair, reliable and offer efficient price formation.
FINMA propose handling of ICO enquiries
On the basis of the above-mentioned criteria (function and transferability), FINMA will handle ICO enquiries as follows:
- payment ICOs: for ICOs where the token is intended to function as a means of payment and can already be transferred, FINMA will require compliance with anti-money laundering regulations; FINMA will not treat such tokens as securities.
- utility ICOs: these tokens do not qualify as 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 (in the same way as asset tokens).
- asset ICOs: FINMA regards asset tokens as securities, which means that there are securities law requirements for trading in such tokens, as well as civil law requirements under the Swiss Code of Obligations (for example the need to satisfy prospectus requirements).
ICOs can also exist in hybrid forms of the above categories. For example, anti-money laundering regulation would apply to utility tokens that can also be widely used as a means of payment or are intended to be used as such.
What does this mean
FINMA recognises that blockchain technology has innovative potential. It supports the Swiss federal government’s Blockchain/ICO Working Group (in which it participates).
That said, FINMA underlines the importance of there being an underlying civil law framework which can act as decisive factor. It is the latter which may enable the establishment of blockchain technology as being sustainably and successfully in Switzerland.
In general, in early 2018, there is a notable absence of clarity about ICOs and blockchain. With these guidelines, FINMA provides at worst a starting point and at best a realistic model for assessing ICOs and how to treat them. There is no surprise that the focus on AML and terrorism prevention are at the core of its thinking.