In its guidelines published on February 16, 2018, FINMA, the Swiss Financial Market Supervisory Authority sets out how it intends to enforce financial market legislation with respect to ICO organizer enquiries. The guidelines set forth the principles on which the answers will be formulated and what type of information is needed, thus ensuring clear action directions for market participants.
As the number of ICOs (Initial Coin Offerings) planned or already executed in Switzerland has been constantly increasing, there is also a significant increase of enquiries regarding the applicability of regulation on this market. ICOs are a digital blockchain-based form of public fund raising for all kinds of entrepreneurial purposes.
As the legal regulatory framework and its applicability were not entirely clear, FINMA published a set of guidelines, complementing an earlier version from 2017. In these new guidelines, FINMA establishes how it intends to treat certain enquiries from ICO organizers. Given the high demand and the dynamic nature of this market, creating transparency was one of the main priorities.
Individual assessments for each case
The financial laws and regulations in order are not applicable to all ICOs. In certain cases, they may not be a subject to regulatory requirements; depending on the manner the ICOs were designed. Therefore, it is necessary to consider circumstances on case-by-case basis. ICOs are potentially affected by financial market regulations in certain areas, as previously established in the FINMA Guidance 04/2017. At the current time, there is no specific regulation for ICOs, nor a consistent legal doctrine or a relevant case law to set an example.
Functionality and transferability of tokens
Part of the assessment process is focused on the economic purpose and function of the blockchain-based units, known as tokens, which are issued by the ICO organizer. The main factors are the fundamental purpose of the tokens and if the said tokens are transferable or if they can be traded. At the moment, neither in Switzerland, nor internationally, is there a general recognizable terminology used to classify tokens. FINMA classifies tokens into three categories, but hybrid forms are not excluded. Tokens are classified into:
- Payment tokens, which are synonymous with cryptocurrencies and have no other connections to development projects or any further functions. In some cases, tokens may develop the necessary functionality to become recognized as means of payment over time.
- Utility tokens are used to provide access digitally to a certain service or application.
- Asset tokens are used to represent assets, for example participations in companies, entitlement to interest or dividend payments. In terms of their economic function, they are the analogues of bonds, derivatives or equities.
Anti – money laundering and securities
According to FINMA’s analysis conducted so far, for the ICOs the most important aspects are money laundering and securities regulation. Projects which fall under the Collective Schemes Act or the Banking Act are not typical.
However, the Anti – Money Laundering Act contains certain requirements for financial intermediaries. One important requirement is the disclosure of the identity of the beneficial owners. The legislation is designed to protect the financial system against money laundering activities and the financing of terrorism. Money laundering risks are considered high in a blockchain-based system that is decentralized. Decentralization enables the anonymous transfer of assets without using regulated intermediaries.
On the other hand, securities regulation aims to ensure market participants that they can make their investment decisions having at least a minimum reliable set of information. In addition, trade activities should be fair, reliable and favor efficient price formation.
Considering all the above mentioned criteria, FINMA will handle enquiries from ICOs as follows:
- Payment ICOs –When the token is meant to function as a means of payment and can be transferred, it is necessary to ensure compliance with the anti – money laundering regulations. However, payment tokens will not be treated as securities.
- Utility ICOs – Tokens do not qualify as securities if their only purpose is to provide digital access to a service or an application. If the utility token functions only as an investment in economic terms, FINMA will treat them as securities.
- Asset ICOs – Tokens are treated as securities, which means that there are securities law requirements for the trade of such tokens, as well as requirements established by the civil law under the Swiss Code of Obligations.
ICOs can also exist in hybrid forms. For example, utility tokens that are used as means of payment or are intended to be used as such can also fall under the anti – money laundering application.
Innovative potential of blockchain technology
FINMA recognizes and supports the innovative potential of the blockchain technology and is participating in the Blockchain/ICO Working Group formed by the Swiss federal government. Clarity in the civil law framework is an important factor in consolidating this technology in a sustainable and successful manner.
Risks faced by investors
Although FINMA is supporting this technology, it has also drawn attention to the risks that ICOs can pose for investors. Acquired tokens may be a subject of high price volatility. ICOs that are still in early stages of development present several uncertainties, which is an aspect investors should consider. In addition, under current civil law, it is unclear whether contracts executed using blockchain technology are legally binding or not.
ICOs will be further investigated
As previously announced in September 2017, FINMA conducts several investigations in cases involving ICOs. If ICO business models have breached the supervisory law, if they were intended to avoid regulation or if they conduct fraudulent activities, FINMA will launch regulation enforcement proceedings.