The Swiss Financial Market Supervisory Authority, FINMA, has published guidelines setting out how it intends to apply financial market legislation in handling enquiries from initial coin offering 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.
FINMA noted that it has seen a sharp increase in the number of initial coin offerings (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. The new FINMA guidelines complement its earlier FINMA Guidance 04/2017, setting out how it intends to treat enquiries from ICO organisers. “Creating transparency at this time is important given the dynamic market and the high level of demand,” FINMA stated.
Each case must be decided on individual merits. Depending on how ICOs are designed, they may not in all cases be subject to regulatory requirements. Thus, circumstances must be considered on a case-by-case basis. As set out in FINMA Guidance, several areas of financial market regulation may potentially impact ICOs. At present, there is no ICO-specific regulation, nor is there relevant case law or consistent legal doctrine.
FINMA's principles focus on the function and transferability of tokens. In assessing ICOs, FINMA said it will focus on the economic function and purpose of the tokens (i.e. the blockchain-based units) issued by the ICO organiser. Key factors include the purpose of the tokens and whether they are already tradeable or transferable. At present, there is no generally recognised terminology for the classification of tokens, neither in Switzerland nor internationally.
FINMA generally categorises tokens into three types:
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 certain period.
Utility tokens are tokens which are intended to provide digital access to an application or service.
Asset tokens represent assets such as participation 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.
Focus on anti-money laundering (AML) and securities regulation. 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 not typical.
The Anti-Money Laundering Act contains requirements for financial intermediaries including, for example, the need to establish the identity of beneficial owners. The 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, in which assets can be transferred anonymously and without any regulated intermediaries.
Securities regulation is intended to ensure that market participants can base their decisions about investments on a reliable minimum set of information. Moreover, trading should be fair, reliable and offer efficient price formation.
Based on the above-mentioned criteria (function and transferability), FINMA said it 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 AML regulations. FINMA will not, however, treat such tokens as securities.
Utility ICOs: These tokens do not qualify as securities only 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. If a utility token functions solely or partially as an investment in economic terms, FINMA will treat such tokens as securities (i.e. 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 (e.g. prospectus requirements).
“ICOs can also exist in hybrid forms of the above categories,” FINMA stated. “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.”
Blockchain technology has innovative potential. Following further consolidation of this supervisory practice, FINMA said it may in the future decide to publish its interpretation in the form of a circular. FINMA recognises the innovative potential of blockchain technology and, therefore, supports the federal government's Blockchain/ICO Working Group in which it is participating. Clarity about the underlying civil law framework will be a decisive factor in establishing this technology sustainably and successfully in Switzerland.
“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,” FINMA CEO Mark Branson stated. “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.”