The Security Token Offerings Saga: Part 2 — Market Perception and Legal Meaning
By INGVARR on ALTCOIN MAGAZINE
The term ‘security token offering’ (STO) has been used with various meanings in the press, academic publications and the business community. At present, an STO is predominantly perceived as a new form of technology, rather than a new type of legal relationship between the participants. So far, the STO concept has primarily come into play in relation to projects for the development of blockchain standards, protocols and platforms which allow managing the entire life cycle (or certain parts) of security using blockchain, starting from the date of issuance until the date when security ceases to exist. These projects are aimed at establishing infrastructure — most commonly with an automated system — that not only allows issuing, recording rights to, and conducting sales and primary and secondary transfers of securities, but also ensures that key events in the life of security are carried out in compliance with all sorts of applicable regulations and rules, including disclosure, reporting, approvals, etc.
There is no generally accepted statutory definition of STO. From a legal point of view, STO may be perceived in two ways. In a wider sense, STO means an offering of a token that falls under a certain type of financial regulation (securities laws, commodities regulations or other). In a narrow sense, STO is perceived as an offering of tokens that are captured by the term ‘securities’ as defined under the securities laws in the jurisdictions where potential investors are located, as well as in the token issuer’s jurisdiction.
To date, those countries that have recognised crypto tokens of different types have not afforded specific treatment to security tokens as a new class of assets. In Switzerland, the Swiss Financial Market Supervisory Authority FINMA differentiated between three types of tokens: utility tokens, payment tokens and asset tokens. FINMA regards asset tokens as securities. Under Swiss law, securities are defined as “standardised certificated or uncertificated securities, derivatives and intermediated securities which are suitable for mass standardised trading”, meaning they are “publicly offered for sale in the same structure and denomination or are placed with more than 20 clients, insofar as they have not been created especially for individual counterparties.” FINMA does not treat payment tokens, or utility tokens whose sole purpose is to confer digital access rights to an application or a service, as securities. However, utility tokens that have an investment purpose at the time of issue (either as their sole purpose or in addition to conferring digital access rights), as well as asset tokens that are standardised and suitable for mass standardised trading, are classified as securities.
In Liechtenstein, the Financial Market Authority distinguished four main types of tokens: security tokens, digital currency, asset-backed tokens and utility tokens. A security token is defined as a “token with securities character with an income generating component and potential rights vis-à-vis the issuer (e.g. governance, participation, ownership)”.
In a recent report issued by the UK financial market regulator, the Financial Conduct Authority (FCA), in October 2018, the FCA distinguished three types of crypto assets: exchange tokens, security tokens and utility tokens. Security tokens are those “which amount to a ‘specified investment’ as set out in the Financial Services and Markets Act (2000) (Regulated Activities) Order (RAO). These may provide rights such as ownership, repayment of a specific sum of money, or entitlement to a share in future profits. They may also be transferable securities or financial instruments under the Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II). According to Article 2 (a) of the Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC, ‘securities’ are ‘transferable securities’ (within the meaning of MiFID II), which are determined as “those classes of securities which are negotiable on the capital market, with the exception of instruments of payment, such as shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares; bonds or other forms of securitised debt, including depositary receipts in respect of such securities; and any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures”.
Malta’s new legislative framework for distributed ledger technology (DLT) assets expressly distinguished between four types of DLT assets: electronic money, virtual tokens, financial instruments (as defined under MiFID II) or virtual financial assets. In November 2018, Maltese Commissioner for Revenue issued guidelines on taxation of transactions and activities involving DLT assets (the Guidelines). According to the Guidelines, DLT assets are categorised into the following types: coins, financial tokens, utility tokens and hybrids. Financial tokens are those DTL assets which qualify as financial instruments under MiFID II. Thus, “security tokens” would be generally captured by the term “financial token” in Malta.
As illustrated above, interpretations of the term ‘securities’ vary in each jurisdiction. In one jurisdiction, a token may be treated as a non-security, or utility, token; in another jurisdiction, it may be considered as ‘security’. For example, in the US, unlike in Europe, all tokens offered through an initial coin offering are considered securities, according to the SEC. This position has been reinforced by recent public statement from SEC’s Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets on digital assets securities issuance and trading. Thus, whether an offering of tokens is an STO depends on the qualification of the token in jurisdictions where the issuer of tokens is incorporated and where investors reside or are located. The qualification of a token as ‘security’ (or not) appears to be key in determining what regulation is applicable to an STO and how the STO should be structured.
Press the link to the UK’s Cryptoassets Taskforce: final report.
Press the link to the SEC Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets Statement on Digital Asset Securities Issuance and Trading.
Press the link to the Maltese Commissioner for Revenue’s Guidelines in Relation to Distributed Ledger Technology (DLT).
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