DIGITAL ASSETS AND MARKET INFRASTRUCTURES IN JAPAN (PART II)
Initial Coin Offerings (ICOs), Initial Exchange Offerings (IEOs) and Security Token Offerings (STOs)
Tokens are often used for fundraising purposes. In this section, we take a closer look at fundraising via initial coin offerings (ICOs), initial exchange offerings (IEOs), and security token offerings (STOs).
Utility tokens
The offering of utility tokens for fundraising purposes is commonly known as ICO. Under the PSA, the offering of new tokens in exchange for fiat or cryptocurrencies is considered a crypto asset exchange service. An issuer must therefore either register as a crypto asset exchange service provider or sell his tokens via one of the registered exchanges. In the latter case, the exchange may either act as an intermediary or buy and sell the tokens on its own account.
Excursion — Registration as crypto asset exchange
To register as a crypto asset exchange, companies must meet certain criteria. Local companies must be incorporated as a stock company and have a minimum capital of JPY 10 million. An exchange must further ensure that its net assets do not fall below the amount of users’ funds that are stored in a hot wallet.
Aside from this, crypto asset exchanges must implement corporate governance and security systems that ensure fair dealing on the exchange and reduce operational risks. The latter includes the separation of funds — both for crypto assets and fiat currencies — and the proper management of users’ funds held by the exchange (for more details, see section 4.1 below). Crypto asset exchanges violating their obligations under the PSA are subject to fines of up to JPY 3 million.
While foreign crypto asset exchanges are generally able to register and operate in Japan, none of the 22 registered exchanges is currently a foreign exchange.
Self-offering
Under the ICO regulations of the Japan Virtual Currency Exchange Association (JVCEA), an issuer who has successfully applied for a crypto asset exchange license must analyze its internal control and the feasibility of the target business comprehensively before launching its ICO. The analysis must be based on certain documents, including the issuer’s financial statements, material agreements, business plan, whitepaper, and other documents deemed necessary by the issuer. The results of the analysis must be submitted to the JVCEA for final review. Only if the JVCEA does not raise any objections, the issuer may launch its ICO in Japan after giving notice to the FSA.
When selling tokens to the broader public, an issuer must disclose a wide variety of information to the public in order to allow investors to make an informed decision. This includes among others:
(i.) information on the issuer
(ii.) information on the tokens and the token sale (incl. pricing information, incentives, sales period, token allocation, caps, future distributions)
(iii.) information on the use and the accounting treatment of the raised funds
(iv.) information on the project
(v.) governing law and jurisdiction
Once the ICO is completed, the issuer must provide token holders with sales data, including information on the number of tokens issued and the total amount collected. Token issuers are further subject to ongoing disclosure and must publish data about the status of the project and market value of the tokens at regular intervals. This generally applies for a period of five years unless the protection of users is not compromised, and the issuer has informed the JVCEA.
An issuer may not use the raised funds for any other purpose than disclosed to investors during the ICO and must manage them separately from its other funds. The private key controlling the raised funds must generally be stored offline. The issuer must further establish an internal control system to prevent the misappropriation of funds by its officers and employees or the theft by third parties.
IEO
Registered exchanges that allow other projects to launch their token offerings via their exchange must implement internal control systems to safeguard investors from investing in projects which are not feasible or an outright scam. At the same time, they must ensure that the token issuer has systems in place to prevent inappropriate solicitation of the token sale or the misappropriation of funds.
When assessing whether a token offering can be launched via its platform, an exchange must consider the issuer’s financial situation. To do so, an exchange must review the financial statements of the token issuer and, if possible, conduct a hearing with a certified accounting or auditing firm. The sales price of the newly issued tokens must be determined in accordance with reasonable valuation methods (e.g. surveys on investment demand). Registered exchanges must also ensure that the raised funds do not exceed the amount which is determined in the business plan of the issuer. The results of the overall assessment must be submitted to the JVCEA for final review. If the JVCEA finds that the offering is not feasible, the exchange must not proceed.
To ensure that the trading of tokens is safe, exchanges must audit the smart contract and the blockchain protocol before launching the token sale. The duty to ensure safety does, however, not end with the token sale. Rather, exchanges are required to monitor the system on an ongoing basis and report vulnerabilities to the JVCEA.
Before offering new tokens on their platform, cryptocurrency exchanges must further publish certain information on their homepage. This information is largely identical to the information indicated in the previous section. Following the offering, the cryptocurrency exchange must ensure that the issuer properly maintains the internal control systems and disclosure mechanisms. This does not apply if five years have passed since the offering or where the exchange has informed the JVCEA that investor protection is not compromised if compliance is no longer monitored by the exchange.
Note: If an issuer actively engages in the token sale, this might be considered a crypto asset exchange service by the issuer and trigger registration requirements under the PSA despite selling the tokens via a registered exchange.[26] Whether this is the case must be determined on a case-by-case basis considering the degree of engagement and other factors.
Security tokens
The solicitation of an offer to sell securities in Japan is generally regulated under the FIEA. The term is understood broadly and covers any communication which allows investors to decide whether to purchase or subscribe for the offered securities. While there is no bright-line test, providing information on the terms of an offering is a clear indication of solicitation. As a rule of thumb, the more granular the information, the more likely it is that the marketing is considered a solicitation. Offers via the internet are generally considered a solicitation to invest in securities if they are made through a website that is publicly accessible. The use of the Japanese language is not necessarily required. Only where investors from Japan are effectively excluded from participating in the offer, for example, by geo-blocking or a KYC-process, an offering is not considered a solicitation of an offer to sell securities in Japan. A disclaimer, according to which Japanese investors are excluded from the offer, is not sufficient on its own but may, in combination with other measures, prevent the FIEA to apply.
The FIEA distinguishes between public offerings and private placements, self-offerings, and offerings via intermediaries.
Public Offering
The offering of tokenized type I securities and electronically recorded transfer rights is considered a public offering if the tokens are offered to 50 or more investors. Qualified institutional investors (QII) and professional investors as defined in the following section, are not considered when assessing the number of investors.
Public offerings with a total issue price of JPY 100 million (~ USD 915,000) or more must be registered with the FSA and accompanied by a prospectus.
Private Placement
Offerings via private placements must not be registered with the FSA. Under the FIEA, the following offers are considered private placements:
(i.) offers to QII only where the transfer to persons other than QII is unlikely
(ii.) offers to professional investors only which satisfy all of the following requirements
//solicited party is not the state, the Bank of Japan (BoJ), or a QII
// solicitation by a Financial Instruments Business Operator (FIBO) on its own behalf or on behalf of a client
// transfer to persons other than professional investors is unlikely
(iii.) offers to a small number of investors (< 50)
The definition of QIIs is rather extensive and consists of a long list of examples. The list includes investment corporations, venture capital companies with a stated capital of JPY 500 million or more, investment limited partnerships as well as special purpose companies, other legal persons and individuals holding securities of at least JPY 1 billion.
Professional investors within the meaning of the FIEA are QIIs, the state, the BoJ, investor protection funds, and other corporations specified by cabinet order. The latter includes among others foreign corporations, specific purpose companies, and listed companies.
Tokens acquired in a private placement by QII or professional investors may not be resold to persons other than QII or professional investors as the case may be. If the tokens are resold in violation of the restrictions on resale, the issuer must file a registration statement with the FSA. This does not apply if the tokens are sold to a small number of investors and are subsequently resold by the initial investors to more than 49 persons.
Self-Offering
Companies selling their own tokens in a private placement or public offering do generally not have to register as a FIBO. This applies to both the offering of tokenized type I securities and the offering of electronically recorded transfer rights.
Only where the tokens represent beneficial interests in a (foreign) investment trust, (foreign) mortgage securities, units in (foreign) collective investment schemes, or where another case explicitly mentioned in the FIEA applies, the issuer must register as type II FIBO. The registration requirements apply irrespective of whether the offering is a public offering or a private placement.
Third-Party Offerings
Intermediaries who are engaging in the offering of security tokens must register as a type I FIBO under the FIEA.
tokenized type I securities — type I FIBO
electronically recorded transfer rights — type I FIBO
Excursion — Other laws
Token issuers must not only comply with the PSA or the FIEA but also with other laws and regulations. The applicable laws do not only depend on the features assigned to a token but also on the way the tokens are distributed. Certain laws may contain form requirements (e.g. physical form), which must be carefully considered when structuring the token and offering. As a general rule, it is however possible to tokenize most assets, including private shares. This topic will be covered in more detail in another article.
If you want to learn more or should you need legal or regulatory advice, please feel free to contact us directly under https://innovationlaw.jp/en/.
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