The increasing popularity of cryptocurrency sales and “initial coin offerings” (“ICOs”) has been an active area of concentration globally for financial regulators and self-regulatory organizations.1 Lawmakers and regulators in every region are considering whether cryptographic assets, known as “tokens” or “coins,” are novel propositions requiring new regulatory regimes or fit squarely into existing legal and regulatory architectures.
On October 9, 2017, the Financial Services Regulation Authority (“FSRA”) of the Abu Dhabi Global Market (“ADGM”) joined the ranks of various regulatory agencies from countries including Australia,2 Canada,3 and the United States4 that have addressed ICOs. ADGM issued its Supplementary Guidance on the regulation of ICOs and virtual currencies (the “Guidance”).5 The Guidance offers parameters for classifying, for legal and regulatory purposes, various types of digital assets, and is intended to be read alongside the relevant Rulebooks of the FSRA and the Guidance & Policies Manual of the FSRA.
FSRA is primarily concerned with consumer protection. It prefaced the Guidance by emphasizing the importance of clarifying its regulatory posture with respect to digital assets, as these products might be used to defraud, launder money, and finance terrorism or other unlawful acts. The Guidance itself classifies digital assets into the following categories:
- Tokens that function as “securities” and are therefore subject to regulation as “Specified Investments” under the Financial Services and Markets Regulations (“FSMR”);
- Tokens that do not exhibit the features of a regulated instrument or investment and therefore qualify solely as “commodities,” which are subject to certain conditions but are not regulated as Specified Investments under the FSMR;
- Virtual currencies, which are treated as commodities rather than legal tender and subject to certain conditions, but are not regulated as Specified Investments under the FSMR; and
- Derivatives with a virtual currency or token as the underlying asset, which are regulated as Specified Investments under the FSMR.
The FSRA observed that a one-size-fits-all approach is inappropriate for digital assets and stated that it will determine whether a given ICO is subject to regulation under FSMR on a case-by-case basis. Under the Guidance, issuers of digital assets that qualify as “securities” will now be required to satisfy several conditions under the FSMR, one of which is the obligation to prepare and issue a prospectus as is customary with traditional securities offerings.
Where the tokens being issued do not qualify as “Specified Investments,” issuers do not have to comply with many of the FSMR requirements. However, the FSRA has advised investors to exercise extreme caution when considering such opportunities.
The FSRA Guidance is generally consistent with the product-and activity-based regulation approaches of the United States and the European Union. Under the regulatory framework in the U.S., the Securities and Exchange Commission (“SEC”), the Commodity Futures Trading Commission (“CFTC”), and the Department of the Treasury Financial Crimes Enforcement Network (“FinCEN”) each have incorporated digital assets into their respective regulatory frameworks. The SEC considers whether tokens would qualify as “investment contracts” utilizing a multi-factor legal analysis, known as the Howey Test, to clarify whether the tokens would be securities and therefore subject to regulation as such.6 The CFTC maintains that all digital assets are commodities subject to its general anti-fraud authority and that derivative instruments with digital asset underliers fall within the CFTC’s exclusive jurisdiction.7 FinCEN regulates issuers and exchangers of digital assets that qualify as “virtual currencies.”
Similarly, in the EU, token issuers must consider whether a given token product qualifies as an interest in a collective investment scheme or alternative investment fund, “e-money,” or a “financial instrument” under MiFID.
As businesses are increasingly marketing tokens to investors across the globe, we expect and welcome continued regulatory guidance and clarity on jurisdictional questions. Those interested in conducting or participating in a token sale should consult with their regulatory attorney to discuss how various regulatory regimes around the world may apply.
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Several regulators have issued reports, consultation papers and requests for comments: The European Commission’s Consultation Document is available here; the UK Financial Conduct Authority’s Discussion Paper is available here; the European Securities and Markets Authority’s Report is available here; the Financial Industry Regulatory Authority’s Report is available here.
- The Australian Securities & Investment Commission released guidance on token sales, available here.
- The Canadian Securities Administrators released a Staff Notice on Cryptocurrency Offerings, available here.
- A Reed Smith client alert on the SEC’s and CFTC’s respective jurisdictions over digital assets is available here.
- The Guidance is available here.
- A Reed Smith client alert on the SEC’s Howey Test approach is available here.
- A Reed Smith client alert on the CFTC’s latest digital asset-related enforcement action is available here.
Client Alert 2017-268
