Initial coin offerings (ICOs) have caught the attention of investors and regulators alike.
An ICO is a method of raising money, like an initial public offering, where a company offers early investors some of the new cryptocurrency it is looking to launch in exchange for their financial backing (usually done via bitcoin, ethereum or in some cases fiat currency). Investors buying the new digital money are buying what are referred to as tokens in a new cryptocurrency project. The new cryptocurrency can then be sold or bought on cryptocurrency exchanges if the offering is successful.
In Asia, China, Hong Kong, Singapore, Japan and South Korea are some of the most active jurisdictions in cryptocurrency trading, prompting regulators to make changes to existing laws. Some, such as China and South Korea, have banned ICOs, while others have issued clarification statements on ICOs, warning potential investors on the possibility of fraud.
This depends where the ICO takes place.
Musheer Ahmed, general manager at the Fintech Association of Hong Kong observes that enforcement action around ICOs in various jurisdictions is likely to happen on two major fronts.
Firstly, fraud charges will be filed against ICOs that were scams and lacked any depth in their offering: for instance, if they fail to have a legitimate project backing them or if the company behind the ICO is deemed fraudulent. Some enforcement activity has already started in a few jurisdictions.
Secondly, many securities regulators have been closely monitoring tokens that have the characteristics of securities (which are regulated) but are listed as utility tokens (which aren’t). The latter provides the holder with access to a product or a service, and there is very little guidance around them.
In most jurisdictions, the listing of securities and derivatives requires exchanges to have the required licences beforehand. Regulators will likely scrutinise various so called crypto-exchanges to see if they have been listing unapproved tokens and allowing the trading of derivatives.
What are ICO regulations like across Asia?
China has taken a strong and clear stance against ICOs. In September 2017, the PRC banned ICOs, citing concerns over illegal fundraising. The statement, which was issued by a number of regulators, including the People’s Bank of China, prohibits financial institutions from carrying out any ICO funding related activity. Additionally, those who have completed ICOs should refund their investors.
The country’s Financial Services Commission banned the raising of money through virtual currencies in September 2017. Following the hacking of the Youbut exchange, in December 2017, the country announced the requirement to open cryptocurrency accounts on a real name basis from January 2018.
ICO bans in China and South Korea mean ICOs are moving to other places. According to Aurélien Menant, founder of Gatecoin, the company is seeing an increase in projects from those countries setting up in Hong Kong as well as users registering on our platform.
"Many ICOs are structured to provide both service and investment features, blurring the legal status"
Ahmed agreed. “We are seeing a change in subscription levels of all ICOs, with higher quality ICOs attracting more investments, while ICOs with weak teams and products are not getting fully subscribed,” he said. “Since these bans came into force towards the end of last year, we will possibly impact in terms of a slowdown in the number of ICOs in the region over Q1 and Q2 this year.”
Some ICOs are launching out of Europe, in particular Switzerland, home to the Crypto Valley Association, an ecosystem which encourages innovation in and distribution of cryptocurrency. There are also other places such as Gibraltar and parts of Asia where the local jurisdictions are more conducive to ICOs and token sales.
“The effectiveness of these bans also lies in restriction of the flow of funds into ICOs being launched in other jurisdictions,” said Ahmed. “As long as ICOs accept investments from investors in regions where bans are in place, the acceleration of ICOs will take time to slow down significantly.”
A vast majority of investments in ICOs tends to be through pre-ICO syndicates. Though there is no complete ban on ICOs per se in the USA, many ICOs exclude citizens of the USA from investing in their ICO. This practice would probably now extend to PRC citizens and for other countries where a ban has been enforced.
The Securities and Futures Commission (SFC) in Hong Kong issued a statement on ICOs in September 2017. It states that digital tokens may be securities and that they are subject to local securities laws. Parties involved in the dealing, advising, marketing and managing of digital tokens in an ICO that is considered as a security must be licensed by the SFC. A further alert was released on February 8 warning of the risks of investing in ICOs and regulatory action has been taken against a number of issuers.
“It’s good to see that the SFC is proactive in responding to the new crypto-ecosystems,” said Clifford Chance’s Rocky Mui. “But the challenge is how all relevant stakeholders could engage in constructive discussion to have regulatory clarity on how the system should develop going forward.”
In November 2017, the Monetary Authority of Singapore (MAS) released a guide to digital token offerings and outlined that any offer of digital tokens will be required to comply with the Securities and Futures Act, including the filing of a prospectus. MAS must approve intermediaries that facilitate offers or issues of digital tokens, including primary and trading platform operators. A new payments services framework is being developed to target anti-money laundering (AML)/combatting the financing of terrorism (CFT) risks in the dealing of cryptocurrencies.
“Many ICOs are structured so that they provide both service and investment features, blurring the legal status,” said Nizam Ismail, partner at RHTLaw Taylor Wessing.
"Japan's financial regulator's basic policy is that they do not want to restrict innovation but at the same time there isn’t a clear definition of cryptocurrency"
He adds that while MAS is looking to set out AML/CFT guidelines, pending such guidance, issuers are still exposed to Singapore’s more generic Corruption, Drug Trafficking and Other Serious Offences Act and the Terrorism (Suppression of Financing) Act, so a robust AML/CFT compliance framework is necessary to mitigate against such risks for ICO creators.
While Japan’s financial regulator, the Financial Services Agency (JFSA), issued a statement in October 2017 warning investors of the risks of ICOs, Japan is still a cryptocurrency hub. Japan promulgated the Virtual Currency Act, under the Payment Services Act in April 2017. The creation of the law was largely driven by the collapse of the Mt Gox bitcoin exchange in 2014 which led to the arrest of its chief executive officer and more than 800,000 bitcoins disappeared.
The Act recognises bitcoin and ethereum, the two most established cryptocurrencies, as forms of payment, but not as legally-recognised currencies. Under the law, cryptocurrency exchanges must register with the government and may only obtain a licence after meeting requirements such as undergoing an annual audit by a certified accountant and installing a secure IT system. Cryptocurrency exchanges also have to comply with the Act on Prevention of Transfer of Criminal Proceeds, the Japanese law targeting AML/CFT.
“Cryptocurrency exchanges must segregate clients’ assets from their own accounts and there is an obligation for the business to report information to customers,” said Masakazu Masujima, partner at Mori Hamada & Matsumoto. “The JFSA’s basic policy is that they do not want to restrict innovation but there isn’t a clear definition of cryptocurrency.”
“This causes ambiguity and it is difficult to enforce regulation when it is unclear whether for example, the lending of bitcoin is regulated under lending business law and when an insurance premium is paid for by bitcoin, if that is regulated under insurance law,” he added.
According to So Saito, principal at So Law Office, the fund regulations under the Financial Instrument Exchange Act (FIEA) only apply to ICOs if they constitute collective investment schemes, but this is a broad and diverse concept.
“Specifically, where an ICO is used to collect money from others, to invest in a business and pay dividends to holders, such structures most likely invite the application of the FIEA fund regulations,” explained Saito. “Where ICOs are in exchange for payment in bitcoin or ether, the FIEA regulations are unlikely to come into play because neither are money under Japanese law.”
“When cryptocurrencies start having securities features such as dividends and voting rights, they should be regulated as securities,” explained Masujima. “The JFSA is closely monitoring cryptocurrencies but it doesn’t move quickly.”
“You need to consider yet another regulation if virtual currencies collected by way of an ICO is invested in a certain asset class,” explained Saito. “For example, some ICOs which invest in real estate might be regulated under the Act on Specific Joint Real Estate Ventures in Japan, which does not distinguish virtual currencies from money.”
Many investors are jumping on the ICO bandwagon because the short-term gain is deceivingly attractive, but they must understand the risks to reap the rewards. Regulators in Asia and around the world are working on clarifications and new regulations to ensure this area of the capital markets is transparent, but investors and issuers are faced with uncertainties as they figure out whether their projects might bring them into the orbit of different securities regulations.
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