FINMA guidance: legislative regulation of ICO

FINMA published new guideline on regulating ICO

The Swiss Financial Market Supervisory Authority (FINMA) published a plan that examines and contains information on the ways, means and methods of applying financial market legislation by the organization, when considering requests from organizers of ICO. In order to ensure transparency for all market participants, the plan also sets out the exact data that the FINMA requires from organizers of ICO and standards to be met by their own answers.

The FINMA notes a sharp increase in a number of ICO trades organized by Switzerland or held on its territory. At the same time, the demand for information concerning legislative part of the issue also increased. ICO is a digital method of attracting public investments for start-ups, based on blockchain technology. Due to the absence of a clear legal field for ICO, the FINMA has presented the plan designed to clearly indicate and regulate the procedure of processing information requests from organizers of ICO, which will complement the Guidance plan previously published by the FINMA (04/2017). Given the high demand and dynamism of the market, it is now especially important to create transparency conditions for all its participants.

Each case must be considered individually

Legislation and legal framework of the financial market are not always applicable to ICO. Regulatory requirements can not be applied to all ICOs without exception, given the diversity of their organization. In each case, all factors must be considered individually. According to the FINMA Guidance (04/2017), in some cases, ICOs fall under the influence of the standards of the financial market. At the moment there is no legal framework developed specifically for ICO, as well as any stable case-law or legal theory.

FINMA principles are based on the functions and transfer of tokens

During the regulatory/normative evaluation, the FINMA will primarily be guided by the economic functions of tokens (units of blockchain system) issued by an organizer of ICO. The main factors during above evaluation are the function of tokens in a given system and the possibility of their transfer/exchange. At the moment, there is no official terminology for classifying different types of tokens in Switzerland or in the world.

The FINMA divides all tokens into three types, but there may be mixed versions:

• payments tokens are the same as cryptocurrency. They do not carry additional functions and are in no way connected with other projects being developed. In some cases, it takes time before tokens acquire the basic functionality and become a full-fledged means of payment;
• utility tokens operate as a key for digital access to applications or services;
• asset tokens represent resources, such as shares of material underlying assets, companies or revenue flows, or give the right to own/hold dividends or interest payments. From the point of view of their economic function, such tokens can be considered as own capital, bonds or derivatives.

Focus on combating money laundering and securities regulation

According to the FINMA, the most important issues for ICO are money laundering and securities regulation. Projects rarely fall under the banking law (regulates the acceptance of deposits) or the law on mutual funds (regulates the products of investment funds).

The law on combating money-laundering contains obligations for financial intermediaries, for example, the requirement to determine the identity of beneficiaries. This law is designed to protect the financial system from schemes for money laundering and financing of terrorism. Such decentralized systems as blockchain in this case are of special risk, since they allow the transfer of assets anonymously and without intermediaries.

Regulation of securities should provide a reliable minimum of data to guide market participants before investing. In addition, the exchange should remain fair, reliable and with effective pricing.

In view of above criteria (function and transferability), the FINMA will consider requests regarding ICO as follows:

1. Payment ICOs. If tokens play the role of cash funds and can be transferred, the FINMA will be governed by the rules of anti-money laundering law, but such tokens will not be treated as securities.
2. Utility ICOs. Such tokens are not considered to be securities if their only function is to give access to an application or a service, and also if token initially has such a function when it is issued. However, utility token will be considered a security if it is wholly or partly acting as an investment (i.e., equated by status to an asset token).
3. Asset ICOs. The FINMA equates asset tokens to securities, therefore, their exchange is subject to regulations on securities legislation, as well as civil law standards under the Swiss law of obligations (e.g. requirements for securities prospectuses).

Some ICOs combine features of several types. For example, the law on combating money laundering can also be applied to utility tokens, if they can be used (or they were designated) as a means of payment.

Innovative potential of blockchain technology. In the future, the FINMA may expand and disseminate these standards in a form of circular in order to further strengthen supervisory practices.

The FINMA is aware of all the innovative potential of blockchain technology and supports the Blockchain/ICO Working Group of the federal government, where it participates. For successful and reliable integration of this technology in Switzerland, it is necessary to achieve transparency of the civil legal framework in relation to blockchain and ICO.

Mark Branson, President of the FINMA, expressed his opinion: "Introduction of blockchain technology opens prospects far beyond financial markets. However, projects based on blockchain can not run counter to existing legal field, especially since they operate in a similar way to other already regulated activities. We approach all requests and ICO very carefully, which allows the innovators of the industry not to get lost in existing legal field and launch their projects in accordance with all laws aimed at protecting investors and integrity of our financial system."

For investors

The FINMA again draws attention to the possible risks for investors working with ICO. High volatility is characteristic for tokens obtained through ICO. In addition, ICO is often organized at the very beginning of a project and therefore implies numerous risks. Moreover, it is not clear at the moment whether contracts concluded by means of blockchain have binding legal force under the civil code.

ICO analysis will continue

In September 2017, the FINMA announced that it was analyzing several cases related to ICO. If the FINMA finds out that ICO is built on a business model that violates the rules of supervisory authorities, is designed to circumvent regulation or is fraudulent in intent, compulsory proceedings will be commenced.