30 November 2017

German BaFin and ESMA clarify their stance on initial coin offerings

The growing number of token sales or “Initial Coin Offerings” (ICOs) has prompted the German Federal Financial Supervisory Authority (BaFin) to issue a “consumer warning” on November 9, 2017. BaFin also elaborated on its position in the November edition of its monthly “BaFin-Journal”, published on November 15. In a separate, but almost contemporaneous publication, the European Securities and Markets Authority (ESMA) also took a stance.

Overall, these were balanced statements that signalled a strong “buyer beware” message, but also implied a certain level of tolerance for properly issued ICOs. The regulators made clear that their approach is a careful case-by-case analysis.

Buyer beware

Like many other regulators, the German BaFin is concerned that many ICOs are highly speculative investments, but it voices this concern without pointing to any specific transactions. Specifically, BaFin urges consumers to ensure they fully understand:

  • the structure of the offering and the proposed purchase;
  • the promised benefit of being a token / coin holder;
  • the risk of the underlying project and purchasing tokens / coins.

BaFin also reminds consumers about the need to weigh their investment needs and risk appetite against the potential benefits and risks.

Many of these echo the messages we advocated in our “Know Your Token” guide in July 2017.  

Issuers must comply with EU directives

In a similar fashion, the European Securities and Markets Authority published a press release on November 13, 2017 pointing out the highly speculative nature of participating in many ICOs.

Importantly, it also reminded potential issuers of their need to comply with applicable laws and regulations. A particular focus for issuers should be whether the coins or tokens offered qualify as financial instruments under the relevant EU directives, including most importantly, the Directive on Markets in Financial Instruments (MiFID), as amended.

Our views

These publications are interesting at various levels. First, they make clear that Europe’s regulators are concerned or at least alerted by the number and structure of ICOs conducted in recent months.

However, they also show that the relevant authorities will analyse these transactions on a case–by-case basis and do not indicate any impending regulation specific to the ICO or crypto-currency market.

Finally, the fact that BaFin (for now) chose a consumer warning, rather than publishing an enforcement case to state an example confirms our analysis that in many ICOs, the offered tokens are structured in a way that is outside the definition of financial instruments. This helps confirm our own view that whitepapers (and related documents) prepared for token sales often do not have to follow the EU Prospectus Regulation or similar disclosure regimes.

The fact that many ICOs occur outside the scope of many of the EUs specific investor protection rules does not, however, mean that these offerings can be conducted in a legal vacuum. General principles of contract and anti-fraud rules, which are found in the civil codes (or equivalent source of law) of most if not all EU Member States, consumer protection laws and last, but not least, criminal laws all apply.

What do we typically look at?

From a European perspective, we generally assess coin / token utility as against:

  • securities regulation and corporate laws, including whether the tokens offered qualify as financial instruments and/or convey voting rights, profit shares or similar rights in relation to any legal entiy;
  • collective investment scheme regulation, including where a vehicle invests participants’ money according to a certain strategy and could distribute profits or other proceeds generated by it to token or coin holders; and
  • e-money regulation, which is a complex area but includes electronically stored value that represents a claim on the issuer for the purpose of making payment transactions.

It is also critical to consider whether or not whitepapers and other marketing materials promise an underlying platform that will itself be regulated.

Other key developments

We are also closely following other developments across a number of jurisdictions that affect our clients that are issuers, exchanges and funds in this area. The continued trend reflects a spectrum ranging from proactive support, through to balanced acceptance, to outright bans.

This market is rapidly developing. Watch this space for further developments. Contact us if you have any queries.

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