Out-Law News 3 min. read

No single means of regulating ICOs, says FINMA

'Initial coin offerings' (ICOs) will not be regulated in a uniform way in Switzerland, the country's financial regulator has confirmed.

The Financial Market Supervisory Authority (FINMA) said that the way in which ICOs are regulated will be determined on a case-by-case basis and will depend on what function the tokens being offered perform and their "transferability".

In the main, though, FINMA identified three types of ICOs or tokens - payment ICOs, such as cryptocurrencies, utility ICOs and asset ICOs, and said that which category an ICO falls into will dictate how it is regulated.

FINMA said that in some cases, Swiss securities laws will apply to ICOs, while in others anti-money laundering regulations will apply, such as to payment tokens transferred on a blockchain. In a minority of cases it is also possible that laws governing deposit-taking or investment fund products could apply, the regulator said. ICOs could also come in "hybrid forms" and be subject to a mix of the different rules, it said.

ICOs are an increasingly popular way for businesses to raise money. Typically, businesses will develop a digital token, such as their own proprietary virtual currency, and look to sell those tokens to investors in a bid to raise capital in return for existing cryptocurrency, such as bitcoin, ether or ripple rather than fiat currency such as dollars, euros or pounds. The trade of these tokens is recorded using blockchain.

Investors can in most cases sell on those tokens for profit on certain peer-to-peer exchange platforms should the value of the tokens increase. They are sometimes further incentivised into buying the tokens by being given the opportunity to share in profits generated from the business ventures that benefit from their investment. 

FINMA's new guidelines were issued in response to the "sharp increase" it has seen in the number of ICOs planned or executed in Switzerland. This increase has spurred "a corresponding increase in the number of enquiries about the applicability of regulation", the regulator said.

FINMA chief executive Mark Branson said: "The application of blockchain technology has innovative potential within and far beyond the financial markets. However, blockchain-based projects conducted analogously to regulated activities cannot simply circumvent the tried and tested regulatory framework. Our balanced approach to handling ICO projects and enquiries allows legitimate innovators to navigate the regulatory landscape and so launch their projects in a way consistent with our laws protecting investors and the integrity of the financial system."

Commercial litigator Danielle Murphy of Pinsent Masons, the law firm behind Out-Law.com, said: "FINMA’s approach, by announcing guidelines to assist start-ups and companies engaging in the ICO market, is encouraging. This is because it recognises a potential for further development in respect of ICOs and the uses of blockchain technology whilst indicating in what circumstances specific legal considerations, such as anti-money laundering regulations, will apply.

While ICOs have been "gaining traction for some time", Murphy said, the UK has not introduced bespoke regulation to address their use.

"The FCA has observed that many ICOs will fall outside UK regulation, confirming that whether an ICO falls within the FCA’s regulatory boundaries will be decided on a case-by-case basis," Murphy said. "As a result, guidance from overseas regulators on this area is welcomed and may provide some insight as to how a case-by-case analysis might apply in a UK context."

There has been a mixed reaction to the growth of the market for ICOs from financial authorities across the world.

Litigation expert Jennifer Craven of Pinsent Masons, who specialises in civil fraud matters, said: "It is fair to say that without formal UK guidance or regulation, whether specific to ICOs or on cryptocurrency more generally, this remains an area that investors should be wary of. ICOs do not currently require a regulated prospectus and investors may be misled by documentation provided. Issuers behind ICOs might not intend to use the funds in the way any investment is marketed, leading to the possibility of fraud."

"The risks of fraud and loss following investment in an ICO is heightened by the likelihood that most ICO projects are at an early stage and by the fact that tokens and cryptocurrency values can be volatile and subject to rapid changes," she said.

Regulators around the world have been playing catch-up on ICOs and the way they should be regulated. Regulators in the US and Singapore have offered detailed views on how existing regulations apply to ICOs, and the Hong Kong's Securities and Futures Commission (SFC) has also expressed its view on where they fit into the regulatory environment in the city. The UK's Financial Conduct Authority (FCA) issued a risk warning to consumers over investing in ICOs in September 2017, and New Zealand's Financial Markets Authority (FMA) set out its own approach later in the year.

According to a leaked draft of its anticipated new fintech action plan, the European Commission will announce plans to assess how existing EU regulations apply to ICOs.

Charlie Clarence-Smith of Pinsent Masons has analysed the regulatory positions on bitcoin, blockchain and ICOs in 65 jurisdictions. His study found differences in the way regulators around the world address risks in the use of digital currencies, particularly bitcoin, and ICO investments.

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