Swiss regulator offers assistance in navigating the regulatory framework.

By Andrew Moyle, Stuart Davis and Charlotte Collins

The Swiss Financial Market Supervisory Authority (FINMA) has published a set of guidelines, setting out how it intends to apply its financial markets legislation in the context of initial coin offerings (ICOs).

Despite the growing trend for ICOs globally, FINMA is the first national regulator to provide such helpful clarity for ICO participants, who are typically left to work out for themselves whether and how their structure fits into existing regulatory frameworks. ICOs, in which investors receive blockchain-based coins or tokens in exchange for funds, were not envisaged when many existing frameworks were developed. Further, the increasing deployment of ICOs has not given rise to ICO-specific rules and regulations in most jurisdictions, although a minority of regulators such as the Gibraltar Financial Services Commission have announced that they are creating regulatory regimes specifically targeting ICOs. Consequently, the application of current regulation and legislation to ICOs is in many cases unclear, with the legal analysis depending very much upon the way in which a particular ICO is structured.

In response to the “sharp increase” in the number of ICOs in Switzerland, FINMA has decided to try to bring some transparency to the market. FINMA acknowledges that clarity concerning the underlying legal framework is crucial for establishing blockchain technology sustainably and successfully in Switzerland, a sign that the regulator is keen to encourage ICOs in its jurisdiction, as long as the correct rules are followed.

FINMA’s principles for analysing ICOs focus on the function and transferability of tokens, as these features determine which areas of regulation are relevant. For example, some types of tokens will display the characteristics of securities, and will need to be regulated as such. FINMA will focus in particular on the underlying economic purpose of a token, and, in the absence of universally agreed categories, suggests its own individual token classifications — payment token, utility token, and asset token.

The guidelines highlight that the areas of regulation most likely to be relevant to ICOs are anti-money laundering (AML) and securities rules, with legislation relating to deposit-taking activities and collective investment schemes less likely to apply.

FINMA’s general approach (subject to a case-by-case analysis) is as follows:

  • Payment tokens: these are tokens intended to be used as a means of payment for acquiring goods or services, or as a means of money or value transfer. Payment tokens generally will not be treated as securities, although FINMA will require compliance with AML regulation.
  • Utility tokens: these are intended to provide digital access to an application or service, by means of a blockchain-based infrastructure. Utility tokens generally will not be treated as securities (unless they function solely or partially as an investment in economic terms) and AML regulation will not apply, as long as the main reason for the issuance is to provide access rights to a non-financial application of blockchain technology.
  • Asset tokens: these represent assets, such as a debt or equity claim on an issuer, and are analogous to equities, bonds, or derivatives in terms of their economic function. Asset tokens generally will be regarded as securities, and securities regulations will apply.

FINMA stresses, however, that hybrid categories also exist, in which case the requirements are cumulative. For example, although a non-security utility token may not be subject to securities law and prospectus requirements, a utility token that also bears the qualities of an asset token would be subject to such requirements.

A core aspect of FINMA’s guidelines is the ability of issuers to approach FINMA for guidance on the characterisation of an issuer’s ICO from a Swiss law perspective. The guidelines specify the principles upon which FINMA will respond to such enquiries, and set out in an Appendix the minimum information that FINMA requires in order to make an assessment.

While many regulators have been quick to warn of the risks of ICO participants falling foul of legal and regulatory requirements, as well as the risks for retail consumers who invest in ICOs, they have not been as willing to provide guidance for ICO participants on how to navigate the regulatory framework. In many cases the speed with which this industry has developed has caught regulators somewhat off-guard, and many are still getting to grips with the features of an ICO and the potential legal and regulatory implications.

Given that many other markets have also seen a marked increase in ICO activity, it is to be expected that other regulators will follow suit and publish at least some indicative guidance on the topic. This is particularly the case given that even Swiss issuers will be subject to overseas securities law requirements if they market or issue tokens to overseas purchasers. Consequently, although FINMA’s guidance on the characterisation of a token under Swiss law will be helpful for issuers targeting Swiss-domiciled purchasers, the guidance will have limited use among more outward-looking ICO issuers targeting purchasers domiciled in jurisdictions outside of Switzerland.