V Anjana, Solution Architect, TCS
Access of capital has always been a challenge for small and medium players in the traditional marketplace. With Blockchain disrupting this space, the advent of ICOs (Initial Coin Offering) opened the flood gates for crowd funding. While the startup industry received the desired boost, investors too, had multiple options to fund the companies of their choice. ICOs paved way for an alternate mechanism of fund raising – the Security Token Offering. STOs bring the best of both worlds – the ease of fund raising associated with the ICOs and the fool-proof mechanisms associated with the traditional markets. As per the laws, the funds raised through STO fall under the gamut of regulatory provisions in each jurisdiction.
Each country/region has its own framework to regulate STOs as below:
United States: In the US, tokenized assets fall within the regulatory framework as per the Howey’s Test. Howey’s law states that the funds raised by a company is deemed as an investment contract if:
- It is an investment of money/assets
- There is an expectation of profits from the investment
- The investment is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
The regulations in the US are considered stringent, however there are certain provisions in the regulations that are conducive for STOs.
For example, Regulation CF (Crowd Funding) can be used by any issuer to sell up to $1.07M of their offering in a 12-month period to non-accredited investors. However, the tokens issued under this category cannot be traded in the secondary market for a period of 12 months.
Another option could be to apply for an STO under the Regulation D. In this case, a STO can be generally advertised, sold to accredited investors only, and there is no limitation on the amount that can be raised. So far, this is the most common used SEC exemption for security tokens.
There are other regulations as well including Regulation A+ and Regulation S. Depending on the type of asset and the amount to be raised, the applicable regulation can be chosen and used.
Switzerland: FINMA, the regulatory authority of Switzerland uses the term “asset token” in place of security token. The asset token is classified similar to a security under the Swiss financial market law by the FINMA. The regulation mandates maintenance of records of tokens including all transactions, adherence to anti-money laundering and publishing of prospectus for an STO.
Singapore: Singapore’s central bank, the Monetary Authority of Singapore, has issued a set of guidelines for digital tokens. As per these guidelines, the digital tokens constitute capital market products as defined in the Securities and Futures Act (SFA) (i.e., securities, derivatives contracts and so on). In these cases, the existing relevant licenses apply, based on the activities performed by the businesses: whether as a token issuer, exchange platform, advisor or otherwise. In fact, in 2019, the MAS had warned an issuer not to proceed with its securities token offering in Singapore until it can fully comply with regulatory requirements under the SFA.
Japan: Japanese regulators have also rolled out changes to their existing securities regulation to include the impact of security tokens with the view of protecting customer interest and streamlining the tokenization process.
ISSA paper on Crypto Assets raises the following aspects from the regulatory perspective:
- When a tokenization platform for Crypto Asset holdings and transactions spans across multiple jurisdictions, the need to take a different view of the legal status of the same asset or transaction arises
- CSDs might also find their Crypto Asset settlement and custody services regulated under the national regulations of their home country. They will need to assess whether they can provide new services such as digital wallets under their existing licenses.
- The paper highlights that new roles and services like the smart contract verification, which are an opportunity for digital wallet service providers are likely to emerge because of tokenization. Regulators and policymakers will need to consider how to define and regulate such novel roles
When classifying security tokens as financial instruments, it brings in a range of legal provisions and in turn gives a better handle for the regulators to manage the issue, trading and custody of security tokens. While the tokens provide an innovative and specialized avenue for investment, the evolution of the regulatory angle will further bolster investor confidence and also redefine how business will be done in this space.
Disclaimer: Views or opinions represented in this blog is based on author’s own research and does not represent TCS