The Australian Securities and Investments Commission (ASIC) has released INFO 225 Initial coin offerings to offer guidance on the potential application of the Corporations Act 2001 (Cth) to businesses seeking to hold an initial coin offering (ICO). This guidance notes that the Corporations Act applies regardless of whether the ICO was created and offered from Australia or overseas.
In keeping with the view expressed by regulators around the globe including the United States Securities and Exchanges Commission, the Canada Securities Administrators and the Monetary Authority of Singapore, ASIC has indicated that the legal status of an ICO depends on the ICO’s structure and operation, and the rights attached to the tokens offered in the ICO.
Broadly, the tokens offered during the ICO may trigger particular licensing and disclosure requirements under the Corporations Act if the tokens represent financial products (ASIC considers relevant financial products which tokens could fall within include interests in managed investment schemes, shares, derivatives or non-cash payment (NCP) facilities). Any company operating a cryptocurrency exchange will also be required to hold an Australian Market Licence (AML) if the tokens traded on the exchange constitute financial products.
Even if the ICO is not governed under the Corporations Act, it may still be subject to the general law and Australian consumer laws in relation to the offer of services or products. For instance, Australian consumer law prohibits misleading or deceptive conduct in a range of circumstances. Care must be taken with ICO promotional materials to ensure that they do not mislead or deceive potential investors.
Determining if a token is a financial product
Is your ICO a managed investment scheme?
Similar to the Howey test in the US for testing investment contracts, ASIC’s view is that if the ICO involves investors contributing assets, including digital currency, in a common enterprise to obtain a financial benefit or interest in property but without those investors having day-to-day involvement in the operation of the common enterprise, then this may be classed as a managed investment scheme (MIS) that would fall within the scope of the financial services regulation in the Corporations Act.
Companies holding an ICO may seek to frame the entitlements or interests received by contributors as a receipt of a purchased service and therefore not within the definition of a MIS. However, ASIC has clarified that where the value of the tokens acquired is affected by the pooling of funds from investors or use of those funds under the arrangement, however the ICO will most likely be subject to Corporations Act requirements regarding disclosure, registration and licensing of MISs.
In determining whether an ICO amounts to a MIS, ASIC has noted that the rights attaching to tokens are to be interpreted broadly. This will include rights that may arise in the future or on a contingency, and rights that are not legally enforceable. This interpretation of the Corporations Act appears intended to capture a wide breadth of ICOs within the scope of existing regulation.
Is your ICO an offer of shares?
Shares are a collection of rights relating to a company, including ownership, voting and some right to future profits. If the tokens offered during the ICO have these features, based on the whitepaper, and are issued to fund a company or an undertaking resembling a company, the company holding the ICO will need to comply with the same disclosure requirements as for initial public offerings, such as the requirement to prepare a prospectus.
ASIC notes that while investor protections exist in relation to defective IPO prospectuses (ie, investors may have capacity to withdraw their investments), no such protection exists for ICOs made without a prospectus.
Is your ICO an offer of derivatives?
Generally, derivatives are financial products that derive their value from an underlying instrument or reference asset. This underlying instrument could include a share, a share price index, a pair of currencies or a commodity, including other cryptocurrencies.
ICOs offering tokens that derive their price from other financial products, or underlying market or asset prices moving in a certain direction before a particular time or event, may indeed be derivatives and subject to obligations under the Corporations Act. ASIC has suggested that the use of smart contracts may alleviate tokens from being classified as derivatives in some instances.
When are tokens issued under an ICO a NCP facility?
A NCP facility is an arrangement through which a person makes payments, or causes payments to be made, to more than one person other than by physical delivery of currency. While tokens offered under an ICO are unlikely to be NCP facilities, an ICO may involve a NCP facility if the arrangement facilitates payments to numerous payees in non-cash form or payments initially in non-cash form are converted to fiat currency to complete the payment. Coin offerors who propose an ICO which will facilitate transfers constituting an NCP facility will need to do so under the authority of an Australian financial services licence which permits the licensee or its representatives to operate a NCP facility.
This position has been longstanding, in 2014 ASIC publicly stated that facilities by which digital currency is used to pay for goods and services may be classified as NCP facilities.
Do you need an AML to conduct an ICO?
You do not need an AML to conduct an ICO. However, if the tokens offered are found to be financial products, any platform enabling token holders to buy or sell their tokens may involve the operation of a financial market and will need an AML or an exemption from the requirement to hold one.
Distinguishing ICOs from crowd-sourced equity funding
ASIC has also warned consumers that while ICOs may be informally referred to as “crowd funding”, ICOs are not “crowd-sourced funding” (CSF), which has different obligations under the Corporations Act. We have examined CSF regulation for public and proprietary companies in earlier updates. It may be misleading or deceptive to describe ICOs as crowd-sourced funding when it is not operating under that regime in the Corporations Act.
Generally, an ICO should be conducted in a manner that promotes investor trust and confidence, and complies with the relevant laws. ASIC has recommended that companies wishing to hold an ICO contact the Innovation Hub for informal assistance reflecting ASIC’s willingness to engage with proposed coin offerors.
ASIC’s cooperative and transparent approach follows that of Canadian regulators, which has led to Quebec’s securities regulator recently accepting an ICO into its regulatory sandbox. These are important steps by ASIC towards providing regulatory certainty and building greater investor confidence around tokens as an asset class.
Importantly, noting the exception of the Chinese ban on ICOs, ASIC’s regulatory guidance is in line with the position of other regulators from around the globe. For instance, the financial regulator in Hong Kong, like ASIC, has also outlined situations where a token may be a financial product in its recent regulatory guidance.
For offering entities, ASIC’s comments are applicable even to ICOs where the offering entity is based outside of Australia. For entities wishing to target Australian investors, conducting an ICO may subject you to Australian consumer law even where the token is not a financial product. The financial services regulatory regime may also be triggered where a token that is a financial product is being offered from another jurisdiction into Australia. Whether this will impact the scope of tokens which Australian investors are currently investing and trading in will be observed in the near term.
ASIC’s regulatory guidance is a milestone towards establishing regulatory certainty for ICOs. It may prove influential in legitimising tokens in the eyes of the investment community.