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ICOs increasingly under scrutiny by European regulatory authorities
November 15, 2017

ICOs increasingly under scrutiny by European regulatory authorities

Several investor warnings published by regulatory authorities throughout Europe

On November 9, 2017, the German Federal Financial Supervisory Authority (BaFin) has published a consumer warning targeted at investors participating in crypto token sales (often referred to as "Initial Coin Offerings" or "ICOs"). BaFin repeated its warning in more detail in its monthly journal (November issue, published on November 14, 2017 - in German). A similar investor warning was published by the European Securities and Markets Authority (ESMA) on November 13, 2017.

In its warning of November 13, 2017, ESMA highlights the fact that some ICOs may fall outside the scope of existing securities/capital markets regulation, being vulnerable to fraudulent activity with little or no investor protection. It further points out the highly speculative nature of crypto token sales (even for what the industry commonly refers to as a sale of "utility tokens") which, in the opinion of ESMA, is often accompanied by insufficient or even misleading information set forth in "white papers" frequently published in connection with crypto token sales.

ESMA warning for "firms involved in ICOs"

While the consumer/investor warnings issued by BaFin and ESMA - as well as by several other European regulatory authorities - mainly focus on risks faced by investors participating in crypto token sales (i.e., investor risks), an additional statement which was also published by ESMA on November 13, 2017 goes significantly further, specifically targeting "firms involved in ICOs".

According to ESMA, "firms involved in ICOs" should give careful consideration as to whether the respective crypto token sale falls under capital markets regulation. Especially where crypto tokens qualify as "financial instruments", the existing European regulatory framework may apply and give rise to various obligations to comply with, especially by the relevant token issuer. While "ICOs" come in various shapes and forms, it is likely that many crypto tokens (i.e., crypto tokens that the industry commonly refers to as "security tokens", but also the so called "utility tokens") indeed do qualify as "financial instruments", especially considering the fairly broad definition under the Markets in Financial Instruments Directive (MiFID) to which ESMA refers. The statement issued by ESMA today points out that if crypto tokens, in a specific case, do qualify as "financial instruments" (or, more specifically, as a "tradable security"), the issuance of such tokens requires the respective issuer to publish a prospectus in compliance with the applicable national prospectus regime(s) (e.g., in Germany, under the German Securities Prospectus Act (WpPG) or the Investment Products Act (VermAnlG)). Further regulatory frameworks (e.g., under the Alternative Investment Fund Managers Directive (AIFMD) and under the Anti-money Laundering Directive) may, according to ESMA, apply in respect to the initial offering as well as the dealing or placing of and/or advising on crypto tokens.

ICOs will be kept under close watch by European regulatory authorities

With their simultaneous warnings and statements, national as well as European financial market regulators have made clear that crypto token sales will be under close scrutiny by regulatory authorities throughout Europe. It is a common misperception in the industry that regulatory challenges may be circumvented simply by using an issuing entity under a non-EU jurisdiction (such as Switzerland or Singapore) for crypto token sales.

"ICOs" may become a valuable and important financing alternative for early stage companies in selected industries. However, issuers of crypto tokens will have to weigh their options if they intend to be fully compliant with applicable laws and regulations (especially financial markets laws and regulations). The SAFT project initiated, among others, by leading U.S. technology law firm Cooley is an important step towards a legally compliant, yet convenient and fairly lean framework for "ICOs". Similar frameworks will have to be developed in Europe.