The term ICO has been at the epicentre
of discussions in the FinTech industry, being the main method of fundraising
used by startup companies to develop innovative ideas on the Blockchain
technology or other applications using Distributed Ledger Technology (“DLT”).
A. From
ICOs to STOs
The term ICO has been at the epicentre
of discussions in the FinTech industry, being the main method of fundraising
used by startup companies to develop innovative ideas on the Blockchain
technology or other applications using Distributed Ledger Technology (“DLT”).
Although bringing a revolutionary
change in traditional means of financing, ICOs have been criticised for their
legal uncertainty and struggled to become widely acceptable by governments due
to the increased risk for fraud.
The term ICO does not distinguish what
type of token is being offered, while most ICOs argue that their token is not a
security but rather serves a function – a utility – on the issuers’ platform.
As ICOs have faced multiple
challenges, startups and companies wishing to make a transition to the digital
world have been striving to find more satisfactory means of funding where there
is more security to potential investors, less uncertainty and less fraud.
Security
Tokens are regarded to be the game changers which will provide a more secure
path to companies seeking to raise funds.
B. STOs
– Security Token Offerings
Unlike ICOs, STOs are as their name
suggests, securities and are treated as securities from day one. They are
digital assets that are subject to security regulations and need to be
compliant with any registration and/or authorisation requirements before being
issued.
STOs are game changers for financial
and ownership models, allowing any company to offer revenue such as annual
income form the operations of the issuing company or other periodical income,
percentage on profits, equity, debt or dividends and sometimes voting rights.
It is argued that Security Tokens are
an improved model of traditional financial instruments because they are liquid,
secure, virtually incorruptible and accessible to trade by anyone with an
internet connection from all around the world. These give investors the
opportunity to acquire Security Tokens with minimum investment – a digital analogue
to the traditional term of securities such as shares or debts.
Private
and/or public offerings of security tokens enable access to a pool of investors
without sacrificing regulatory oversight. Therefore, STOs embody all the
advantages of ICOs and traditional financial instruments giving stability and
trustworthiness to the investors.
C. Security
Tokens – Definition
Although
there is not a widely approved definition or legislation interpreting what
deems a token to be a “Security Token’, transferable securities as per
Directive 2014/65/EU on markets in Financial Instruments, “MiFID II”, means those classes of securities
which are negotiable on the capital market, with the exception of instruments
of payment, such as:
-
shares
in companies and other securities equivalent to shares in companies,
partnerships or other entities, and depositary receipts in respect of shares; -
bonds
or other forms of securitised debt, including depositary receipts in respect of
such securities; -
any
other securities giving the right to acquire or sell any such transferable
securities or giving rise to a cash settlement determined by reference to
transferable securities, currencies, interest rates or yields, commodities or
other indices or measures.
Therefore,
one can argue that Security Tokens conferring similar rights to shares fall
within the “other securities” notion under sub-paragraph (a) above,
interpreting Transferable Securities as per Directive 2014/65/EU on markets in
Financial Instruments, “MiFID II”.
D. The
Obligation
As per
the EU Prospectus Regulation (the “Regulation”), any public offering of securities is prohibited without the prior publication
of a prospectus, which has to be approved by the appropriate authority under a certain
procedure, unless such public offering falls under the exemptions of the
Regulation. However, such exempted offers of securities to the public should not
benefit from the passporting regime. This means that the issuer of the STO has
to ensure that it complies with every Member State’s national requirements on
the ‘offering of securities’ before the issuance of the STO. Below that
threshold, Member States are able to require other disclosure requirements
at national level.
E. Which
are the exemptions to the obligation to draw up a prospectus provided under the
Regulation?
The
obligation to publish a prospectus under the Regulation shall not apply to any
of the following types of offering of securities to the public:
-
A public offering of securities where
the total consideration is less than EUR 1.000.000 in the European Union or EEA*
(expressed as the total consideration of the offer in the European Union or EEA
over a period of 12 months). -
An offer of securities addressed
solely to qualified investors as defined
by the law. -
An offer of securities addressed
personally to fewer than 150 natural or legal persons per EU or EEA member
state, which are not qualified investors. -
An offer of securities whose
denomination per unit amounts to at least EUR 100.000.
Minimum sale price to be EUR 100.000 per unit. -
An
offer of securities in the EU or EEA addressed to investors who acquire
securities for a total consideration of at least EUR 100.000 per investor, for
each separate offer.
*It
is worth noting that different thresholds apply in each Member State as the
Regulation provides that Member States are free to set out in their national
law a threshold between EUR 1.000.000 and EUR 8.000.000. In Cyprus the
threshold is currently set at EUR 1.000.000 but there is procedure in place to
increase it to EUR. 5.000.000.
Member States are electing to set up
the threshold between 1 and 8 million EUR according to the size of their
financial markets. Some examples: Germany, the United Kingdom and Italy have
elected to set up the threshold at 8 million EUR – Malta, Ireland and Lithuania
have set the threshold at 5 million EUR.
Note:
Irrespective of the above exceptions, when Securities are offered to the public
or admitted to trading on a regulated market, a prospectus should be drawn up,
approved and published.
F. Listing
of Security Tokens on Secondary markets
Certain
countries have started collaborating with token exchanges in an effort to build
the infrastructure allowing Security Tokens to be legally traded on a “centralised”
regulated security token exchange.
In order for Security Tokens to be
admitted for trading on the secondary markets, an infrastructure must be built
in order to allow for trading of Security Tokens whilst complying with KYC and
AML requirements.
Certain solutions are being explored
such as the possibility of centralizing compliance on the token issuance level by
embedding a code on tokens ensuring they can only be traded by parties who are
compliant.
Listing of Security Tokens will have
to be overseen by the regulator who will grant the license to the exchange and
permit it to operate. In effect, this will further provide investors a more
trusted way of buying and selling Security Tokens as these exchanges will have
to comply with KYC and proper systems safeguarding from cyber attacks and
fraud.
G. Final
Remarks – Comments
Yet,
despite the extraordinary success of ICOs, there is already a new model taking
prominence, this being the STO. The
latter seems to be the future of the industry, possibly because it represents a
sale of securities, rather than mere coins or utilities. Needless to say, this
attracts the more serious investors who want the comfort and guarantees of
investing in a security (be it a share, debt or other financial instrument) via
a token.
As
mentioned above, in order to offer securities to the public, one must follow
the rigid requirements of the Prospectus Directive.
However,
the numerous exemptions available at law give the proposed issuer sufficient
flexibility to be able to structure the intended STO without incurring an
unnecessary burden, whilst still selling a product under the title of security.
Through
STOs, Security Tokens provide the potential of unlocking trillions in otherwise
illiquid assets. The concept of STOs, although at its early adoption, has
proved to have the potential to be applied on any real-world asset – from an
art painting, music rights and real estate, to ships and renewable energy.
One
still needs to understand how the market will adapt in order to fully accommodate
Security Tokens to create a safe, legal and fully compliant infrastructure in
order to unlock the full potential of Security Tokens and tokenization of
assets on the blockchain.
Nevertheless,
Security Tokens have the potential to bring a number of improvements to the
traditional financial products, by removing middlemen, providing more liquidity
to the market and in the same time also offering safety to investors.
Security
Token offerings are the future.
They are a combination of the 21-century decentralised
technology along with security laws which existed for many years and are
capable of bringing the financial world as we know it to a whole new
dimension.
H. Disclaimer
This publication has been prepared as
a general guide and for information purposes only. It is not a substitution for
professional advice. One must not rely on it without receiving independent
advice based on the particular facts of his/her own case. No responsibility can be accepted by the
authors or the publishers for any loss occasioned by acting or refraining from
acting on the basis of this publication.
Authors
CHRISTOS P. KINANIS
Lawyer – Managing partner
Kinanis LLC
Christos.Kinanis@kinanis.com
ELENA ANDREOU
Lawyer
Kinanis LLC
Elena.Andreou@kinanis.com
Dr. FRANCESCO SULTANA
Lawyer – Manager
Kinanis Fiduciaries Limited
Francesco.Sultana@kinanis.com
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