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12 September, 2017
On 1 August 2017, the Monetary Authority of Singapore (the “MAS”) issued a statement to the media (the “Media Release”) clarifying that the offer or issue of digital tokens in Singapore will in fact be regulated if these digital tokens constitute products regulated under the Securities and Futures Act (Cap. 289) (the “SFA”). Given this clarification, it is important to review how the issuance of certain digital ‘coins’ or ‘tokens’ can fall under the purview of the SFA.
ICOs/ITOs in a Nutshell Initial Coin Offerings (“ICOs”) or Initial Token Offerings (“ITOs”) are newly emerging crowdfunding ventures attracting increasing amounts of interest in digital and venture capital circles. The digital ‘coins’ or ‘tokens’ generated in an ICO/ITO are block-chain based ledger entries, the ‘ownership’ of which is tied to
a cryptographically secured key that allows the holder of the key to add additional entries. While digital coins are generally a form of virtual currency that is electronically created and stored (and thus not currently subject to
regulation), 1 digital coins that have additional features are more akin to a ‘token’ and should be viewed as such. Tokens generated in an ITO are not virtual currencies per se (although they may be traded like one) but instead represent the digital tokenisation of some underlying right/obligation. For the remainder of this paper, we will restrict our discussion to coins with such additional features (i.e., tokens) rather than coins that are only virtual currency.
ICOs/ITOs can be categorised based on the products or services that underlie them.1.
Donative –Where the coin/token issued creates no rights or obligations, and is more akin to a recognition that the owner has supported by donating to the campaign. The most famous example of this would be a
‘Kickstarter’ campaign.2.
Securities – Where the underlying would constitute a security within the
meaning of the SFA. This could be in the form of equity or debt
instruments that convey an economic and/or voting interest.3.
Services – Where the underlying is a service provided by the issuer (or a related party of the issuer). The types of services involved are potentially limitless (e.g., tokens for blockchain application, advertising space, rights to
energy rights, tokens for rights to access office space or information).
However, almost all allow the owner of the token or coin to use the services at no further charge, or at a great discount.4.
Contractual Obligations – These include contractual contingencies (e.g., a convertible instrument), revenue sharing arrangements, and profit sharing arrangements. 5.
Hybrids – These represent some combination of security, services, and/or contractual obligations.
As with other similar forms of crowdfunding (e.g., P2P platforms), ICOs/ITOs are typically launched before a project begins in order to solicit funds for that project.
As such, ICOs/ITOs operate essentially as capital-raising tool that also serve as an initial distribution model for newly-issued coins/tokens. However, unlike many other forms of crowdfunding, ICOs/ITOs often offer participants early liquidity once the coins/tokens are ‘listed’ on any number of exchanges.
How is an ICO/ITO Conducted?
Generally, ICOs/ITOs are first announced on various cryptocurrency forums. The announcement thread will usually include key information about the project, such as the timelines, the members of the project development team, and other notable features of the project. The announcement may be accompanied by a ‘white paper,’ which acts as an offering memorandum for the ICO/ITO.
Participants typically receive little investment information beyond what is set out in this ‘white paper,’ which will also detail the intended purpose of the project and any rights or privileges attached to the coins/tokens to be issued in the offering. 2
Coins/tokens issued during an ICO/ITO are sold at a fixed price, and denominated in cryptocurrency or fiat currency. During the ICO/ITO campaign, supporters of the project will buy some of these distributed coins/tokens, generally with virtual currency. Digital funds are collected done through a global, public address (in which case the participants need to send cryptocurrency from an address which they control the private key) or by creating accounts of each participant and providing them with a unique cryptocurrency address.
The newly-issued coins/tokens, if not subject to resale restrictions, are often traded on an exchange. The coin/token price may then generally reflect the overall cryptocurrency market sentiment. This may lead to an increase in price, and a sale of the coins/tokens for a profit. Also, after the project is developed and launched, the coins/tokens’ value may become secured to an underlying real, working product, or service. This can also increase the value of the coin/token.
Thus, alongside the inherent attractiveness of ICO/ITO ventures, there is an element of speculative potential.
Regulatory Framework for ICOs/ITOs ICOs/ITOs are commonly perceived as alternate capital-raising ventures, albeit, one that is often believed to be significantly lighter in terms of regulation and costs. For that exact reason, many offerors seek to conduct ICOs/ITOs in a perceived regulatory void.
In the Media Release, MAS observed that digital coins/tokens often represent a ownership or interest over an issuer’s assets or property, functionally making them a “security” within the meaning of the SFA.
Singapore’s Regulatory Framework
The relevant legislation here is the SFA, together with its respective implementing regulations, notices, and guidance notes. Activities regulated under the SFA, which include the offer of securities, are generally subject to certain regulatory requirements such as the filing of a prospectus unless there is an exemption (such as those for small offers or private placements, or offers made to accredited or institutional investors). In addition, a platform that acts as an intermediary for securities offers (e.g., a dealer) will be required to hold a capital markets services
licence for dealing in securities under the SFA.
The core issue, therefore, is the consideration of the nature of the coins/tokens, and whether they fall under the definition of ‘securities’ in the SFA.
Definition and Regulation of Securities
The SFA has a very broad definition of the term, “securities.”3
In summary, it includes shares/stock (or derivatives or units thereof), debentures (or derivatives or units thereof), or units in a collective investment scheme (“CIS”).4
Shares/stock and CIS can be understood, collectively, as ‘equity instruments,’ where both involve holders that have ‘legal or beneficial ownership’ interest (be that an economic or voting right) in an asset or entity. Conversely, debentures represent a creditor’s interest in an obligation created by the entity, more plainly called ‘debt.’
Towards a Principles – Based Approach
The current definition of ‘securities’ under the SFA has be characterised as a positive list approach, setting out certain specific classes of instruments (e.g., shares/stock, CIS, debentures) subject to regulation. The Media Release clarifies that MAS clearly intends to focus the definition of a ‘security’ towards a more principles-based approach that considers the underlying asset of an instrument.
Moreover, the Media Release is just one indicator in a number of notable developments that supports this principles-based approach. In 2015, a Consultation Paper was issued (the “2015 CP”) wherein the draft amendments removed the definition of securities from section 239 of the SFA and broadened the section 2 definitions to include certain “investments” such as “securities” and “securities-based derivatives.”5
These suggested amendments have the effect of expanding the scope of the definition of “securities” such that, as long as an underlying asset confers some beneficial interest (such as economic or voting rights) or legal title, it should be considered a “security.’’6
There is evidence that MAS already consider these expanded principles to be in place. In the “Frequently Asked Questions on Lending-Based Crowdfunding,”
MAS highlighted the relevant provision in section 239 of the SFA, where any invitation to lend money to an entity can be deemed to be an offer of debentures.7
In doing so, the MAS pointed towards the fundamental purpose of the transaction,and noted that this relationship should be analysed rather than applying a plain reading to the classes of pre-defined instruments. Debentures could thus be understood as any written, unavoidable, obligation to repay, whether these are bonds, notes, or certificates or other similar instruments.
Looking at the Underlying Products/Services
A critical analysis of the overall framework of an ICO/ITO is therefore needed before one can make an assessment as to whether the coin/token falls under the definition of “securities” under the SFA. A deeper analysis of ‘equities’ then would be relevant in drawing a parallel to instruments used in ITOs/ICOs. Owning ‘equity’ entails owning an economic or a voting right through a legal or a beneficial ownership in an equitable stake in the entity. While this package of rights is generally bundled together (i.e., voting rights are tied to economic rights), they have been frequently ‘decoupled.’ For example, voting rights are commonly decoupled from economic rights in preference shares. This allows investors to have greater (or lessor) economic or voting rights, resulting in the creation of
various classes of shares. Analysing units in a CIS would result in a similar interpretation, where participants own economic and legal rights over the property/assets at hand. Regardless of the exact combination of rights, it is
understood that all of these ‘bundles of rights’ should be considered regulated equities under the law as long as they confer upon investors certain legal or beneficial rights in an issuing entity.
Using this principles-based approach, one can determine that the substance of certain structured ICOs/ITOs amount in fact to the issuance of a security by the rights and obligations created in the offering. While many ICOs/ITOs are structured so that they provide both service and investment features, blurring the legal status, it is only in taking a critical look at the rights and obligations created in the offering that one can determine if the solicitation is for a service or a security. Where the coins/tokens issued grant participants rights mimic forms of
debt or equity, these are likely to be deemed securities. Coins/tokens that confer upon participants rights such as services, non-monetary rewards, physical assets (like gold or physical spaces), are further away from the securities line but may still be susceptible to being deemed a security due to the investable nature of the
instrument. While they differ superficially from the types of rights ‘traditional’ equity grants in entities, in substance, they still represent legal or economic rights in investments that may fall under the ambit of regulated securities.
Looking Abroad
Globally, most authorities have yet to announce their finalised position on the regulation of ICOs/ITOs. However, in the United States, the Securities and Exchange Commission (the “SEC”) has just made it clear that there are
circumstances where an ICO/ITO could constitute the offer and sale of a security.8
And, in an investigative report issued recently, the SEC stated that whether an ICO/ITO constitutes the offer and sale of a security “will depend on the facts and circumstances, including the economic realities of the transaction.”9
In doing so, the SEC noted that the issuance under investigation represented that the tokens issued would be available for secondary trading via several platforms.
Likewise, while the Chairman of the Australian Securities and Investments Commission initially said in an interview that ICOs are not considered equities,10 he went on to note that a coin/token launched in an ICO/ITO could be considered a security if financial obligations were offered in relation to the coin/token such that it is effectively a security —namely, an equity, debt-like instrument, or a derivative or either.
Where do we go from here?
The regulation of securities in Singapore appears to be, at first glance, one that adopts a positive list approach. However, MAS has demonstrated a movement towards a principles-based approach in its interpretation of the SFA with the Media Release, which supplements the approach seen in the regulations on lending-based crowdfunding and the refinements set forth in the 2015 CP.
Moving forward, considering the clarity put forth by MAS, it is clear that the issuances of ICOs/ITOs are activities that should only be done with independent legal advice, so as to determine if they do, in fact, constitute the issuance of regulated products. Further guidance should also be sought on basic anti-money laundering and countering terrorist financing protocols, thereby addressing the related risks associated with digital tokens. While MAS has not yet issued regulations covering this concern, the Media Release notes that these are forthcoming. Also, intermediaries facilitating or advising on offers of digital tokens/coins that are considered securities should take note that they will be subject to regulation in their activities.
In the event that a coin/token is issued in violation of Singapore securities law, rescission rights could apply and the courts could potentially unwind the ICO/ITO transaction, such that parties to the contract are restored to the position they were in prior to entering into the contract (with all damages awarded to the issuer).
There are also potential criminal sanctions for making a securities offer in violation of Part XIII of the SFA.
It is also important to note that it does not matter where the ICOs/ITOs are offered. If the issuer is Singapore-based, the SFA will generally apply to all sales of securities. Furthermore, a structure where the issued coins/tokens are only sold to persons overseas may be one that, by its very structure, shows an intention to attempt to circumvent Singaporean securities law due to a perceived awareness of the ICO/ITO itself being a regulated activity.11
ICOs/ITOs, done responsibly, have the potential to allow enterprises to raise capital efficiently shares of the capital of a company. In essence, stock is a certificate showing evidence of a share (or a portion) of a company.
Debentures – ‘debentures’ are defined in section 2(1) of the SFA. They are “any debenture stock, bond, note, and any other debt securities issued by a corporation or any other entity, whether constituting a charge or not, on the assets of the issuer.” Section 239(3) also offers further guidance on the definition of a debenture, where any invitation to deposit money with or lend money to an entity will be deemed to be an offer of debentures of the entity. Debentures or debt instruments are generally understood as written promises to repay a debt (e.g., bills, bonds, notes, certificates of deposits). In a debtor-creditor relationship, under the terms of an instrument, the issuer has an unavoidable/determined obligation to either deliver cash or some other financial asset to the holder of the debt. See, “Singapore Financial Reporting Standards,” Pocket Guide, 2008 Edition.]
CIS– ‘CIS’ is defined in section 2(1) of the SFA as:
“a) an arrangement in respect of any property—
(i) under which the participants do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management; and
(ii) under which any of the following characteristics are present
(A) the property is managed as a whole by or on behalf of a manager; or
(B) the contributions of the participants and the profits or income from which payments
are to be made to them are pooled;
(iii) the purpose or effect, or purported purpose or effect, of which is to enable the participants (whether by acquiring any right, interest, title or benefit in the property or any part of the property or otherwise)
—
(A) to participate in or receive profits, income, or other payments or returns arising from the acquisition, holding, management or disposal of, the exercise of, the redemption of, or the expiry of, any right, interest, title or benefit in the property or any part of the property; or
(B) to receive sums paid out of such profits, income, or other payments or returns…”
1 MAS has clarified that intermediaries in virtual currencies will be subject to anti-money laundering and countering terrorist financing regulations in the future.
2 The content of a white paper could include:
- what needs a project would fulfil;
- how much ‘money’ is required to undertake the project;
- how many of the virtual tokens the project pioneers will keep for themselves;
- what type of money is accepted; and for how long the ICO/ITO campaign will run.
However, in the absence of regulatory requirements, the content of this ‘white paper’ is not prescribed, and is instead left to issuers of the coins or tokens to determine the scope and specificity of the disclosure. There are also no prescriptions on the nature, accuracy, and completeness of information in white paper.
3 Of relevance to this discussion, there is a definition in Part I (section 2–Definitions) and another in Part XIII (section 239–Shares and Debentures) relevant to offers of investments.
4 This is a substantially simplified list, and conflates the problem in reading section 2 in conjunction with section 239. For example, the definition under section 2 of the SFA includes CIS and units in business trusts (or derivatives thereof). It also includes a ‘catch all,’ allowing MAS freedom to prescribe any other ‘product or class of products” to be a security, and a list of excluded instruments (e.g., bills of exchange and promissory notes). However, section 239 does not directly regulate CIS or business trusts, as those are separately regulated under different divisions of Part XIII. However, this does not mean that an offer of an interest in CIS is not a ‘security.’
Regardless, a common understanding of the securities instruments listed above is as follows.
Shares – these are defined in section 2(1) of the SFA as sharing the meaning set out in section 4(1) of
the Companies Act (Cap. 50). That definition states that a ‘share’ is a portion of the share capital of a
corporation, and generally includes stock.
Stocks–‘stocks’ are generally defined as standardised certificates for the issue or subscription to
5 Consultation Paper on Proposed Amendments to the Securities and Futures Act, February 2015, Monetary
Authority of Singapore. The two terms are themselves defined under the proposed section 2 of the revised SFA.
6 This revised definition is as follows. “securities” means —
a) shares or any similar instrument representing a legal or beneficial ownership interest in a corporation, partnership, limited liability partnership or unit in a business trust; or
b) debentures of a government, corporation, body unincorporated, partnership or business trust…
7 FAQs on Lending-Based Crowdfunding, Monetary Authority of Singapore.
In the United States, securities can broadly be understood as possessing several elements, and are understood as instruments representing transactions where a person invests his money or acquires a legal or financial interest in a common enterprise, and expects to receive profits from the efforts of the third party involved in the enterprise.
Securities and Exchange Commission v. W. J. Howey Co. , 328 U.S. 293.9The investigation had looked into whether The DAO, a ‘virtual’ organisation embodied in computer code and executed on a blockchain, had violated securities laws through the issuance of DAO Tokens. The SEC concluded that DAO Tokens are in fact securities. The DAO tokens provided both economic and voting rights to investors, where investors expected to earn profits through projects funded by The DAO enterprise and were also afforded a degree of voting rights in some of The DAO’s endeavours. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, The United States Securities and Exchange Commission.
10 http://www.coindesk.com/asic-on-blockchain-australias-securities-watchdog-unlikely-to-regulate-icos/
11 SFA Guidelines on Application of Section 339 (Extra-Territoriality) of the Securities and Futures Act
For further information, please contact:
Azman Jaafar, Partner, RHTLaw Taylor Wessing
