19 March, 2019
In January 2019, the Australian Department of the Treasury published an ICO Issues Paper initiating a public consultation on initial coin offerings (ICOs).
In the Issues Paper, the Treasury reviewed current developments in the crypto sector including market prospects and regulatory approaches not just in Australia, but with a look around the globe. Interested parties can submit statements to the Treasury until 28 February 2019 and thus participate in the further development of Australia’s regulatory framework for ICOs.
In Germany, one consultation on the questions of ICOs and token has been launched so far. Certain interest groups lobby in Berlin and BaFin ran a consultation on anti-money laundering obligations in connection with virtual currencies. Addressed solely to financial institutions, the public, however, was excluded from the process.
What is the content of the Issues Paper?
The Treasury’s Issues Paper acknowledges that FinTechs have the potential to transform the Australian economy. Australia intends to be a global leader in technology and financial innovation to facilitate productivity and economic growth that also ensures efficiency and inclusiveness of the financial system. ICOs are challenging the regulatory frameworks – not only in Australia but globally.
Definition and categories
In a first step, the Issues Paper outlines current progress around ICOs. It takes a look at the definitions and token categories. It makes references to the distributed leger technology underlying issued tokens. The paper sees three categories of tokens based on the rights they may incorporate: currency token/stablecoin granting “the right to another digital currency”; equity/asset/investment token granting “the right to a promised future cash flow” and utility/access token granting “the right to access a product or service”. However, it also acknowledges that the classification of a particular token may face difficulties. ICOs are a new form of fundraising also containing new chances.
Opportunities and risks
The Issues Paper also outlines the opportunities and risks connected to ICOs – for the industry, consumers and investors, and the economy as a whole.
They enable the industry to raise funds against equity, funds for management or forward sales revenue. This allows start-ups to build and develop platforms or products. Also, compared to traditional financing and fundraising, certain costs can be avoided. Nevertheless, the increase in efforts and costs connected with the preparation of the sale, start-ups may underestimate the upfront costs. ICOs allow access to a large number of investors each contributing low amounts, procuring new investor groups. On the other side, reputation can be at risk as there were several failed or illegal ICOs as well as scams. The paper identifies uncertainty of or unfamiliarity with the regulatory regime as risks.
Consumers get the chance to participate at an early-stage of a start-up and thus profit from its growth (compared with a limited access before while waiting for an IPO or access reserved to professional investors). ICOs also bring liquidity to the early-stage market and allow participation in the performance of the token (in particular when becoming an accepted asset class). In addition, counterparty risk may be reduced by smart contracts. Those advantages and opportunities are accompanied by risks for consumers, in particular in connection to inappropriate due diligence or insufficient understanding of the challenges connected to an ICO and the underlying technology. To counteract, the Australian Securities and Investment Commission (ASIC) issued an investment warning back in April 2017 (which is also updated). The paper acknowledges high financial risks, failed or fraudulent ICOs, inappropriate data in white papers, misleading information or misrepresentations, missing protection when financial regulation does not apply, extreme volatility, and operational risks in connection to the product or the digital infrastructure.
Ultimately, the economy as a whole faces risks and opportunities. The paper references jurisdictions actively trying to attract ICOs to facilitate innovation and connected growth as well as to invite capital. Those jurisdictions may also benefit from ancillary services (like crypto exchanges, wallet providers as well as advisors and consultants (legal and financial)). However, speculations based on historical records link the risk of excess, fraud and capital misallocation resulting in lower returns on investment preventing economic growth. When lager ICOs fail, this may also affect the trust and confidence in the regulatory system as such and damage the financial sector.
Regulation of ICOs
The paper’s regulatory outline concerns not only the Australian perspective, but engages with regulatory schemes abroad including China’s and South Korea’s ICO-ban and the guidance notes of US-American SEC and European ESMA. With more particular detail, the paper presents the regulatory regimes in the USA and Switzerland. The regulatory burdens (e.g. long response time) in those countries are addressed. It also provides the idea of a separate framework for all ICOs.
In Australia, investors are protected either through the Australian Securities and Investments Commission Act covering financial products and administered by the AISC or the Australian Consumer Law covering other cases and administered by the Australian Competition and Consumer Commission (ACCC).
However, in the field of ICOs, the power of regulation of none-financial ICOs has been delegated from ACCC to ASIC (allowing a uniform approach). The paper discusses feedback from the industry that consumer laws are currently appropriate to ICOs.
In case of ICOs constituting a financial product, there are four particular regulatory schemes which may apply. The ICO can be a managed investment scheme, a share offering, a derivative, or a non-cash payment facility. ASIC has issued guidance on this in May 2018 subject to an update in the first quarter of 2019. In addition, industry established minimum standards play a role in regulation, but might be not sufficient.
The paper discusses proposals to create a new, separate regulatory framework for ICOs to support the Australian marketplace. The Treasury however sees the costs connected with a new regime as a significant counterweight to the economic benefits. A new regime would also create legislative complexity and oppressing innovations by freezing current ICO models.
In addition, the paper takes a look at tax treatment of ICOs.
Questions raised
To encourage submissions to the consultation, key questions are raised at the end of each section of the paper. The questions ask, among other things, for the clearest way to define ICOs and token categories, the importance of secondary markets, the key drivers to the ICO market and how ICOs contribute to valuable innovation. Practically none of the statements in the paper are absolute, but welcome public input. The interest of the Government becomes apparent when it is asked how important ICOs are to being a global leader in FinTech. The discussion brought to the public also includes the question whether ICOs shall be inside or outside of the current financial regulation and whether it enables ICOs and a legitimate ICO market. It also asks for changes required to achieve this aim. It appears that the paper seeks to prompt a well-functioning ICO market in Australia and looks for different views from people which deal with ICOs and cryptocurrencies.
And Germany?
The German government and the regulator BaFin appear to have a more conservative view, (sometimes) overlooking the opportunities for industry, consumers and economy (while emphasising the risks). It is welcome that BaFin provides consumer warning to potential investors as this is part of the maturing market. While in the early days technical experts were investing, general consumers need to be aware of the connected risks before making an investment.
BaFin conducted a consultation on anti-money laundering obligations in connection with virtual currencies in October 2018 (only available in German).
BaFin also issued an advisory letter on the classification of tokens as financial instruments in March 2018, stating case-by-case decision will be made (however, not counteracting uncertainties). The coalition agreement of the current government notes distributed ledger technology and ICOs, but there is hardly any movement. The Australian Issues Paper emphases interest in establishing an ICO market and supporting innovations and FinTech.
The Australian market accommodates several crypto exchanges (one recently received insurance cover for loss and theft by Lloyd’s). The latest news from Germany was less optimistic when the equity token from Neufund was required to raise the minimum investment to EUR 100,000 after (almost two years) long BaFin consultations (the Issues Paper considers a regulatory burden when determinations last up to six month). Amplified interest of the German government in the establishment of a German crypto market and BaFin giving clear guidance how to create an environment allowing new technology to prosper would go a long way. It will be interesting to see whether the Security Token market will be able to flourish in this environment or whether Bitbond’s STO will only be an exception. At least the federal ministry of finance’s announcement to collect comments from market participants through the launch of www.blockchain-strategie.de sounds promising.
Dr. Michael Jünemann, Partner, Bird & Bird
michael.junemann@twobirds.com
