By James Inness and Stuart Davis
Initial coin offerings (ICOs) involve issuers offering virtual coins or tokens that are created and disseminated using blockchain or distributed ledger technology. Virtual coins resemble cash in a number of ways but may also afford holders additional rights, such as the ability to access the platform or software, or participate in the profits, of the issuer of the virtual coins or tokens. Post-issuance, virtual coins or tokens are tradeable on a secondary market.
Tokens as securities
The popularity of ICOs as a funding mechanism has mushroomed in 2017. In response, regulators in key financial centres around the globe have warned issuers that existing regulatory regimes for securities offerings may apply to the person(s) making or marketing ICOs. Some regulators have gone further, adopting a blanket ban on fundraising though ICOs.
Given the additional regulatory scrutiny of ICOs and the significant, sometimes criminal, sanctions levied for breaches of the rules, many issuers are erring on the side of caution and structuring ICOs as securities offerings.
EU prospectus regime
The EU regime governing the offering of securities potentially provides opportunities to ICO issuers compared to the private placement regimes of other jurisdictions around the world.
First, the EU prospectus regime requires only issuers of “transferable securities” to publish an approved prospectus, rather than applying to securities generally. The threshold question is whether virtual coins are “transferable securities,” and this will turn on the nature of the instrument being offered and will require analysis on a case-by-case basis. This should be contrasted with the prospectus/disclosure regimes of other jurisdictions, many of which apply to securities generally, regardless of transferability.
Secondly, in many jurisdictions, there are limited exemptions to the full scope of the prospectus/disclosure requirements for offers made exclusively to accredited investors. Conversely, the EU Prospectus Directive contains a number of exemptions from the requirement to publish an approved prospectus (PD Exemptions) that allow a range of structuring options, including:
- Offers made to “qualified investors”
- Offers made to 150 non-qualified investors per European Economic Area (EEA) member state
- High-denomination securities (worth more than €100,000)
- A floor on minimum investment (of at least €100,000 per investor)
- A ceiling on the total size of the investment (of €100,000 or less)
Thirdly, many prospectus/disclosure regimes set additional requirements for the offering memorandum’s registration or content, or even limit/prohibit the secondary market trading of securities altogether, even when the offer is made only to accredited investors. Conversely, in the EU, an issuer can rely on one of the PD Exemptions in relation to an offer without facing such requirements or prohibitions — provided that the issuer complies with any additional local financial promotion rules. This freedom reduces the offering’s complexity — meaning, the offer can be completed relatively quickly compared with other jurisdictions.
Therefore, the EU Prospectus Directive regime offers issuers a number of potential benefits in terms of flexibility, low complexity, speed of issue, and the availability of immediate secondary market trading that make the EU an attractive place to raise finance. Whether or not the EU becomes a hub for a new wave of ICO issuers wanting to issue security tokens remains an open question. The benefits outlined above should encourage issuers to consider an offering in the EU; however, other considerations — including where target technology investors are concentrated — will also undoubtedly be important.
Read more on ICOs:
Coining it in: ICOs as the New Fundraising Paradigm?
SEC: Certain Initial Coin Offerings Are Securities Offerings
Initial Coin Offerings – An Unregulated Market? – Written in German.