On 16 August 2019, the German Federal Financial Supervisory Authority (BaFin) published an updated guidance notice (German) on the issuance of crypto token (e.g. through ICO, ITS or TGE) providing assistance with licence requirements and prospectus obligations token convey.
In 2018, BaFin received numerous enquiries as to whether blockchain-based token (or coins) trigger a prospectus obligation or licence requirement. The majority of questions focused whether the token represent a security or a capital investment, or whether the issue and trade constitute banking business or financial services. In our recent series (part 1) we have extensively assessed the legal classification of token (find parts 2-5 linked below) and regularly advise clients on this hot topic.
An ICO (Initial Coin Offering), often called STO (Security Token Offering) or TGE (Token Generating Event), is an innovative corporate finance method. In order to realize a business within the framework of an ICO, funds are raised by a company. The product issued in an ICO is a blockchain-based coin or token (hereafter referred to only as token).
BaFin assesses case by case whether a token is subject to the prospectus obligation and/or the license requirement based purely on a technologically neutral application of the relevant law. Bearing the numerous enquiries in mind, BaFin also addresses the leaflet to ICO issuers and their legal representatives.
Efficient and constructive enquiries
In the guidance notice, BaFin makes special referrals to the requirements for an efficient and constructive enquiry concerning the legal qualification of token. BaFin particularly criticises incomplete attachments and documentation. According to BaFin, some early applications were submitted without any documents attached, and some documents that were required for the regulatory classification (e.g. White Paper/General Terms) have been in part amended without notification. Documents showed contradictory statements, or questions of BaFin were not sufficiently answered. Irrelevant answers of token issuers regarding the assessment posed a particular nuisance to BaFin.
To ensure a timely and orderly process BaFin thus requests submission of all relevant and updated documents. Additionally, BaFin requests a substantiated self-assessment of the legal qualification which should be based on the information provided by BaFin. BaFin further recommends initiating contact at an early stage to allow for a duly response with regard to ICO timeframes and deadlines. The case-by-case review is often time consuming, especially with regard to the possibility to draft and accept a securities or capital investment prospectus. We can deliver the right advice for an efficient enquiry process with BaFin.
Confirmation of regulatory treatment
BaFin confirms its previous notices on ICOs differentiating utility token, currency token and security token. While “true” utility token are usually outside of any prospectus obligation or license requirement in Germany, currency token and security token fall within that scope. Hybrid forms require a case by case assessment of their functionality and content.
I terms of regulatory treatment BaFin confirms that it is not the denomination or labelling of a token within one of the three categories, but the rights associated with the token that classify it as a security and the actions performed as banking business or financial service.
Features of securities
For the qualification as securities, the token must fulfil the essential characteristics namely standardisation, negotiability and transferability in (capital) markets as well as incorporation of ´rights comparable to securities. BaFin clarifies that a security token that is designed as a capital investments (within the meaning of the section 1 (2) German Capital Investment Act - VermAnlG) becomes a security (within the meaning of the EU Securities Prospectus Regulation and the German Security Prospectus Act - WpPG) in the moment it is “tokenised”. Tokenisation is the illustration of a specific right on the blockchain. According to BaFin, tokenised capital investments become negotiable in the capital markets and securities sui generis, (unless the token is not freely transferable and negotiable) rendering the VermAnlG with minor significance for token. The instead applicable Prospectus Regulation and WpPG, require a prospectus for the placement of securities in Germany. The range of coverage, BaFin highlights, extends to any unrestricted and public offer on the Internet. These are available to a worldwide audience, naturally including Germany, thus triggering the German prospectus requirement.
The very first issuance of token and its previous advertisement may already require a licence. This is particularly the case for deposit business, e-money business, investment business and various financial services. As stated above, it is the design of a token which is the basis for regulatory requirements: BaFin points out relevant is the design of a token where orders are executed:
• Token that can be returned at the purchase price, likely constitute deposit business.
• Token sold in exchange for fiat money that embody a claim against the issuer and are accepted by third parties as a means of payment, likely constitute e-money.
• Token exchanged for funds that are then (re-)invested to the acquirer’s benefit, likely constitute an investment fund and the issuer is managing a collective investment undertaking.
• Token that qualify as financial instruments within the meaning of the German Banking Act (KWG), likely constitute the object financial services when used for trade.
The time and effort put into a detailed guidance notice is reason to assume a general openness of BaFin to enquiries and coordination with the issuers. To guarantee a timely processing of the high number of enquiries, these enquiries s should be complete, formally correct and provide high quality information. Special attention should be given to the legal self-assessment which proved to present particular challenges when the issuer has not been advised by legal professionals. As crypto regulation is moving forward (e.g. with the implementation of the fifth European Anti-Money Laundering Directive in Germany) requirements and qualifications may change and BaFin will keep updating its respective guidance notices.