Initial Coin Offerings, or ICOs, have become big business, with a surge of individuals and organisations turning to the digital economy.
With reports that more than US$2 billion has been raised through ICOs already this year, it seems that ICOs, or at least the mechanics behind them, are here to stay. However New Zealand law is starting to catch-up with this easy, technology-enabled, way for companies to raise capital online and across borders.
Top law firm MinterEllisonRuddWatts is helping businesses understand this new development and where it fits into the current, and changing, legislation – as well as how it can be used to help achieve capital raising objectives.
“Over time, the lines between traditional capital raising methods and ICOs are like to become blurred as we start to see a convergence of the old paper-based financial markets and the new digital economy for money,” says Jeremy Muir, Partner at MinterEllisonRuddWatts.
Senior Associate Andrew Suggate adds: “The main appeal of ICOs is their speed, ease and flexibility. A company, group or individual can create a token which serves as a mechanism to participate in a project or enterprise. Issuing these token can then, subject to compliance with any applicable securities laws, allow for both the raising of funds for and a means of payment within a the project or enterprise. “
“The DAO” (Decentralised Autonomous Organisation) raised US$150 million through an ICO in 2016. The DAO invited people to buy digital tokens in exchange for ‘rewards’ which it likened to dividends. This caught the attention of the US Securities and Exchange Commission (SEC) who in July this year ruled that The DAO tokens were in fact securities.
Australia, the UK, Singapore, Malaysia, Hong Kong and Canada have echoed the view that certain classes of tokens may be securities, with China going as far to declare ICOs illegal and requiring issuers to repay investors.
In New Zealand, regulators have yet to express their views on the status of these offers under securities law.
The Financial Markets Conduct Act 2013 (FMCA) has provisions that apply to offers of ‘financial products’ and has a broad definition of ‘security’ that covers other financial arrangements. Securities are not themselves regulated. But the Financial Markets Authority (FMA), the New Zealand financial markets regulator, has the power to declare that a security is a financial product (although not retrospectively) and from that point the financial product is under the regime.
Comparing the four broad classes of tokens to the definitions of what constitutes a ‘financial product’, Muir and Suggate concluded in their white paper that, depending on their characteristics, some tokens could be financial products, and the definition of security is broad enough to potentially capture any token.
“If a token offered through an ICO is a financial product, that ICO would need to meet the requirements of the FMCA. If it is offered to retail investors, these requirements would include disclosure, governance, licensing and financial reporting obligations,” says Jeremy Muir.
Whether, and in what form, regulated offers of tokens that are financial products will be permitted is yet to be seen, as there has not yet been a retail offer of such a token in New Zealand.
In terms of New Zealand’s role in promoting this new digital economy, Jeremy Muir says: “a balancing act is needed to protect investors without stifling an innovative new investment technology.”
In the coming months, the FMA is expected to release general guidance on ICOs for offerors and investors. This should provide greater detail of the regulator’s views on when tokens will be financial products under the FMCA.
However, not all tokens will be financial products. Muir and Suggate recently assisted VerifyUnion to offer the UC Coin in New Zealand – the country’s first ICO.
“The first ICO is an exciting development for the New Zealand digital economy,” says Andrew Suggate.
The UC Coin allows holders to access and acquire services in the VerifyUnion ecosystem, which is an Ethereum Blockchain-based solution seeking to solve the issue of creating trusted digital identities. This solution lets users manage their digital identity by storing and verifying that identity on the Blockchain, and by permitting service providers access to that identity for KYC and other identity management purposes.