One of the most important questions asked when contemplating creating a crypto digital asset on the blockchain (whether you call it a “coin” or a “token” or some new name) is how will such digital assets be treated under the law in the relevant jurisdiction(s)? How it is treated under the relevant law is critical in terms of your regulatory obligations and the obligations of those involved in any offering, holding and related services. So how are such digital assets viewed under English law?
The UK Financial Conduct Authority (FCA) helpfully published a Consultation Paper in January 2019 followed by a Policy Statement in July 2019 setting out guidance on cryptoassets and their treatment within the UK regulatory perimeters under English law (the Guidance).
The Guidance sets out the main categories of cryptoassets outlined below, and describes whether they fall under the regulatory perimeter of financial services activities and the definition of a “Specified Investment” under the Financial Services and Markets Acts 2000 (Regulated Activities) order 2001 SI 2001/544. Firms carrying out certain Specified Investment activities in relation to cryptoassets in the UK must get the appropriate authorisation from the FCA or ensure that they are exempt. The Guidance indicates that every digital asset needs to be analysed on a case by case basis to determine its regulatory perimeter, namely:
a) Security tokens: These tokens meet the definition of a Specified Investment and are within the regulatory perimeter. They have specific characteristics which means that they provide rights and obligations akin to specified investments, like a share or a debt instrument including those that are financial instruments under MiFID II.
b) E-money tokens: These are tokens which meet the definition of electronic-money (e-money) under the Electronic Money Regulations 2011 (EMR) and would be regulated under the EMR.
c) Utility tokens: These tokens grant holders access to a current prospective product or service but do not grant holders rights that are the same as those granted by Specified Investments (as above) and therefore fall outside the regulatory perimeter.
d) Exchange tokens: These tokens are designed to provide limited or no rights for tokens holders, and there is usually not a single issuer to enforce rights against. They are used as a means of exchange and are not issued or backed by any central authority or any traditional intermediaries. They fall outside regulatory perimeters and would not be classified as a Specified Investment.
It is therefore vitally important to determine whether a digital asset is a Specified Investment. So what factors need to considered to classify a digital asset as a Specified Investment ? Given the diversity and complexities of various digital assets, it is not always easy to make this determination. The Guidance helpfully sets out the following factors that should be
considered in analysing whether a digital asset is a security and in particular a Specified Investment:
• The nature of contractual rights and obligations the holder has by virtue of holding or owning that cryptoasset
• Any contractual entitlement to profit-share (like dividends), revenues, or other payment or benefit of any kind
• The language used in relevant documentation, like cryptoasset ‘whitepapers’, that suggests the digital assets are intended to function as an investment, although it should be noted that the substance of the token (and not the label used) will determine whether an instrument is a specified investment. For example, if a whitepaper declares a token to be a utility token, but the contractual rights that it confers would make it a share or a unit in a collective investment scheme, it is going to be considered to be a security token
• Whether the digital asset is transferable and tradeable on cryptoasset exchanges or any other type of exchange or market
• A direct flow of payment from the issuer or other relevant party to holders may be one of the indicators that the digital asset is a security, although an indirect flow of payment would not necessarily indicate the contrary. If the flow of payment were a contractual entitlement that would be considered to be a strong indication that the digital asset is a security.
Although the Guidance provides some clarity for market participants in the industry, the UK’s approach to digital assets is still being developed and the FCA plans to provide further clarity on the subject. The above considerations are also not exhaustive and should not be considered as a substitute for proper legal advice. It is important to consider the nature and characteristics of digital assets that are being designed and consider carefully how they are likely to be treated under the law before they are launched, using the Guidance and good legal counsel.
By Abradat Kamalpour, Partner Ashurst LLP and Architect FinTech Legal Labs and Ida Mokhtassi, Associate Ashurst LLP
In Partnership with Electroneum