The rapid global rise of crypto assets as a new asset class has seen governments and regulators around the world scramble to identify suitable regulatory regimes. Out of the dust of that rise, we can now see the emergence of nascent regulatory frameworks, from the European Commission’s Digital Finance Strategy, to Gibraltar’s proposed ICO Regulations. A common theme of these frameworks – mandated disclosure requirements for offerings of crypto assets. So what are “Whitepapers” and how are they likely to be impacted?
Whitepapers: what are they?
Whitepapers have traditionally been used in the technology sector to provide technical information to potential customers on a product and to explain, in technical terms, how that product provides the solution to a particular problem. It therefore performs the dual function of providing technical information while also acting as a marketing document.
While whitepapers are not required to follow a legally prescribed form, they generally follow a well-trodden structural path starting with a short abstract detailing the purpose of the whitepaper, followed by a description of the problem they seek to solve, a technical description of how the product works, a description of how the product resolves the relevant problem and finally concludes with a summary of why this particular products functionality is the best choice for solving the specified problem.
Can the traditional form whitepaper be used for all crypto asset offerings?
While the potential regulatory requirements applicable to a new crypto asset may be broad and varied depending on the nature of the product, from e-money and brokerage licencing to AML requirements, the disclosure component will be most heavily impacted where the product is a form of coin or token. The rise in Initial Coin Offerings (ICO’s) within traditional regulatory frameworks, has left issuers and their counsel with one key precursory question to any ICO, is this coin a regulated financial instrument or an unregulated product? The answer, while more clear cut in some jurisdictions than others, dictates the approach to be taken to the offering document. A conclusion that the coin is a regulated financial instrument, invariably results in the obligation to produce a “prospectus” with its form and content prescribed by applicable securities laws and the traditional “whitepaper” is defunct. If the conclusion however, is that there is no regulated financial instrument, the whitepaper remains the document of choice.
While for unregulated offerings, whitepapers remain the predominant disclosure form, in response perhaps, to increased regulatory scrutiny, high profile enforcement actions by securities regulators and the growth of institutional players, there has been a detectable, but not universal, shift in approach. Components common to securities offerings, such as selling restrictions, securities style legends and robust risk factors, have started to appear.
Whitepaper or Prospectus for an ICO?
The initial determination as to whether a coin is a regulated financial instrument is a critical, but often complex task. The absence of a consistent international regulatory approach, requires a detailed jurisdiction-by-jurisdiction analysis in every target market, to avoid an inadvertent breach of securities laws. Some jurisdictions are more advanced in their adoption of laws and issuance of guidance specifically targeted at the asset class, which often simplifies and de-risks the analysis. Liechtenstein, for example, implemented its Token and Trusted Technology Service Provider Act on 1 January 2020, providing clarity on the treatment of crypto assets and the UK Financial Conduct Authority (FCA) published a Consultation Paper in January 2020, setting out guidance on crypto assets and their treatment within the UK regulatory perimeters under English law (for more information on the FCA’s guidance, please refer to our CryptoAM Talking Legal article published on 26 May 2020 which can be accessed [https://www.cityam.com/talking-legal/] ). In other jurisdictions however, the analysis requires a determination by analogy to existing securities laws.
If the crypto asset you are issuing is a security, what are the implications for the disclosure document?
While securities laws in jurisdictions across the globe vary in form and scope, invariably one commonality is a requirement that, absent a specific exemption, issuers undertaking securities offerings produce and submit to their national regulator for approval, a disclosure document which includes prescribed information.
In the European Economic Area for example, subject to specific exemptions, the EU Prospectus Regulation mandates that issuers making an offer of securities to the public within the EEA must file and submit for approval with an EEA competent authority a prospectus, compliant in form and content with detailed disclosure rules (see EU Prospectus Regulation (EU/2017/1129) . Unlike a whitepaper, a Prospectus Regulation compliant prospectus must carefully adhere to specific information requirements, in addition to disclosing all information material to an investor for making an informed assessment of (a) the financial position of the issuer, (b) the rights attached to the securities and (c) the reasons for the issue and its impact on the issuer (see Delegated Regulation (EU/2019/980)).
For crypto assets outside the ambit of current securities laws, issuers may continue to voluntarily issue a whitepaper. While a lack of mandatory rules as to content provides flexibility to use a more informational and promotional document, it may also provide incentive to exclude disclosure of underlying risks. As noted above, there has been a detectable shift in whitepapers for ICO’s to include elements more akin to securities offering disclosure. Issuers should also be aware that, while securities law requirements may not apply, jurisdictions are likely to have in place other legislation impacting content. The New Zealand Financial Markets Authority for example, has made clear that even if issuers are not selling a financial product, ‘fair dealing’ requirements still apply to whitepapers and other communications about the ICO under the New Zealand Fair Trading Act 1986.
The emergence of new regulatory regimes
Regulatory regimes specifically targeting crypto assets are starting to emerge and their potential impact on whitepapers can be clearly seen. Most recently, on 24 September 2020, the European Commission published its Digital Finance Strategy, which included a proposal to develop a comprehensive framework for crypto assets by 2024, consisting of clear disclosure requirements which would oblige a significant number of crypto asset issuers to produce a whitepaper prior to a public offering (we will have to wait and see if they will still call it a “whitepaper” or something else by then). Similarly, in January 2020, the Japan Financial Services Agency released draft ordines to amend current legislation for crypto assets and ICO’s.
Where they exist at all, regulations specifically targeting crypto assets are nascent, and the task of properly identifying applicable rules and disclosure requirements is a potential bear trap for issuers. Enforcement actions by securities regulators around the world, particularly in the ICO space, are clearly evident, from the United States and Japan, to South Korea and Switzerland, highlighting the importance for issuers of undertaking a sound jurisdictional analysis.
Evident from the above, is how crucial it is for issuers to properly identify the regulatory classification of their crypto asset and prepare disclosure accordingly. But beyond the current regulatory regimes, issuers should be prepared for the imminent arrival of new and targeted rules prescribing and mandating disclosure for the crypto asset class.
By Abradat Kamalpour, Partner Ashurst LLP and Architect of FinTech Legal Labs (www.fintechlegallabs.com), Conor Funston, Consultant Ashurst LLP and Ida Mokhtassi, Associate Ashurst LLP.