As we have already discussed recent regulatory updates by the Spanish government on taxation and registration matters for the purposes of anti money laundering in our earlier article, this time we will broadly examine the categories of tokens and the recent regulatory guides on how commercialization of tokens is treated for investment law purposes.
LEGAL AND REGULATORY FRAMEWORK
In July 2021 Spanish Stock Market Regulator (Comisión Nacional del Mercado de Valores; hereinafter:- “CNMV”) published a proposal for a circular to address the mass advertising of crypto-assets. The Circular provides a normative definition of crypto assets, as “digital representation of an asset or right that can be electronically transferred or stored by using distributed ledger technologies or other similar ones”.
The CNMV and Bank of Spain released a new press statement on cryptocurrency investment risks in 2021. In 2018, CNMV and Bank of Spain issued a joint press statement on “cryptocurrencies” and “initial coin offerings (ICOs)’, on the associated risks related with purchasing virtual currencies or investment products linked to them.
Besides, the CNMV has issued two other documents outlining its viewpoint and position on specific matters corresponding to virtual currencies. However, only the CNMV has issued a statement to explain that it has not authorized any prospectus, nor has it exercised any authorisation for, or power to verify, any transaction in relation to virtual currencies and it remains effective up to date.
CATEGORIES OF TOKENS
CNMV still does not yet have a clear standpoint as to the legal categorisation of crypto tokens, and has unofficially claimed that virtual assets shall not be treated as securities. Moreover, CNMV believes that nature of the cryptokens vary, and the widely used distinguishing characteristics can be classified into two:
- “Security tokens” which generally grant participation in the future income or the increase in the value of the issuing entity or of a business;
- “Utility tokens” which give the right to access a service or receive a product, without prejudice to which, on the occasion of the offer, mention is usually made of expectations of revaluation and liquidity or the possibility of trading them in specific markets.
On the other hand, the draft law introduced in april 2021 also included the instruments issued by means of distributed ledger technology within the list of financial instruments in the Spanish securities market law. In view of this, as specified by the reports from the European Securities and Markets Authority and the European Banking Authority (EBA), virtual tokens can be categorized into four, namely:
- currency tokens (cryptocurrencies with no rights or investment purposes);
- security tokens, which usually provide property rights, interest rights or dividends attached to a business;
- utility tokens, which facilitate access to a product or a service, but do not serve as a payment method for other products or services; and
- hybrids, which might fall into more than one of three categories listed above.
The CNMV and the Bank of Spain warn that, to date, there has not been any “cryptocurrency” issue or ICO registration, authorization or verification by any supervisory body in Spain. This implies that there are no “cryptocurrencies” or “tokens” issued in ICOs whose acquisition or possession in Spain can benefit from any of the guarantees or protections provided for in the regulations relating to banking or investment products.
Despite the foregoing, after carefully reviewing how digital assets are marketed and acquired, the CNMV has confirmed that the virtual token offering and commercialisation might have investment law implications:
- Direct marketing
Digital currencies are bought via platforms operating on the internet (exchanges) and cryptocurrency automatic teller machines (ATMs). In either of the cases, the investor does not have an exclusive ownership to virtual assets, but only has rights in connection with an unsupervised exchange or intermediary. Consequently, purchasers might be exposed to the risk of an insolvency of the intermediary and noncompliance with underlying rules of appropriate record keeping and, diligent custody and assets recording and accurate management of conflict interests.
- Contracts for differences (“CFDs”)
Entities offering these types of products must be authorized by the CNMV in order to provide investment services and comply with all reporting obligations and other applicable codes of conduct. Thereby, market participants shall be aware that this kind of contracts generally involves greater risks.
- Futures, options and other derivatives
If these categories of financial products have earlier been authorized by a regulated supervisor, their active marketing by a public offering by market professionals to retail investors may entail a prospectus approved by the CNMV or another EU authority that has been subject to passporting arrangements.
- Collective investment vehicles that invest in cryptocurrencies
The CNMV has affirmed that UCITS (Undertakings for the Collective Investment in Transferable Securities) can invest in virtual currencies through financial instruments whose profitability is linked to those currencies and that do not incorporate an implicit derivative instrument, provided that their price is published in a market each day. Moreover, Hedge funds might invest in cryptocurrencies through derivatives as well, if the derivative settlement does not imply the delivery of the applicable currencies, even though these kinds of funds can only be traded with professional investors. In any case, investments in cryptocurrencies and the risks must be expressly and prominently mentioned in the prospectus and key investor information document of any Spanish collective investment scheme. These types of investment funds or vehicles must be approved or registered by CNMV.
- Acquiring structured bonds whose underlying asset is a virtual currency.
By acquisition of structured bonds where the underlying asset is cryptocurrency (Exchange Traded Products or ETPs, and Exchange Traded Notes or ETNs). Under public offering scheme, marketing of exchange-traded products and exchange-traded notes necessitates to have approval by supervisory authority of an explanatory prospectus that has also been subject to the relevant EU passporting procedure.
CNMV recognizes the potential benefits of technologies and innovation that might drive the financial services industry and particularly regards the proportionality principles on exercising supervisory powers. CNMV acknowledges that the transactions formed as Initial Coin Offerings (ICOs) generally shall be treated as issuance or public offerings of transferable securities based on the extensive definition of transferable security under Spanish law (Article 2.1 of the Spanish Securities Law)
- tokens that assign rights or expectations of a share in the potential increase in value or profitability of businesses or projects or, in general, that they constitute or assign rights equivalent or similar to those of shares, bonds or other financial instruments included in Art. 2 of the Spanish Securities Law; or
- tokens that entitle access to services or to receive goods or products, that they are offered referring explicitly or implicitly to the expectation that the purchaser or investor will obtain a profit as a result of their increase in value or some form of remuneration associated with the instrument, or reference is made to its liquidity or tradability on equivalent or allegedly similar markets to regulated securities markets.
Nevertheless, with respect to the second point, if it cannot be reasonably established that there is an interrelation between the profit expectations or an increase in value and the evolution of the underlying business or project, then the token should not be considered a financial instrument. In the event that the ICOs qualify as financial instruments, regulations in relation to Markets in Financial Instruments Directive II, the Prospectus Directive and the Alternative Investment Fund Managers Directive should apply to them.
It is worth to note that if the ICO does not qualify into Public Offering (e.g. fewer than 150 investors or involves a minimum investment of €100,000 or a total amount of less than €5 million), if it has been advertised (including websites in Spanish offering the tokens), then this entity would be an entity authorized to provide investment services should intervene in relation to its marketing, thus the provisions of Art. 35.3 of the Securities Market Law would be applicable. The CNMV understands that this requirement is deemed to be fulfilled if the entity authorized to provide investment services intervenes:
- on the occasion of each individual subscription or acquisition of the securities or financial instruments as a placement agent, broker or adviser, subject to the rules applicable in each case; or
- by validating and supervising the offer in general and, in particular, the information provided to investors, and the placement or marketing procedure used (without an authorized entity having to intervene on the occasion of each subscription or acquisition). With regard to the validation of information, the authorized entity must ensure that the information is clear, impartial and not misleading, and that it refers to the characteristics and risks of the securities issued, as well as the company’s legal, economic and financial situation, in a sufficiently detailed manner to allow the investor to make a well-informed investment decision. Likewise, the information for investors shall include a warning on the novel nature of the registry technology and on the fact that the custody of the tokens is not carried out by an authorized entity.
Last, but not the least, it should emphasized that, regardless of the place of issuance of the tokens, if the issue complies with the abovementioned criteria (and may, therefore, qualify as a transferable securities issue), then its active marketing in the kingdom of Spain (for example displaying the availability of websites in Spanish offering the tokens) will be subject to the aforementioned rules as well.
Up to now, the CNMV has not yet authorized any ICOs, even though it has analyzed numerous prospective ICO structures. Moreover, the draft law stipulates that the CNMV might mandate the advertisers of crypto-assets for investment purposes to authorisation, involving the forewords of warnings on risks and characteristics, although they are not products covered within the scope of Spanish securities market law. In this respect, the CNMV published a draft circular for public consultation in June 2021, aimed at developing the standards, principles and criteria to which advertising activity associated with crypto-assets will be subject and, specifically, to define the objective and subjective scope, as well as the supervisory powers of the CNMV on the advertisement of crypto-assets.
However, a more universal regulatory approach and development is still needed at European and international level, as it is quite difficult to fit existing legislative instruments into new business and alliance models. Hence, the complication of applying the prevailing norms in a digital sector and notably its transnational nature necessitates efforts at international cooperation.