STOs – Securitized Token Offerings – are the current hot trend in the crypto industry, with more businesses and startups looking to the STO as a viable method of raising funds from public and institutional investors alike.
I previously wrote about how businesses might set about conducting an STO in the US, and the various options available in North America that comply with the rules and regulations of the SEC – the securities and exchange commission which governs securities laws in the US.
However, the United States is only one jurisdiction. There are a completely different set of rules and regulations that need to be accounted for when it comes to launching an STO in Europe. While the climate for STOs is far more welcoming than in the US, with more accessible markets and greater regulatory latitude, the very nature of the European Union (EU) as a collection of nation states presents its own set of issues.
The European Union and the European Securities and Markets Authority
In the EU, the body responsible for securities regulation is known as the European Securities and Markets Authority (ESMA), and it has issued guidance for investors and businesses.
In 2017, ICOs were labelled by ESMA as “high risk” investments, but it stated that “depending on how they are structured, [ICOs] may fall outside of the regulated space”. In particular, payment and utility tokens may not be deemed securities by ESMA, or by the relevant EU member state.
While this ruling encouraged new crypto businesses to start up in Europe, the “hands off” approach also served as a warning to investors: if the ESMA elects not to regulate utility token sales, there are no safeguards and you’re entirely on your own.
There were also other statements from ESMA, which did not necessarily set strict boundaries for businesses, but did imply that it trusts businesses to act in a lawful way. For example, it stated that companies “must give careful consideration as to whether their activities constitute regulated activities” or they will face the possibility of legal action.
The Ins and Outs of the Prospectus Directive
For STOs, there are several relevant pieces of ESMA legislation which need to be accounted for. This includes the Prospectus Directive, which demands that adequate information is provided to investors prior to the sale of securities anywhere in the EU.
What constitutes as adequate information depends on the relevant national financial authority, but essentially, businesses need to provide investors with everything they need to know in order to make an informed decision, such as business information, financials and shareholding structure.
EU member states may be exempt from the need for a prospectus, up to the value of €8 million. This exemption figure is decided by the individual nation state so it does not always match the maximum allowance.
Further prospectus exemptions can be obtained where the funding is only to be sought from “qualified investors”, or where the minimum investment required from each investor is €50,000 or more. In the case of this exemption type, the securities cannot then be freely traded to retail investors.
But There’s Still More to Consider…
As well as meeting ESMA guidelines and abiding by the laws of the country they operate in, businesses also need to work within other regulatory frameworks, including the Markets in Financial Instruments Directive (MiFID), the Alternative Investment Fund Managers Directive (AIFMD) and the Fifth Anti-Money Laundering Directive.
This latter piece of legislation deals with due diligence and attempts to prevent illicit money sources from entering into the EU. In practical terms, this legislation relates to KYC/AML standards set out by the ESMA.
Furthermore, there are several countries in Europe which are anomalies when it comes to STO regulation. For example, although Liechtenstein is not an EU country, it does comply with the EU prospectus directive.
In fact, the first European STO in compliance with ESMA requirements was conducted in Liechtenstein by the Nash exchange platform, after the company made significant inroads with Lichtenstein’s Financial Market Authority (FMA) in October 2018.
Switzerland is another anomaly and the prospectus directive does not directly apply to the country. However, the Swiss Financial Market Supervisory Authority (FINMA) is currently harmonizing much of its regulatory framework with MiFID and the EU prospectus directive.
Other countries that have more friendly policies for blockchain businesses and STOs include Malta, Gibraltar, and the United Kingdom, of which the latter has already passed the new prospectus issue exemptions into law as part of the Financial Services and Market Act.
However, the UK proves a tricky market for crypto businesses and while both the UK’s Financial Conduct Authority (FCA) and ESMA are working to avoid any split in the legislative structure post-Brexit, no specific guidance on blockchain technology has been released, leaving the UK in an uncertain position with regards to crypto assets as well as its future relationship with the EU.
The European STOs of the Future
While it is up to the governing bodies of individual member states to rule on what constitutes a financial instrument and a regulated activity, it is better to err on the side of caution. With this in mind, any company conducting an STO in Europe should operate from the starting assumption that their token offering falls into the category of a security and should ensure they are compliant with regulation accordingly.
In general, the EU has been a favorable market for both ICOs and STOs to date, with the ESMA plumping for the carrot over the stick. The aim is to encourage companies to join the regulated market, while warning investors away from unregulated ICOs.
With greater harmonization and greater clarity between nations, we can expect improved progress on what constitutes a security at an EU level. Until that point, there will remain complexity in launching an STO to the European market.