Initial Coin Offerings ("ICO") are a new and exciting form of fundraising. Due to this, regulators are still evaluating how they should be treated so it is very difficult to figure out what type of regulations an ICO actually has to comply with.
At an EU level, Initial Coin Offerings ("ICO") are not directly regulated. However, European authorities have weighed into the issue providing some preliminary guidance. The European Securities and Markets Authority ("ESMA") has taken the view that depending on how an ICO is structured, the coins or tokens could fall within the definition of a "transferable security". This could require the ICO to publish a prospectus and acquire approval from a competent authority.
The ESMA has also warned that certain coins or tokens may constitute "financial instruments". This could result in ICOs being regarded as conducting regulated investment activities, which must comply with requirements under MiFID II and the AiFMD.
Launching an ICO in the Netherlands
Neither the Dutch Authority on Financial Markets ("AFM") nor the Dutch Central Bank ("DNB") have clarified the regulatory approach for ICOs in the Netherlands. Accordingly, whether an ICO is subject to Dutch financial laws will be assessed on a case-by-case basis. The outcome of this assessment will be dependent on the nature of the issued tokens, the issuing entity and the platform on which the token can be traded.
Relevant regulations for an ICO in the Netherlands
The range of regulations an ICO could be subjected to includes financial regulations, anti-money laundering, tax obligations and consumer protection.
Some of the key activities which trigger Dutch financial supervision law include:
- attracting funds from the public;
- offering securities;
- offering financial instruments;
- providing investment services and/or performing investment activities; and
- providing payment services.
Attracting funds from the public
It is prohibited to attract repayable funds from the public unless the attracting entity has obtained a banking license or when the funds are attracted as a result of an issue of transferable securities. Funds can be deemed repayable when the issuer agrees to pay the funds back at some point. Some issuers agree with their token-buyers that their 'investment' will be returned if certain goals are not reached (for instance a minimum percentage of tokens must be issued) or that a form of collateral must be deposited. When this is the case, this activity could qualify as attracting repayable funds from the public.
The scope of 'public' is debated but according to the DNB; professional market parties do not qualify as the public. Therefore, attracting repayable funds from professional market parties should not fall within the scope of this prohibition. If tokens are issued to non-professional market parties, such as retail consumers, the prohibition to attract repayable funds from the public could be met.
Securities form a subcategory of financial instruments within the meaning of the Wft. A security is defined as (a) a transferable share or similar right (b) a transferable bond or other transferable debt instrument or (c) any other transferable right by which (a) or (b) can be obtained when the attached rights are exercised or converted.
Tokens could qualify as a share if token-holders participates in the capital of the issuing company and receives money in exchange. Additionally, the token may qualify as a bond or other debt instrument if the token-holder receives money in exchange for a loan.
If the tokens qualify as shares, bonds or any other transferable right, it must then be assessed if these instruments are transferable. If this element is missing, the instruments do not qualify as a security.
Additionally, if the ICO is considered to be offering securities in the Netherlands it must publish a prospectus approved by the AFM (unless an exception applies). If a prospectus is required and is approved by the AFM, the ICO would be able to ‘passport’ it and offer securities in other Member States.
Offering financial instruments
It is also important to assess whether the ICO’s tokens could qualify as a financial instrument other than a security. One category of financial instruments to assess closely is the 'participation right in an investment scheme', as outlined in the Alternative Investment Fund Management Directive. If the issuing company does not intend to pool funds and collectively invest those funds, it would likely not be deemed an Alternative Investment Fund.
Providing investment services or performing investment activities
In the Netherlands it is prohibited to provide investment services or to perform investment activities without having obtained a license from the AFM. Investment activities are wide-ranging and include receiving and passing on client orders in financial instruments as well as advising clients on financial instruments.
When considering these services and activities, it is important to assess what the exact role of an issuing company will be in relation to the tokens, especially if the tokens qualify as financial instruments.
If the ICO’s tokens are also intended to perform payment transactions, it should be assessed whether the ICO is possibly issuing payment instruments and/or facilitates payment transactions, within the meaning of the Payment Services Directive and the corresponding Dutch law.
A payment instrument is any personalized device and/or set of procedures agreed between the payment service user and used by the payment service user in order to initiate a payment order. Known payment instruments include things like debit / credit cards but also PIN-codes, passwords and other login details as well. These regulations are tailored to regulate funds, but that does not mean an issuing company could not be considered a payment service provider. Acting as a payment service provider is prohibited in the Netherlands without having obtained a license from the DNB.
Anti-Money Laundering Obligations
Most European supervisors, including the AFM, have issued statements that issuers of tokens should abide by anti-money laundering legislation to prevent money laundering and the financing of terrorism. Accordingly, the issuing entity should implement strict AML procedures, like KYC.
Issuing tokens may fall within the scope of VAT obligations. This will come down to the underlying functionality of the token. Generally speaking, attracting funds through the issuance of equity is outside the scope of VAT purposes. The exchanging of fiat (or even crypto) for other cryptocurrencies is also VAT exempt. However, issuing instruments which give the holder the right to use them for various acquisitions of goods/services are VAT taxable.
Consumer Protection considerations
When marketing to Dutch consumers on the Dutch market, irrespective of the possible regulatory qualification of the tokens, issuing companies will have to observe the restrictions stipulated by the Dutch Act on unfair commercial practices ("OHP").
Unfair commercial practices encompass those which are contrary to the requirements of professional diligence and are likely to materially distort the economic behavior of the average consumer. Marketing must also not be aggressive or misleading and must not in any other way qualify as an unfair market practice.
That said, this only covers commercial practices aimed at consumers. Non-consumers, like professional investors, will likely be out of scope.