STO regulation and law in the United Kingdom

The UK regulator, the Financial Conduct Authority (“FCA”), takes a technology neutral stance to regulation. As such, irrespective of the technology, it is the underlying activity or underlying asset, which may fall within the regulatory perimeter.

Security tokens are currently defined by the FCA as any token, which constitutes a “specified investment” (i.e. an investment regulated in the UK). Therefore, if a token has the same/similar characteristics as a “share” or “debenture” it would likely be deemed to be a specified investment and, as such, any regulated activity in relation to that token (e.g. arranging for persons to acquire the security token) will be regulated in the UK. FCA notes that even if a token which looks like a share is not a transferable security under MiFID (for instance, it has restrictions on transferability), it may still be capable of being a specified investment for UK purposes.

Further guidance has been provided in relation to the definition of a security token in the FCA’s recent Guidance on Cryptoassets Consultation Paper.

A prospectus is required before a “transferable security” is offered to the public or is admitted to trading on a regulated market. A security token which operates as a share or debenture is likely to constitute a “transferable security.” Therefore, if that security token is being offered to the public, e.g. by being listed on a crypto exchange or offered online on the issuer’s website, a prospectus will likely be required.

However, there are a number of exemptions which may be used to avoid being required to publish an approved prospectus, such as circumstances where (a) an offer is only made to “qualified investors” (i.e. professional investors), (b) an offer is directed at fewer than 150 persons per EEA state, and (c) the minimum consideration payable by any investor is at least EUR 100,000 (or the equivalent thereof) (d) the security tokens/transferable securities offered are denominated in amounts of at least EUR 100,000 (or the equivalent thereof) or (e) an offer is made only in the UK and the total amount offered is less than €8m.

If a token constitutes a “transferable security” and is being offered to the public, the issuer of the security token would be required to publish a prospectus which has been approved by the FCA as being compliant with the prospectus requirements.

As mentioned in the answer to question 2, to avoid being required to produce an approved prospectus, STO issuers will commonly rely on an exemption from the prospectus regime such as where the total amount of the offer is less than €8m.

The entire process is likely to take between 2 to 4 months from start to finish depending on the complexity of the business and the speed by which relevant internal information required for the prospectus approval process can be gathered.

This process requires extensive due diligence to ensure the veracity of all facts and information set out in the prospectus document. Whilst the FCA should only take up to 10 working days to respond to each submission, it usually takes several submissions and a series of back and forth discussions with the FCA to receive final approval for a prospectus.

The UK’s money laundering regulations do not to apply to a firm issuing its own shares and, therefore, should not apply to an issuer of share tokens in an STO.

Businesses carrying out investment services (such as those that arrange for investors to invest in an STO), collective investment undertakings, insurance intermediaries, and credit institutions will fall within the definition of “financial institution” and so will also fall within the remit of the money laundering regulations when acting in the course of those businesses. As a result, if a business is using an STO to raise capital for certain types of investments, or using security tokens to sell certain types of insurance-based investments, this activity will likely fall within the remit of money laundering regulation in the UK.

New money laundering regulations are also coming into force soon under the fifth anti money-laundering directive, which must be transposed by member states by 10 January 2020 and should be transposed by the UK irrespective of Brexit. The regulations will include new measures to require money laundering checks by (crypto) exchanges.

Rights in relation to securities constitute a “specified investment” and so fall within the regulatory perimeter within the UK. Therefore, it is possible to undertake an STO in relation to “rights in a security”.

The issuer of a security token might not need to be authorised (as the issuance by a company of its own shares is not regulated). However, the carrying on of regulated activities (e.g. arranging deals in investments) in respect of securities is generally subject to authorization/licensing unless an exclusion applies.

Issuers should also be aware of the implications of the UK financial promotion regime where they issue communications outside of the approved prospectus in respect of security tokens.

The taxation of security tokens is still being considered by the UK’s tax authority, HM Revenue & Customs (“HMRC”). However, HMRC has recently published guidance relating to the taxation of individuals in relation to cryptoassets, which sets out, that an individual who transfers security tokens, whether by sale, exchange, or gift, may be liable to pay capital gains tax on that transfer.

The FCA has, as set out above, produced a consultation paper containing Guidance on Cryptoassets which considers STOs. This consultation is expected to result in the production of a policy statement in Summer 2019 which should set out the regulatory framework that the FCA will apply in relation to STOs.

As also set out above, HMRC has also released guidance on the Taxation of Cryptoassets for Individuals. It is expected that similar guidance for companies should be released shortly.

Otherwise, the Treasury Select Committee published a report on Cryptoassets in September 2018, which includes security token offerings, as did the Cryptoasset Task Force in October 2018. Both these reports focused on perimeter guidance in relation to security token offerings and the circumstances in which they would fall within the regulatory perimeter.

CMS has drafted summaries of each of the above guidance and reports, which can be found here.