ESMA warned that the Prospectus Directive, the Markets in Financial Instruments Directive (MiFID), the Alternative Investment Fund Managers Directive (AIFMD) and the Fourth Anti-Money Laundering Directive should all be considered by firms in the ICO space.
ICOs involve issuing tokens on a cryptocurrency blockchain, to give investors exposure to projects or technology platforms. These tokens can entitle holders to a profit share or just let them use the service in question.
The pan-European securities watchdog emphasised that the four pieces of legislation listed were “not intended to be an exhaustive account of the applicable rules, nor of the requirements laid down in these legislations”.
The news comes after GlobalCapital exclusively reported in October that ESMA was preparing to issue a warning on ICOs, after speaking to Anneli Tuominen, the vice-chair of ESMA.
She told GlobalCapital that ESMA was looking to properly liaise with national competent authorities of individual member states to co-ordinate policy on the issue.
The US Securities and Exchange Commission recently made a major determination on the matter when it said that virtual currencies issued as part of ICOs could be covered by federal securities law, citing the Howey test.
In the new release, ESMA emphasised that national rules could apply to ICOs, as well as pan-European legislation.
“Depending on how they are structured, ICOs may fall outside of the scope of the existing rules and hence outside of the regulated space,” said ESMA.
“However, where the coins or tokens qualify as financial instruments it is likely that the firms involved in ICOs conduct regulated investment activities, such as placing, dealing in or advising on financial instruments or managing or marketing collective investment schemes.”
Bradley Rice, senior associate at Ashurst, wasn't sure that the announcement told the industry anything it didn't already know.
"If you were launching an ICO yesterday or today, the guidance wouldn’t make you change anything," he said. "The statement is just two pages reiterating what other regulators have said and doesn’t give firm guidance on whether a coin is a transferrable security or any other type of regulated instrument."
But a partner with Morrison & Foerster in London, Vladimir Maly, thought the statements by ESMA were "quite helpful" given the early stage progress of ICO regulation around the world.
"It’s the first time that in a written format, ESMA has tried to put out to investors in the market a very short, but to the point list of issues to focus on when considering an ICO," he said. "While the guidance isn’t very detailed, it would be unfair to expect much more at this stage, given the ICO regulatory space is still being developed around the world."
Legal traps aplenty
ESMA highlighted a number of ways that ICOs could fall under the various legislation it listed.
For MiFID, soon to be complemented by MiFID II in January, ESMA highlighted that tokens could qualify as financial instruments, making them subject to organisational, business rules and transparency requirements, "depending on the services provided".
"In the case of ICOs, where the coin or token qualifies as a financial instrument, the process by which a coin or token is created, distributed or traded is likely to involve some MiFID activities/services, such as placing, dealing in or advising on financial instruments," ESMA added.
Under AIFMD, however, the regulator insisted that an "ICO scheme could qualify as an alternative investment fund, to the extent that it is used to raise capital from a number of investors, with a view to investing it in accordance with defined investment policy".
These investment schemes would again be subject to more transparency requirements and rules.
Alongside the warning to those raising capital, ESMA also warned investors buying the tokens to be careful with their money, calling ICOs "extremely risky and highly speculative investments".
"Some ICOs may be used for fraudulent or illicit activities, with several recent ICOs having been identified as frauds, while ESMA cannot exclude that some are being used for money laundering purposes," the pan-European regulator added.
Holding fire
Tara Waters, a senior associate at Ashurst, added that she suspected the Financial Conduct Authority and other regulators won't do anything that has a "chilling effect" on people's ability to raise capital with ICOs — for the time being.
"It’s just a matter of creating standards to make sure people investing in these companies understand what they are doing and what recourse they may have," she said.
Rice added that he doubted the industry would see new ICO regulation, and added that existing regulation was sufficient and that enforcement action in some jurisdictions would set guidelines for the industry.
“I think ESMA will be led quite heavily by national competent authorities on this topic and will step in when necessary to ensure regulatory consistency," he added.
The regulatory environment is still uncertain for ICOs, as regulators around the world examine the capital raising method.
"For the time being, it is quite difficult to determine whether ICOs will become more widely accepted by regulators globally," added Maly. "Some regulators are making it clear that they are trying to prevent the activity from being continued while others are relatively supportive.”
Switzerland recently decided to bring ICOs into the scope of securities regulation, but other countries such as China and South Korea have decided to outright ban them. Many other jurisdictions remain undecided.