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Legal Aspects of STO in Switzerland: How to Issue Security Tokens in Crypto Valley

December 25, 2018

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While all young stars-to-be move to Hollywood, and IT companies rush to California’s Silicon Valley, blockchain startups have their own hub – Switzerland. For centuries, this small country has been known for its safe banks, watches and chocolate. And now it has also become the world’s Crypto Valley for its openness towards blockchain companies, cryptocurrencies and Initial Token Offerings.

Why Switzerland?
A giant Bitcoin logo projected onto the Swiss National Bank in Zurich, April 2018

Crypto projects prefer the Swiss jurisdiction because of low taxes and business-friendly regulations. In January 2017, a global hub for virtual currencies known as the Crypto Valley was established in Zug, making Switzerland one the world’s leading countries for crypto?urrency and blockchain technologies. It has already attracted dozens of first-mover crypto companies and organizations, including Ethereum, Monetas, Bitcoin Suisse, Xapo, ShapeShift, ConsenSys, and Tezos.

The Swiss regulatory authorities were one of the first to clarify how ICOs and STOs will be treated from a legal perspective. Back in 2014, the Swiss Federal Council of the Swiss government published a report on virtual currencies that explained their economic significance, legal treatment, and risks. In particular, they admitted that cryptocurrency “takes on the role of money, but is not regarded as legal tender and therefore should be classified as an asset (property)”.

Swiss classification of tokens

The financial market and blockchain-related companies are supervised by the Swiss Financial Market Supervisory Authority (FINMA). It determines the applicability of regulation to crypto tokens on a case-by-case basis, taking a similar stance to that of the US Securities and Exchange Commission.

When assessing ICOs, FINMA focuses on the “economic function and purpose of the tokens”, with the “underlying purpose of the tokens and whether they are already tradeable or transferable” being primary factors in how they will be classified.

FINMA’s guidelines on ICOs classify tokens into several categories.

  • Payment tokens are intended to be used, now or in the future, as a means of payment for acquiring goods or services or as a means of money or value transfer. They do not stipulate rights towards the issuer.

  • Utility tokens are intended to provide access digitally to an application or service by means of a blockchain-based infrastructure.

  • Asset tokens represent assets such as a debt or equity claim on the issuer. Asset tokens promise, for example, a share in future company earnings or future capital flows. In terms of their economic function, therefore, these tokens are analogous to equities, bonds or derivatives. Tokens which enable physical assets to be traded on the blockchain also fall into this category.

  • Asset and utility tokens can also be classified as payment tokens (referred to as hybrid tokens). In these cases, the requirements are cumulative; in other words, the tokens are deemed to be both securities and means of payment.

According to Swiss law, the following asset tokens are defined as securities.

  • Tokens that represent an uncertificated security and the tokens are standardized and suitable for mass standardized trading, i.e. they are publicly offered for sale in the same structure and denomination or are placed with more than 20 clients, insofar as they have not been created especially for individual counterparties.

  • Asset token that represents a derivative (i.e. the value of the conferred claim depends on an underlying asset)

Focus on AML and KYC

Whilst utility tokens don’t require to get licensed as securities dealers, digital assets that are considered securities shall meet a list of legal rules.

In particular, exchange of cryptocurrencies into fiat money, custody wallets, banks, securities dealers and asset managers are generally subject to Anti-Money Laundering requirements, such as registration, supervision and identification of counterparty obligations.

The Anti-Money Laundering Act aims to protect the financial system against the risks of money laundering and the financing of terrorism. The risks are especially high in a decentralized blockchain-based system, in which assets can be transferred anonymously and without any regulated intermediaries. That’s why the act contains requirements including the need to establish the identity of beneficial owners.

Companies issuing and trading asset tokens should conduct Know Your Customer (KYC) procedure and get a security dealer license.

Note: In addition to regulatory obligations, securities are subject to prospectus requirements under the Swiss Code of Obligations if they are analogous to equities or bonds.

Licensing as a securities dealer

Anyone falling within the category of asset tokens should apply for a securities dealer licence. The licence will be granted if the startup fulfills requirements regarding the organization, capital, reporting and trading activities.

Organisational requirements

  • A securities dealer must have an adequate organisation in place that allows for the execution of its activities.

  • The securities dealer must have a board of directors and a management team.

  • The members of the management team will have to be fit and proper for the execution of their respective functions.

  • There must be an adequate separation between trading, asset management and administration.

  • The securities dealer must also establish an internal control system consisting of compliance, risk management and internal audit.

  • An external regulatory audit firm must also be appointed.

  • It is possible to unify some of the control functions with a specific person.

Capital requirements

  • Any securities dealer must have fully paid-in minimal capital of at least CHF 1.5 million ($1.517 USD).

  • Any shareholder indirectly or directly holding more than 10% of the capital or the voting rights of a securities dealer, or that may in any other way influence the business activities of the securities dealer, must meet FINMA’s fit and proper criteria.

  • The provisions applicable to banks regarding their own capital and accounting generally also apply to a securities dealer.

  • Privileged deposits of clients are subject to enhanced protection.

Reporting, information and approval obligations

Any securities dealer will have to comply with multiple reporting, information and approval obligations on an ongoing basis.

  • Any change to the preconditions for granting the licence, but in particular the articles of association, regulations, material change of business activity, management, board of directors and external audit firm, as well as build-ups, investments, and divestments of foreign operations, must be pre-approved by FINMA.

  • Any indirect or direct acquisition or sale of a stake in a securities dealer reaching, exceeding or falling below the thresholds of 20%, 33% or 50% of the capital or the votes must be reported to FINMA.

Algorithmic and high frequency trading

Participants in Swiss trading venues that are engaging in algorithmic or high frequency trading activities have recording requirements and their systems must ensure adequate functioning.

Future law amendments to know about

Switzerland is constantly enhancing its legislation on cryptocurrencies. On December14, 2018 FINMA and Switzerland’s Federal Council announced the introduction of an improved legal framework, publishing the report titled “Legal Foundations for Distributed Ledger Technology and Blockchain in Switzerland”. 

They plan to bring in the following adjustments.

  • In banking law – examination of a corresponding adjustment of bank insolvency law provisions and submission of any adjustment proposals. Thus, investors will be protected from fraudulent companies.

  • In financial market infrastructure law – introducing a new category of authorization both for traders and exchanges, operating with financial digital assets and related to blockchain. It will empower FINMA to interfere with their activities, if necessary.

  • In the AML law – introducing adjustments in order to regulate decentralized crypto exchanges managing users’ digital assets.

  • In collective investment schemes law – amending the Collective Investment Schemes Act in order to allow for a new category of funds (so-called limited qualified investment funds, L-QIFs). As a result, new innovative products could be placed on the market more quickly and cost-effectively in the future.

Daria Volkova is a legal advisor at Platinum.

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