During the last few days, European Securities and Markets Authority (“ESMA”) as well as Germany’s Federal Financial Supervisory Authority (“BaFin”) both issued statements concerning so called Initial Coin Offerings (“ICOs”).
ESMA published two different statements on November 13, 2017 addressed to firms involved in ICOs and potential investors respectively.
BaFin first published a consumer warning on November 9, 2017, followed by a detailed statement in the BaFin Journal of November 15, 2017.
ESMA reminds firms involved in ICOs of regulatory requirements…
In its first statement (ESMA50-157-828), ESMA outlines its concern that at least some of the firms involved in ICOs may not comply with relevant EU legislation. The applicability of restrictive rules depends on the specific structure of the respective ICO, as ESMA explains. If the coins or tokens offered qualify as financial instruments, ESMA considers it likely that firms involved in ICOs conduct regulated investment activities. Additionally, according to ESMA they may be involved in offering transferable securities to the public.
From the perspective of a company currently planning to finance its business by way of an ICO, the statement published by ESMA should be of particular interest. The same applies to firms currently planning to offer brokerage services in connection with ICOs.
…and warns – in concert with BaFin – investors of the risks involved.
Both ESMA and BaFin emphasize that ICOs are highly risky investment instruments.
In its consumer warning (ESMA50-157-829), ESMA alerts investors to the high risks of ICOs. In particular, it outlines that there is no legal protection in the case of an unregulated ICO. Additionally, ESMA considers ICOs to be vulnerable to fraud or illicit activities, owing to their anonymity and their capacity to raise large amounts of money in a short timeframe. Further risks named by ESMA are the potential loss of all of the invested capital, the lack of exit options and extreme price volatility, inadequate information and possible flaws in blockchain technology.
BaFin tries to draw consumers’ attention in the same direction by making the high risks of ICOs to consumers the cover story of the latest issue of its “BaFin Journal” dated November 15, 2017. BaFin as well underlines that ICOs in many cases are unregulated, with the effect that consumers are not protected by the current legal framework, for instance the provisions of the German Stock Corporation Act (Aktiengesetz). With regard to ICOs, BaFin detects the same risks as ESMA, especially an extreme price volatility of tokens and the risk of a total loss of the investment. Therefore BaFin advises potential investors to gain as much knowledge as possible about the tokens concerned and to be aware of the high risks of fraud and manipulation. Especially due to the lack of transparency legislation, consumers have to take care of gaining information about the offered products themselves and cannot rely on regulated prospectuses, as BaFin emphasizes.
Bottom line: Market participants are put on notice
To firms as well as to investors aware of ICOs and their terms and conditions, the statements issued by ESMA and BaFin do not contain dramatically new insights. Already under present legislation, ICOs may fall under regulatory supervision of European or national authorities. BaFin points out that it will review the concrete terms of each respective ICO and will decide whether a permit under German Banking Act (Kreditwesengesetz – KWG), German Capital Investment Code (Kapitalanlagegesetzbuch – KAGB), German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz – ZAG) or German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) is needed. Therefore, firms involved in ICOs should check the regulatory implications. The importance of the statements by ESMA and BaFin may chiefly be that they clearly indicate that ICOs are high on the agenda of European regulatory bodies. Putting all potential market participants on notice, BaFin explicitly points out that independently from its investigations, involvement in ICOs can be an illicit financial business which is a criminal offense.
(16 November 2017)