This article was written by Alexandre de Boccard and Fabien Gillioz, partners at Ochsner & Associés. It originally appeared in the November issue of Citywire Switzerland magazine.
In 2017, the investment volume of initial coin offerings (ICOs) had sur passed venture capital funding. It is important for both investors and compani es to be aware of the regulatory and legal framework around these issues so they can reduce the risks of administrative, civil and/or criminal liabilities.
However, we believe that the next generation of funding which will be compliant with regulations around the world will no longer be ICOs, but security token offerings (STOs).
What is a security token?
Finma has been the first regulator to explicitly define a security token, more particularly an ‘asset token’ as this term was used in its guidelines on ICOs issued in February 2018.
According to Finma: 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.
From now on, we are likely be to hear a lot more about STOs because they have the potential to become the market standard for funding in both start-ups and well-established companies that want to tokenise their securities offering or hard assets.
Compared with traditional initial public offerings (IPOs), STOs could become a real competitor since their costs are much lower than IPOs. Moreover, companies and investors may prefer digital tokens over conventional securities because trading in the secondary market through licensed security token trading platforms can be more attractive for investors who want to quickly liquidate their tokens with reduced costs.
Security tokens could enable a new world of finance where fees are lower, deals can be executed faster, market friction is reduced, and securities could have more sophisticated structures.
In a nutshell, a company may issue uncertificated securities (droits-valeurs / Wertrechte) for its own account on the primary market without being subject to authorisation, provided the uncertificated securities are not considered as (i) collective investment schemes or (ii) derivatives issued by a company active primarily in finance. This regulatory framework is one of factors explaining the significant number of ICOs / STOs in Switzerland.
The only formal requirement under article 973c para. 2 of the Swiss Code of Obligations is for the company to keep a book of the uncertificated securities issued which records the number and denomination of the uncertificated securities and the creditors.
According to the Finma Guidelines, this one formal requirement ‘can be accomplished digitally on a blockchain’.
Notwithstanding this clear legal framework applicable to uncertificated securities, it is highly recommended that issuers of security tokens obtain a non-action letter from Finma (i.e. a decision where Finma confirms that no authorisation is required under Swiss law).
At the moment, security tokens have a much smaller share of the token market than utility tokens. However, financial institutions need to be aware that the security token market may increase significantly in 2019.
It is also likely that a lot of capital will flow to security tokens instead of utility ones.
For these reasons security tok ens are set to transform equity , bonds and other financial products just as bitcoin has transformed currency, because they provide the owner with a direct, liquid economic interest and a quick delivery of proceeds.
Since every type of ownership can be tokenised – even hard assets – we foresee a massive market.