When does an ICO fall under the Financial Supervision Act (Wet op het financieel toezicht, or Wft)?
Most tokens can be structured, for instance in the form of a (prepaid) entitlement to a future service of the issuer, so that they fall outside the scope of the Wft. One exception to this is if the token for instance represents a share in the project or if the token gives entitlement to part of the (future) returns from the project. In these circumstances the token may qualify as a security or a unit in a collective investment scheme as defined in the Wft. The AFM assesses each case separately to determine whether the Wft applies and will closely supervise whether or not the Wft might apply. Potential issuers need to properly analyse the extent of any overlap with financial regulation and supervision before launching their ICO.
Qualification of a security (effect)
In each case, it has to be determined whether a token qualifies as a security as defined in Section 1:1 Wft on the basis of the token’s legal and other features. In line with the definition in this Section, it is important to establish the extent to which the token qualifies as a negotiable instrument that is equivalent to a negotiable share or other negotiable instrument or an instrument equivalent to a right. A token may also qualify as a security if it represents a negotiable bond or other negotiable debt instrument.
A token additionally qualifies as a security if a share or bond can be acquired through the exercise of the rights attached to a token or through conversion of these rights. Lastly, a token meets the definition of a security if it is a negotiable security that can be settled in cash, where the amount to be settled depends on an index or other measure.
For a token to qualify as a security equivalent to a share, one important consideration is whether the token holders participate in the company’s capital and receive a payment for this. This payment must correspond to the return achieved with the invested capital. Any controlling rights are not decisive in this respect. The AFM moreover uses a wide and economic approach for the term negotiability. Further information on this is available in the Negotiability Policy Rule of the AFM.
If the tokens qualify as a security, a prospectus approved by the AFM is compulsory – to the extent that no exception or exemption applies. Further information is available on the AFM website. In any case, investment firms facilitating trading in such securities must observe the requirements with respect to the prevention of the use of the financial system for the purposes of money laundering or terrorist financing.
Qualification of unit of participation in collective investment scheme
An ICO is subject to financial supervision if it concerns the management and offering of units in a collective investment scheme. This is the case if an issuer of an ICO raises capital from investors in order to invest this capital in accordance with a certain investment policy in the interests of those investors. The funds raised have to be used for the purpose of collective investment so that the participants will share in the proceeds of the investment. An increase in net asset value also qualifies as the proceeds of an investment. In this connection, among other things the AFM applies the guidelines published by ESMA on key concepts of the Alternative Investment Fund Managers Directive.
Under Section 2:65 Wft, a licence from the AFM is required for the offering of units in a collective investment scheme unless the issuer is eligible for the registration regime. Further information is available here on the AFM website.
Trading of tokens falling under the Wft
Platforms facilitating the trading of tokens falling under the Wft also require a licence from the AFM for the provision of investment services pursuant to Section 2:96 Wft. Further information is available on the AFM website. Potential issuers considering an ICO and wishing to issue it subject to financial supervision may contact the InnovationHub of the AFM and DNB for any questions.
Is the AFM against ICOs in principle?
The AFM’s current warning relates to the rapidly increased popularity of ICOs, which in combination with the above-mentioned risks could lead to serious disappointments for investors. Because the transactions are anonymous, malicious parties could use ICOs to defraud investors. There is also the danger that investors have excessive expectations. In addition, the lack of transparency increases these risks.
This warning has nothing to do with the AFM’s recognition of the importance of innovation in the financial markets and that fintech and other companies wish to be able to raise capital by such means. Potential issuers considering an ICO and wishing to issue it subject to financial supervision may contact the InnovationHub of the AFM and DNB for any questions.