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New Guidance on Cryptocurrencies and Initial Coin Offering (ICO)
Exchanges, Wallets, Broking
Registration and other Obligations
Initial Coin Offering (ICO)
Types of Financial Product
Tokens that are not Financial Products
Fair Dealing and Initial Coin Offers
Cryptocurrencies are digital tokens available online via exchanges, initial coin offers (ICOs) and token events. If your business is based in New Zealand and you provide a ‘financial service’ related to cryptocurrencies, you need to comply with the Financial Service Providers (Registration and Dispute Resolution) Act 2008. Key activities considered ‘financial services’ include exchanges, wallets, deposits, and broking.
New Guidance on Cryptocurrencies and Initial Coin
In its view, any cryptocurrency or ICO-derived tokens or cryptocurrencies are securities under the Financial Markets Conduct Act 2013 - even those that are not financial products; a security is any arrangement or facility that has, or is intended to have, the effect of a person making an investment or managing a financial risk.
Tokens could fall into one of four financial product categories - debt securities, equity securities, managed investment products or derivatives - depending on their characteristics. The FMA left the door open to additional classification for such offerings, through which the technology can be used to bootstrap a blockchain network through the sale and release of tokens.
Exchanges issuing their own cryptocurrency to facilitate trading fall within the financial service category of ‘issuing and managing means of payment’.
Exchanges allowing cryptocurrency trading fall within the financial service category of ‘operating a value transfer service’.
If you allow trading of cryptocurrencies or tokens that are financial products under the Financial Markets Conduct Act 2013 (FMC Act) you need to consider whether you are operating a financial product market.
If you’re a wallet provider storing cryptocurrency or money on behalf of others, and you facilitate exchanges between cryptocurrencies or between money and cryptocurrencies, your services fall within the category of ‘operating a value transfer service’.
If you hold money for depositors, you may be offering debt securities. However, if depositor funds are held in trust, your wallets may not be debt securities. Debt securities are financial products. They have additional regulatory requirements under the FMC Act.
If you arrange cryptocurrency transactions, you are providing the financial service of ‘operating a value transfer service’. If you provide transaction services in relation to cryptocurrencies or tokens that are financial products you may have obligations as a broker under the Financial Advisers Act 2008.
If you provide a financial service, you must:
- be a member of a dispute resolution scheme if the financial services are provided to retail clients;
- be registered on the Financial Service Providers Register (FSPR) for each category of financial service you provide;
- pay the applicable fees and levies for the relevant categories of financial service you provide;
- comply with the fair dealing provisions in Part 2 of the FMC Act. These prohibit misleading conduct and deceptive statements being made in relation to financial services;
- comply with anti-money laundering obligations.
ICO is an unregulated means by which funds are raised for a new cryptocurrency venture; an Initial Coin Offering (ICO) is used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks. In an ICO campaign, a percentage of the cryptocurrency is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin.
Also called an Initial Public Coin Offering (IPCO).
Initial Coin Offering (ICO)
When a cryptocurrency startup firm wants to raise money through an Initial Coin Offering (ICO), it usually creates a plan on a whitepaper which states what the project is about, what need(s) the project will fulfill upon completion, how much money is needed to undertake the venture, how much of the virtual tokens the pioneers of the project will keep for themselves, what type of money is accepted, and how long the ICO campaign will run for. During the ICO campaign, enthusiasts and supporters of the firm’s initiative buy some of the distributed cryptocoins with fiat or virtual currency. These coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction. If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful. If the funds requirements are met within the specified timeframe, the money raised is used to either initiate the new scheme or to complete it.
Initial coin offerings are appealing to traders for the same reason that initial public offerings - they offer a high level of volatility as the market comes up with an appropriate price for the asset.
Early investors in the operation are usually motivated to buy the cryptocoins in the hope that the plan becomes successful after it launches which could translate to a higher cryptocoins value than what they purchased it for before the project was initiated.
An example of a successful ICO project that was profitable to early investors is the smart contracts platform called Ethereum which has Ethers as its coin tokens. In 2014, the Ethereum project was announced and its ICO raised $18 million in Bitcoins or $0.40 per Ether. The project went live in 2015 and in 2016 had an ether value that went up as high as $14 with a market capitalization of over $1 billion.
As mentioned above, initial coin offers (ICOs) and token events are a form of fundraising where you receive tokens that carry certain rights, such as providing access to a new product or service, or an interest in an underlying asset or project.
The extent to which an ICO is regulated depends whether a ‘financial product’ is being offered to retail investors in New Zealand (i.e. a ‘regulated offer’ is being made). Whether a token offered via an ICO is a financial product, and if so, what type of product, depends on the token’s specific characteristics and economic substance. The Financial Markets Conduct Act 2013 (FMC Act) sets out four types of financial product:
Managed investment products
Debt securities A token is a debt security if investors have a right to be repaid money or paid interest on money lent to, deposited with, or owed by a person, company, or unincorporated entity making a token offer. For example, a token linked to the value of a dollar or commodity could be a debt security if:
- investors can purchase a token with money;
- investors holding the token have the right to redeem that token for money; and
- an investor holding the token is not the beneficial owner of funds from which redemption proceeds are paid
A pegged cryptocurrency is a token linked to the value of a dollar or commodity like gold. These operate in a similar way to a negotiable bearer instrument (such as a cheque) issued by a bank. Both give the investor holding the token or instrument the right to redeem that token or instrument for money.
To make a regulated offer of debt securities, you must:
- register a product disclosure statement (PDS) appoint a licensed supervisor
- have a trust deed that sets out investor rights and the supervisor’s role meet financial reporting and fair dealing obligations.
Equity securities A token is an equity security if investors buy, or have the option to buy, a share in a company. A token that provides an option to buy a share is an offer of both the token and the equity share.
If you make a regulated offer of equity securities, you must register a PDS. Investor interests and rights will be set out in the company’s constitution. This means a trust deed is not required. Financial reporting and fair dealing obligations apply.
Managed investment products
A token is a managed investment product (an interest in a ‘managed investment scheme’) if:
- investors contribute money or cryptocurrency to receive interests (tokens) in a scheme (a structure or project that allows investors to pool their money)
- returns, income and rewards to investors from the scheme – such as money, cryptocurrency, additional tokens, or changes in the tokens’ value – are principally produced by someone else, and
- investors do not have any day-to-day control over the project or business.
The manager of a managed investment scheme must be licensed by us in order to make offers to retail investors in New Zealand. The manager is the person, company, or unincorporated entity issuing the tokens. When you make a regulated offer of managed investment products, you must also:
- register a PDS
- appoint a licensed supervisor
- have a trust deed that sets out investor rights and the supervisor’s role
- meet financial reporting and fair dealing obligations.
Derivatives A token may be a derivative if, under the terms of the token, the issuer or holder may be required to pay an amount or provide something else in the future, and the amount to be paid or the value of the token is derived from the value or amount of something else, such as a commodity or asset.
The issuer (person, company, or unincorporated entity) of the tokens must also be licensed by us in order to make offers to retail investors in New Zealand. If you make a regulated offer of derivatives, you must register a PDS and meet financial reporting and fair dealing obligations.
A token that is issued as part of an ICO is not regulated by the FMA unless it meets the criteria of a financial product (i.e. it is a debt security, equity security, managed investment product or derivative) and is offered to retail investors in New Zealand.
However, we can designate tokens issued as part of an ICO to be a particular financial product if, based on their economic substance, this is necessary to promote fair and efficient financial markets in New Zealand or any of the other purposes of the FMC Act. For example, a project token giving investors voting rights and a share in the company and its profits could be designated an equity security. A designation could be accompanied by an exemption to modify FMC Act disclosure and governance requirements.
Designations are only made after consultation with industry and do not apply retrospectively. This means that only ICOs that happen after a relevant designation is in place are regulated by the FMA.
ICOs and tokens that are not financial products will still be subject to general consumer protection laws in New Zealand, for example prohibitions against misleading and deceptive conduct and fraud or other criminal conduct.
If you are New Zealand-based and provide financial services, you must:
- be a member of a dispute resolution scheme if any financial services are provided to retail clients
- be registered on the Financial Service Providers Register (FSPR) for each category of financial service you provide. Token or cryptocurrency issuers may be ‘operating a value transfer service’ or ‘issuing and managing means of payment’
- pay the applicable fees and levies for the relevant categories of financial service you provide
- comply with the fair dealing provisions in Part 2 of the FMC Act. These prohibit misleading conduct and deceptive statements being made in relation to financial services
- comply with anti-money laundering obligations.
If your token or cryptocurrency is not a financial product or financial service, you will need to comply with the Fair-Trading Act 1986 to the extent you are in ‘trade’. The Fair-Trading Act also applies to overseas-based tokens and cryptocurrencies offered in New Zealand.
What are fair dealing requirements?
The fair dealing requirements in Part 2 of the Financial Markets Conduct Act 2013 (FMC Act) are broad principles that prohibit misleading or deceptive conduct, false or misleading representations and unsubstantiated representations.
Do fair dealing requirements apply to initial coin offers?
If your ICO is providing a financial product or financial service, all promotional material – including your white paper, website and on social media posts – must comply with the fair dealing provisions in Part 2 of the FMC Act. The provisions prohibit you from engaging in misleading conduct and making false, deceptive or unsubstantiated statements about the financial product or service, irrespective of the type of investor you are offering to, or where they are located.
Even if your ICO is not providing a financial service or financial product, ‘fair dealing’ requirements still apply to white papers and other communications about your ICO under the Fair-Trading Act 1986. This prohibits misleading and deceptive conduct, and applies to the trading of assets, commodities and other goods and services.
The Commerce Commission is responsible for ensuring you comply with this Act.
How to comply with fair dealing requirements
To comply with the fair dealing requirements, all promotional material associated with your ICO – including your whitepaper, website, and any social media, must follow these principles:
Any statements made about the ICO need to be accurate and able to be substantiated. For example, any statements about growth projections and the expected future value of a business should be based on reasonable assumptions, and able to be verified. We may ask you to provide evidence of this and would expect the material to be provided immediately on request.
Be careful to balance risk and reward. Messages about returns and risks must be balanced. Higher-risk ICOs are likely to require more prominent and detailed warnings.
State any assumptions clearly. Assumptions should be reasonable – providing links to further information where appropriate.
Don’t overstate or mis-state your ICO’s current features. For example, you must be able to verify any statements about the history of your ICO and your successes to date. Don’t claim to have endorsements, business partners or an existing customer base unless you can provide formal evidence of this.
Be clear which features of your ICO are aspirational or still in progress. If a feature or benefit of your ICO is yet to be achieved, or is conditional on assumptions being met, this must be clearly stated.
If the overall impression of the promotional material is misleading, it will be in breach of the fair dealing requirements.
FMA intervention powers
FMA has a wide range of powers to address breaches of the fair dealing requirements. These powers allow FMA to issue orders requiring ICO issuers in New Zealand to comply with the law, including amending or taking down non-compliant promotional material. We may publish these orders.
A breach of the fair dealing requirements is also a civil liability offence with a potential pecuniary penalty. ICO issuers can also be ordered to pay compensation to people who have suffered a loss as a consequence of a breach of the fair dealing requirements.
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