France to lead Europe with regulation of ICOs

If France's draft new law is approved, it will address the current uncertainty over whether ICOs fall subject to securities laws or not. It is also aimed at combating risks retail investors can face when they are enticed into purchasing the tokens on offer in ICOs.

France is not the first country to look into whether and how ICOs should be regulated.

The growth of ICOs

ICOs are an increasingly popular way for businesses to raise money. Typically, businesses will develop a digital token, such as their own proprietary virtual currency, and look to sell those tokens to investors in a bid to raise capital in return for existing cryptocurrency, such as bitcoin, ether or ripple rather than fiat currency such as dollars, euros or pounds. The trade of these tokens is recorded using blockchain.

Investors can in most cases sell on those tokens for profit on certain peer-to-peer exchange platforms should the value of the tokens increase. They are sometimes further incentivised into buying the tokens by being given the opportunity to share in profits generated from the business ventures that benefit from their investment. 

Total market capitalisation of the tokens exchanged in ICOs and traded in secondary markets in 2017 was estimated to amount to approximately €5 billion.

The risks around ICOs and the regulatory position currently

Most of the tokens delivered by ICOs do not meet criteria for being classed as financial securities and therefore fall outside of the legal framework that applies to securities. This situation has both benefits and drawbacks.

While loose regulation gives free rein to investments and innovation, its disadvantage is that "it puts all types of issuers and projects on the same level, without providing token subscribers with sufficient means to distinguish between serious and abusive offers", the Financial Markets Authority (AMF) in France has said.

Under existing legislation in France, and due to the structure of ICO operations, many ICOs are unregulated in the country. As a result, investors do not benefit from the guarantees provided by Initial Public Offers (IPO) on regulated financial markets. In a similar way, some ICOs set up abroad but available for purchase by French investors are not regulated in their country of origin and consequently do not protect French investors either.

Although investors are typically presented with information relevant to an ICO, this information tends to be contained in marketing documentation or other informal papers and does not need to conform to the transparency requirements that other types of investment instruments are subject to, such as in relation to the provision of a formal prospectus.

The documentation provided alongside ICOs is therefore often general in nature and not subject to any legal requirement. It can contain major omissions, inaccuracies, present potential investment scenarios in an excessively optimistic manner and contain only partial forecasts.

Furthermore, the capital invested in ICOs is not guaranteed. Investing in an instrument issued as part of an ICO project implies a significant capital risk, while risks that are incurred by subscribers may not always be disclosed on the marketing document. Moreover, some ICOs are suspected of being used to launder money, as highlighted in a report published by the French financial intelligence unit Tracfin in 2014. There is also no guarantee that these projects will or can be completed and that they will not meet the success bet on.

The international approach

Against this backdrop, governments and financial regulators around the world have been grappling with whether and how to regulate ICOs. A mixed approach has emerged.

In some countries, notably China and South Korea, ICOs have been banned altogether amidst concerns expressed by regulators that they have been used as tools for fraud.

In Europe, the European Securities and Markets Authority (ESMA), the UK’s Financial Conduct Authority (FCA) and the Swiss Financial Market Supervisory Authority (FINMA) have all noted that some ICOs can be governed by the existing legal framework for IPOs of securities or by the marketing of financial instruments, while others are not governed by existing regulations at all. ESMA is now reportedly examining every ICO to determine whether they fall subject to regulation. However, there has been a lack of clarity over the criteria for categorising the different types of ICOs.

The US' Securities and Exchange Commission (SEC) has similarly determined that some tokens issued through ICOs can constitute securities. Where that is the case, those ICOs are governed by US federal laws on securities, regardless of its method of distribution. In addition, there are regulations according to each US state that dictate how ICOs should be regulated in those jurisdictions. They vary from no regulation at all to very strict rules.

Other authorities such as the Australian Securities and Investments Commission (ASIC) have declared that, at this stage, they do not intend to regulate ICOs, and will not do so until they have an in-depth understanding of how these operations work. In contrast, Hong Kong's securities regulator is reportedly set to propose new regulations on crypto assets, while the Gibraltar Financial Services Commission (FSC) published guidelines in March 2018 with the aim of making Gibraltar an attractive location from which to carry out ICOs.

The options considered in France

At the end of 2017, the AMF in France opened a public consultation in which it highlighted the functioning of ICOs, their risks and advantages and asked whether such operations should be regulated or not and if so, how. The consultation attracted interest from a wide range of stakeholders, including professionals in the finance sector, businesses active in the digital economy, lawyers and consumers.

AMF outlined three potential regulatory options in its paper: 

• Maintain the regulatory status quo but establish good practices at the same time.
• Regulate ICOs in accordance with the existing legal framework on prospectuses.
• Establish a new authorisation regime applicable to all ICOs available to the public in France

The first option represented the most open approach proposed, but would have had drawbacks since fundraising opportunities entailing serious risks to the public and potentially involving very large amounts of money could then be offered without any safeguards. It would also have meant that investors could end up participating in large-scale scams or fraud without knowing it.

Under that option, however, the AMF could establish best practice rules, including to reiterate the main principles governing public offerings: for example, the need to present risks and rewards for investors in a very clear way. These recommendations would not have a binding legal force.

The second option would have extended the existing 'prospectus' regime to ICOs – it already applies to public offerings. Under this model, all issuers of tokens would be subject to the prospectus rules, regardless of the amounts involved, and would require risks to be clearly disclosed to potential investors. This could have led to strict regulation of ICOs in France, regardless of their form and characteristics, and the same review and approval procedures for public offerings carried out by the AMF would be applied to ICOs.

If France adopted option two it could possibly spur EU-level changes to expand the scope of the prospectus regime to public offerings of tokens, and possibly provide for the adjusting of application review procedures. This is because existing regulations are designed to ensure the provisioning of fully comprehensive prospectuses, which may not be necessary in the context of every ICO.

The third option is the one France has elected to pursue, after winning support from almost two-thirds of respondents to the AMF's consultation. The option represents a bespoke regulation tailored to ICOs, on the grounds that these offerings are so new and sophisticated that they cannot be captured by the existing regulations.

ICOs can also be so varied and imply different risks from the ones that exist for IPOs, and as such there is logic in establishing a specific pre-authorisation regime tailored to the different characteristics of these offerings.

Recent developments in France

On 18 June this year, the French government published a draft bill called Action Plan for Growth and Business Transformation. The bill is now being examined by the Senate after a first reading at the National Assembly. Article 26 of the bill concerns the regulation of ICOs.

On 12 September, the Special Committee at the National Assembly adopted article 26.

Under the article, the AMF would preside over an ICO authorisation regime. Businesses wishing to issue tokens to finance a project or activity would be able to obtain an authorisation from the AMF to do so. Authorisation would be subject to the companies complying with rules designed to avoid abuses and which would require a range of disclosures to be made and safeguards put in place to protect the investor.

Authorisation would not be compulsory. However, the registration of authorised businesses will help create a 'white list' of companies that comply with AMF requirements. These companies should be more attractive to investors than those not on the list as it will let those customers see what propositions are deemed to be safe and what are not.

The legislative proposals have been welcomed by stakeholders in the sector, according to Delphine Gény-Stephann, France's state secretary to the minister of the economy and finance. The bill has not yet been passed, however.

The bill had a first reading at the National Assembly by the Special Committee and was subsequently discussed in public session earlier this month. The bill then moved through to the Senate on 9 October. The bill is subject to an accelerated procedure, meaning it is due to be examined before a Joint Committee of both law making bodies. If this Committee reaches an agreement and proposes a joint draft law, it will then be reviewed in both assemblies.

If the Joint Committee is unable to establish a joint text or if the latter is not approved by one of the two assemblies, then both assemblies must again review the bill. To put an end to the procedure in those circumstances, it would be open to the government to ask the National Assembly to rule as a last resort. In this case, it is the bill as adopted by the National Assembly that is passed.

The main goal of the draft law is to regulate most ICOs, which at this time occur without any legal frame or regulations. France is the first country in Europe to look at doing so specifically, but some argue that EU-wide rules would be more beneficial. These may not be far away. The European Commission's proposed new rules on crowdfunding, published in the summer, advocate subjecting ICOs to a series of disclosure requirements.

The legislative proposals in France would also give a legal definition to tokens issued which do not meet the definition of financial securities.

The regulatory regime envisaged would be flexible enough to embrace all types of ICOs but not too constraining so as too restrain innovation.

Guillaume Morat is a Paris-based expert in the regulation of ICOs at Pinsent Masons, the law firm behind Out-Law.com.