ESMA’s SMSG publishes report on ICOs and crypto assets


1. Crypto assets

The term ‘crypto assets’ collectively refers to crypto currencies, virtual currencies, virtual assets and digital tokens. SMSG’s advice is based on the classification of crypto assets first introduced by the Swiss Financial Market Supervisory Authority which takes into account the assets’ economic function. In its report, SMSG identifies the benefits and risks of each type of crypto asset, and assesses whether the type of asset/token is currently within the scope of regulation under the Second Markets in Financial Instruments Directive (“MiFID II”), the Prospectus Regulation, and/or the Market Abuse Regulation (“MAR”).

· Payment tokens – Payment tokens are used as a means of payment for acquiring goods or services. The holder has no claim on the issuer. Whilst payment tokens can encourage competition in the payment markets and empower financial inclusion, payment tokens can also turn into speculative investments therefore necessitating additional investor protection and market abuse restrictions. The lack of centralisation also means that the market price of these tokens is not subject to rational assessments, is affected by high volatility and will not benefit from any central authority intervention.

Based on the characteristics of payment tokens, payment tokens are not currently covered by MiFID II, the Prospectus Regulation and MAR. SMSG urges ESMA to consult with the EBA and approach the European Commission to amend the Level 1 Text of MiFID II to include payment tokens in the list of MiFID financial instruments; this in turn means that secondary markets in payment tokens would be capable of being treated as multilateral trading facilities (“MTFs”) or organised trading facilities (“OTFs”) for the purposes of MiFID II and MAR.

· Utility tokens – The issuance model of utility tokens is comparable to traditional venture capital funding. Utility tokens provide digital access to an application or service, typically via a blockchain-based infrastructure. The issuer is able to transfer project risk to the token holders without diluting ownership. Token holders face counterparty risk and performance risk. Often, the value of utility tokens hinges on the willingness of users to pay for future services. In the presence of a secondary market, utility tokens can also turn into speculative investments.

SMSG considers it appropriate to exclude non-transferable utility tokens from the scope of MiFID II, the Prospectus Regulation and MAR. But, as transferable utility tokens are subject to market speculation and risks similar to capital market risks, SMSG urges for transferable utility tokens to be included in the MiFID II list of financial instruments.

· Asset tokens – Asset tokens can act as digital identifiers for physical assets. A digital identifier allows for an automatic recording of provenance. Additionally, a particular object can be traced in a supply chain and enables a secure transfer of title. With smart contracts, letter of credit payments to the supplier could automatically be triggered once performance has been proven by a token. Note however that an ICO smart contract in itself does not automatically enforce an entitlement. Unless a smart contract is designed to automate delivery of another crypto asset, a smart contract (whereby the entitlement is to a physical asset) may need to be enforced via conventional means. SMSG considers that token holders may not always be alert to the contractual relationship between them and the issuer. Alternatively, asset tokens could represent a monetary claim on the issuer. Similar to securities, token holders face counterparty risk, dilution risk and custody risk.

Whether an asset token is covered by MiFID II, the Prospectus Regulation and MAR, will depend on the specific characteristics of the asset token. In its advice to ESMA, SMSG sets out a detailed and nuanced approach as to which types of asset token fall within, or should in its opinion be brought within, the scope of MIFID II, the Prospectus Regulation and MAR. In summary:

If an asset token is transferable and provides a financial entitlement, it is akin to a transferable security within the meaning of MiFID II and the Prospectus Regulation. The same conclusion applies if an asset token is transferable, provides an entitlement in kind, and the token holder has decision-making powers in relation to the project for which the token is issued. SMSG advises that ESMA issues Level 3 guidance to clarify that transferable asset tokens are “transferable securities” for the purposes of MiFID II.

If the asset token is non-transferable, and the token holder does not have decision-making powers, SMSG considers the token to have the characteristics of a prepaid asset and, in its view, there is no need to bring such token within scope of financial regulation.

Complexities arise when an asset token is transferable and gives a right to an entitlement in kind, but the token holder does not have any decision-making powers. In such cases, it is necessary to consider (1) how the token is structured and (2) the underlying asset of the token. Broadly, if the asset token shares the characteristics of a derivative and the underlying is not a commodity, SMSG considers that there is merit for ESMA to add such token to the list of MiFID financial instruments. Where the asset token has the characteristics of a derivative and the underlying is a commodity, SMSG advises that ESMA provides Level 3 guidance to clarify the definition of a “commodity” as there are good arguments to treat such tokens as either C5 financial instruments (if cash settled) or C6 financial instruments (if physically settled and tradable on a trading venue).

2. Regulation of ICOs

In its report, SMSG identifies the regulatory approaches towards ICOs of 36 jurisdictions across the EU, EEA and other European jurisdictions. SMSG’s findings are set out in Annex 1 of the report, and are summarised in the table below:

Regulatory approach


Evident and proactive

Have expressly legislated or provided assessment guidelines on how and to what extent ICOs could fall under their respective framework of financial services legislation.

Malta, Switzerland, Lithuania, Gibraltar, Jersey, Isle of Man, France.

Measured and case-by-case

Do not specifically restrict or prohibit ICOs or crypto asset initiatives, but would take a measured approach to related proposals on a case by case basis and in full consideration of legislative instruments within their territory and the EU.

Austria, Belgium, Bulgaria, Denmark, Estonia, Finland, Germany, Ireland, Luxembourg, Netherlands, Portugal, Spain, United Kingdom, Lichtenstein and Guernsey.

Undefined and/or unidentifiable

Securities authorities have not provided clear information as to their stance.

Croatia, Czech Republic, Greece, Hungary, Italy, Latvia, Poland, Republic of Cyprus, Romania, Slovakia, Slovenia, Sweden, Norway and Iceland

3. Sandboxes and innovate hubs

To keep up with industry practices, supervisory authorities have taken the initiative to create ‘regulatory sandboxes’ or ‘innovation hubs’ to facilitate the testing of innovative products in a ‘live’ environment. On 5 September 2018, the FCA announced its collaboration with 11 financial regulators to create the Global Financial Innovation Network (“GFIN”), following its proposition for a ‘global sandbox’.

According to SMSG, regulatory sandboxes and innovation hubs are positive developments, however it is important that ESMA sets minimum criteria for national authorities to ensure transparency, investor protection and minimum regulatory capture.

4. UK developments

The Chancellor of the Exchequer launched the Cryptoassets Task Force in March 2018 as part of the Government’s Fintech Sector Strategy. The Cryptoassets Task Force includes HM Treasury, the FCA and the Bank of England in relation to developing an approach to cryptoassets and distributed ledger technology. On 30th October 2018, the Cryptoassets Task Force published its final report, including its conclusions and plans for financial regulation in this area in the UK. We will publish a separate article outlining the final report in more detail shortly.