Not long ago, lawyers across Asia were devising clever schemes to keep new cryptocurrencies as far from regulators as possible. This year they are trying to come up with ways that make sure crypto offerings fall squarely within securities laws across the region.
So-called initial coin offerings exploded on the start-up scene in 2017 as an alternative to initial public offerings. Unlike IPOs, the market for ICOs has enabled small companies to bypass banks and traditional underwriters of capital raisings by selling digital tokens backed by crypto technologies directly to investors online.
Most ICO issuances have been structured to avoid securities laws. In many cases, the tokens sold by companies did not grant investors rights to share in the profits of the companies, nor did they act as a type of debt that had to be repaid at a certain date. Instead, such instruments often granted access to the company’s products and services.
The technological development has been hailed as a democratisation of fundraising and investment but also quickly attracted scrutiny from regulators around the world, which have accused some companies of issuing securities-like instruments without the proper licensing. Financial watchdogs in Asia have been particularly heavy-handed, with China and Hong Kong all but banning ICO activities.
The solution this year has been to meet the law head-on. Start-ups and their lawyers are exploring ways to make ICOs compliant. They call it a security token offering, or STO. It could become the next big crypto trend in Asia, and around the world, lawyers say — if companies can find a market for them.
“With ICOs, we saw people trying very hard to fall outside of the regulated space,” says Lena Ng, a partner at Clifford Chance, who leads the firm’s financial regulatory practice in Singapore. “STOs are clearly subject to regulation.”
ICO issuance took off in 2017, with companies raising about $7bn through these instruments, up from less than $300m the year before, according to a report in March from PwC, the professional services firm. Issuance hit $19.7bn in 2018 but showed signs of petering out by the end of the year as regulatory hurdles and overall sentiment for cryptocurrencies waned.
Still, the coins have been hit with big regulatory problems in Asia. Last year a company called Black Cell Technology was forced by the Securities and Futures Commission in Hong Kong to “unwind” an ICO sale after the watchdog said the instruments resembled securities.
Start-ups have gone to some lengths to avoid such infractions by setting up their businesses in offshore jurisdictions. One Hong Kong-based company last year first moved its official company domain to the Indian Ocean island of Mauritius. It then sold a token from a limited liability company in the Cayman Islands, which was in turn wholly owned by a trust in the island-nation of St Kitts and Nevis.
However, such elaborate means of avoiding regulatory scrutiny have since gone out of style in the legal sector, Ms Ng says. Inquiries about STOs have surged this year, she adds, indicating that the future of cryptocurrencies is more likely to play out in regulatory daylight.
The catch is that issuing a regulated security is a costly endeavour.
“Is there a business case for securitising these assets?” asks Hoi Tak Leung, a technology specialist and counsel at Ashurst’s corporate practice in Hong Kong. “There’s a cost to that, and the cost to comply can be quite high.”
One of the merits of STOs is that they transfer legally binding rights in a company or an asset to the investor. With many ICOs it is unclear what, if anything, the buyer is taking possession of.
However, as with traditional IPOs, complying with disclosures for public securities is a complex process that can take months and often requires a large, expensive legal team. Such high barriers will greatly reduce the appeal of STOs for small start-ups looking for cheap means of raising funds, Mr Leung says.
Enthusiasm for regulated STOs, nonetheless, is building, as the PwC report shows. Companies raised $442m with STOs globally last year, up from just $22m the year before.
Some of that demand is probably coming from institutional investors, says Etelka Bogardi, a financial services regulatory partner at Norton Rose Fulbright in Hong Kong.
Under most current regulatory frameworks in Asia, STOs will be marketable only to institutional investors such as hedge funds and family offices. In many ways, the future of STOs looks more like a private placement to a small number of professional investors, rather than the broad base of global retail investors originally intended.
For many companies, abiding by securities laws will defeat the purpose of raising money through crypto technologies. “At the end of the day, there is a balance to be struck,” says Ms Bogardi. “These things were clearly a form of capital raising, and when things go wrong people look to the regulators.”
She adds: “It’s moving towards a market for hedge funds and investors who are in the know, and moving away from the democratisation of investing.”
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