Security token offerings (STOs) are a form of fundraising that involves offering or issuing digital tokens to investors. These tokens represent securities under the laws where they are issued. Typically, distributed ledger technology (DLT) and other digital tokenization infrastructures record the interests in the securities.
The security tokens issued under an STO generally entitle holders to rights similar to conventional securities. For example, an equity token may grant voting or dividend rights, while a debt token may grant rights to coupon and principal payments.
However, what constitutes a security asset varies from jurisdiction to jurisdiction. As a result, a particular token may be classified as a security token under the laws of one jurisdiction but not in another.
In many jurisdictions, a token will amount to a security asset when it represents a right to any financial return and claim on the issuer – even when the financial return is entirely dependent on the success of a particular project. Due to the legal status of security tokens as securities, stricter regulatory regimes applicable to securities typically apply to STOs, in addition to recent regulations specific to the issuance of digital tokens.
This article will cover the general regulatory regimes in the Asia Pacific, Europe, and the United States.
In most of the jurisdictions in the Asia Pacific, STOs are generally covered by existing securities legislation and frameworks if they satisfy relevant conditions. This means that existing licensing and product authorization requirements in such frameworks also apply to participants in an STO.
While there are similarities, such as disclosure or prospectus requirements, security law obligations and licensing requirements, including any regulations for digital tokens, vary between jurisdictions. Every interested participant must carefully consider the obligations in each relevant jurisdiction before launching an STO.
The table below summarizes the STO legal positions in the Asia Pacific area:
There is currently no uniform global or European taxonomy for categorizing or defining crypto assets, and STOs are presently not regulated at an EU level. However, several EU-level regulations applicable to the issuance of securities bring a degree of harmonization.
Despite this overlying framework, the approach to regulation of STOs varies considerably between member states. Some states have enacted legislation that supplements the EU position, while others are unlikely to classify security tokens as securities, which means that the harmonized framework does not apply.
In September 2020, a draft proposal for an EU regulation on crypto-asset markets was published to improve harmonization in this area, although it may not apply directly to many STOs. As currently drafted, the regulation would only apply to an STO to the extent that the tokens are not covered by EU financial services legislation (unless the tokens also qualify as e-money tokens).
As outlined below, many STOs are currently covered by EU financial services legislation applicable to MiFID financial instruments and appear to fall outside the scope of the new proposed regulation.
As part of harmonization measures, member states will likely be required to take action to ensure that there is consistency across EU jurisdictions between what is considered a token offering regulated under this regulation and an offering of security tokens regulated under MiFID II, the Prospectus Regulation, and other existing regulations.
However, it is likely to take many months for the draft regulation to be agreed upon and come into effect.
The table below summarizes the legal positions in Europe:
In the United States, tokenized assets can fall within the regulatory framework based on Howey’s Test. Howey’s law states that the funds raised by a company are deemed as an investment contract if:
The regulations in the U.S. are stringent, but certain provisions are conducive for STOs. For example, Regulation CF (crowdfunding) can be used by any issuer to sell up to $15M of their offering in a 12-month period to non-accredited investors. However, the tokens issued under this category cannot be traded in the secondary market for a period of 12 months.
Another option could be to apply for an STO under Regulation D. In this case, an STO can be generally advertised and sold to accredited investors only, and there is no limitation on the amount that can be raised. So far, this is the most commonly used SEC exemption for security tokens.
There are also other regulations, including Regulation A+ and Regulation S. Depending on the type of asset and the amount to be raised, the applicable regulation can be chosen and used.