‘IPO’, three letters to embody the essence of a $3.76tn UK market, so fundamental that their meaning speaks even to the uninitiated. Initial offerings, however, extend beyond the realms of traditional shares. Yet, for the vast majority, news of an STO – Security Token Offering is likely to fly under the radar.
On the one hand, this comes as no surprise. A report by the Cryptoasset Taskforce confirmed that security tokens compose only a very limited portion of the markets within the UK. Consequently STOs, or Security Token Offerings, are about as common as royalty. On the other hand, despite their nature as cryptoassets, they aren’t so very different to the common shares that marketeers and the public alike have come to know.
What is a Security Token Offering (STO)?
Security Token Offerings (STOs) represent the sale of tokens with features comparable to normal securities, a modern-day alternative to the age old need to raise capital. Security tokens are digital liquid contracts for assets that already have value such as property, and grant holders all of the rights conferred on traditional shareholders. They indicate an ownership position in an entity and similar rights. These include voting rights, access to dividends or the distribution of capital upon liquidation.
While cryptocurrencies, often in the form of sparkly golden doubloons, continue to dazzle in the glare of the media spotlight, security tokens for the most part manage to evade any coverage at all. This experience is mirrored on the regulatory front.
The FCA and cryptocurrency
While the FCA has placed a ban on the sale of crypto derivatives to retail investors, the focus of the regulator seems very much to sit with the inherent risks of cryptocurrencies. HM Treasury’s latest consultation, ‘UK regulatory approach to cryptoassets and stablecoins’ does little to alter the status quo. The paper, while diving into the details of expanding the regulatory perimeter for crypto, makes only passing reference to security tokens, a warmup act for the Stablecoins taking centre stage.
The reason for this is clear. Stablecoins not only show great potential for widespread use but are already gaining widespread attention – two factors that in combination place Stablecoins directly in the regulatory crosshairs.
The lack of regulatory airtime, however, isn’t exclusively the result of diminished public interest. Rather, it can be chalked up to the fact that what there is to be said – has already been said.
The FCA definition of security tokens
The FCA adopts a technologically neutral approach to regulation. If a product shows the signs, or shares the attributes of a specified investment as set out in the Regulated Activities Order (RAO) and Financial Services and Markets Act (FSMA) – then no degree of technological mystification is going to dissuade the regulator from approaching it as such.
Through the regulatory lens, a security token is any token that demonstrates characteristics similar to those of shares and other debt instruments. As outlined above, it is a tokenised, digital version of traditional securities and so, unlike utility and exchange tokens, security tokens fall directly within the scope of the FCA – leaving very little room for discussion. The issuer of the token may not require authorisation (just as the issuance by a company of its own shares is not regulated), however, the associated regulated activities, such as arranging deals in security tokens, do.
As a test if, an individual or firm by way of business, conducts a regulated activity with a token which represents a specified investment and is not excluded under the RAO (Regulated Activities Order), then those activities require authorisation. It should be noted, therefore, that security tokens are also within the scope of the financial promotions regime.
In its 2019 consultation paper, ‘Guidance on Cryptoassets’ the FCA outlined a number of characteristics which might indicate that a token constitutes a specified investment. In particular, the FCA drew attention to certain contractual rights and obligations such as entitlement to ownership or profit. The FCA also referenced the need to assess the language used and whether the token is transferable or tradable on an exchange. The FCA also stated that, where the flow of payment is a contractual entitlement, it is highly probable that the token is a security.
As Californian corporates, card schemes and retail investors alike spur on the cryptocurrency market, and the regulator rushes to keep pace with the crypto frontier, we can rest assured that security tokens, at least, are in safe hands.
If you require any advice or guidance around the regulatory implications of security tokens and how it may impact your firm, as well as any of your firms’ regulatory obligations, then please do not hesitate to contact me, or any of the team, at fscom.
This post contains a general summary of advice and is not a complete or definitive statement of the law. Specific advice should be obtained where appropriate.