An extract from The Virtual Currency Regulation Review, 3rd Edition
Introduction to the legal and regulatory frameworki Market size
Switzerland is the home of the crypto valley in Zug, near Zurich, and has an active community of enterprises working in the crypto space. While it is difficult to attribute a rank to Switzerland in the fast-moving global crypto community, Switzerland has taken the role of a pioneer in this area and is one of the most important jurisdictions for initial coin offerings (ICOs) and securities token offerings (STOs).2 The choice of Switzerland as place of incorporation for the Libra Association is testament to the attraction of Switzerland as a home for innovative ventures in the blockchain business.ii Legal framework
Switzerland has a favourable and attractive legal framework regarding cryptoassets, although it does not have a separate legal framework for them. For cryptocurrencies, it already provides a regulatory framework that allows the issuance and trading of such assets, provided that anti-money laundering (AML) rules are complied with.
Switzerland is in the process of further improving the regulatory framework for asset tokens. The Federal Council proposed a new bill on 27 November 2019 regarding various amendments to Swiss laws to take into account the potential offered by the distributed ledger technology (the DLT Bill) that would introduce DLT rights as the digital alternative to certificated securities. DLT rights should be exclusively transferable through the blockchain. According to the DLT Bill, Switzerland would also introduce a new type of licence category for trading venues, where DLT rights could be traded. Moreover, the DLT Bill would provide for segregation rights for cryptoassets held in custody by a third party (e.g., a wallet provider), in case of bankruptcy of such third party. The Federal Council proposes these improvements to the legal framework for distributed ledger and blockchain applications as amendments to current Swiss laws, without creating a separate regulatory regime for such technology. The National Council as the chamber of the Swiss Parliament deliberating the matter first approved the DLT Bill on 17 June 2020 without making material changes to the proposal of the Federal Council. The next step will be the approval by the Council of States as the second chamber of the Swiss Parliament. For further information, see Section X.
The Swiss Financial Market Supervisory Authority (FINMA) has repeatedly stated that it will not distinguish between different technologies used for the same activity: that is, it will apply the principle of 'same business, same rules' to any kind of new technology. FINMA adheres to this principle at present when applying Swiss financial market laws to cryptoassets and blockchain-based applications and this will also apply going forward with the proposed new legislation on DLT rights.iii Regulatory classification of tokens
On 16 February 2018, FINMA published guidance on how to apply Swiss financial markets laws in its guidelines regarding the regulatory framework for ICOs (the ICO Guidelines).3 In the ICO Guidelines, FINMA clarifies how to classify cryptocurrencies and other coins or tokens (collectively with cryptocurrencies, tokens) or other assets registered on distributed ledgers under Swiss law.
According to the ICO Guidelines, FINMA distinguishes the following categories of tokens:
- payment tokens or cryptocurrencies, which are intended only as means of payment and that do not give rise to any claims against the issuer;
- utility tokens, which provide rights to access or use a digital application or service, provided that such application or service is already operational at the time of the token sale; and
- asset tokens, which represent an asset, for instance a debt or equity claim against the issuer or a third party, or a right in an underlying asset.
FINMA has further clarified that tokens may also take a hybrid form including elements of more than one of these categories. These hybrid tokens must comply cumulatively with the regulatory requirements applicable to each relevant token category. FINMA acknowledges that a token's classification may change over time. For the purpose of assessing the regulatory implications of an ICO, the moment of the token issuance is relevant. However, the initial classification may change post-ICO. In the event of any secondary market trading activity with tokens, their classification in the moment of the relevant trading activity must be taken into account.
In addition, FINMA published its views on the regulatory classification of stable tokens (i.e., tokens backed by an underlying asset such as a pool of fiat currencies or other assets) in a supplement to the ICO Guidelines dated 11 September 2019. FINMA specified that stable tokens are not considered a separate type of token category under Swiss regulation and that, depending on the rights attached to stable tokens, these would usually classify as asset tokens or as hybrid between payment tokens and asset tokens.
Payment tokens do not qualify as legal tender or other means of payment under Swiss law. However, the Swiss Federal Council has clarified that payment tokens may be used as private means of payment if the parties to a transaction agree on the use of payment tokens as the applicable means of payment for such a transaction. In addition, the issuance of payment tokens requires compliance with the Swiss AML rules (see Section V).iv Enquiries to FINMA
Notwithstanding the guidance provided by FINMA, given that this field is new and the structures of token offerings are always evolving, regarding the application of the ICO Guidelines in real-life projects, it is normal practice to seek a confirmation from FINMA to the effect of obtaining a no-action comfort from the regulator.
FINMA offers the possibility to file such no-action enquiries in order to confirm the regulatory interpretation.
Securities and investment lawsi Relevance for asset tokens and certain types of utility tokens
Swiss securities laws are relevant for the issuance of asset tokens or any hybrid form of tokens involving the functionality of asset tokens (e.g., a stable token or a utility token regarding the use of a platform that is not fully developed).
However, payment tokens and utility tokens that do not represent any claims against an issuer or a third party are not subject to Swiss securities laws, as they do not represent any rights.4 Such payment tokens and utility tokens should be classified as intangible digital assets sui generis for the time being.5ii Issuance of tokens representing rights against an issuer or a third party
To the extent that asset tokens or utility tokens representing any claims against an issuer or third parties are governed by Swiss law, according to the view expressed by FINMA as well as according to the prevailing view in the Swiss market, these tokens should qualify as uncertificated securities according to Article 973c of the Swiss Code of Obligations (CO).6 The creation of these uncertificated securities requires a decision from the competent corporate body as well as the registration of the first holders of the uncertificated securities in a register held by the issuer. This register is not subject to any form requirements, and therefore it is possible to qualify the distributed ledger as such a register.
If the token sale involves a financial institution pursuant to Article 4(2) of the Swiss Federal Intermediated Securities Act (FISA) acting as custodian for intermediated securities, the tokens can be issued as intermediated securities.7 The advantage of creating intermediated securities would be that the entitlements in the tokens could be transferred by book-entry in the custody accounts of the custodians involved according to the rules of the FISA. However, given that token sales are usually structured in a way that does not involve a securities custodian, we will not cover the further requirements to be taken into account for the issuance of tokens in the form of intermediated securities.iii Transfer requirements for tokens
Under Swiss law, payment tokens and utility tokens that do not represent any claims against an issuer or third parties can be validly created and transferred in accordance with the terms of the respective distributed ledger. A transfer can therefore be validly made by executing a transaction between two wallets.
However, asset tokens and utility tokens representing enforceable rights against an issuer or a third party require, in addition to a valid transfer on the relevant distributed ledger, that the rights represented in such tokens are validly created and transferred to the transferee. Depending on the types of rights represented in the tokens, this could be a written form requirement for the transfer of such rights under Swiss law. Regarding the transfer of tokens representing uncertificated securities (see Section II.ii), the rules of assignments pursuant to the CO must currently be complied with, which require a declaration of assignment in writing by the assignor. To the extent that the tokens were registered with a financial institution acting as securities custodian, such securities could be issued as intermediated securities under the FISA, and it would be sufficient to transfer the securities by way of book entry between the custodians involved in the transaction without a transfer by way of an assignment. However, on the basis that no custodians are involved, the written form requirements for a transfer of uncertificated securities must be complied with for a valid transfer.
Under Swiss law, a written form requires that the parties must either provide a wet-ink signature, which can be delivered through a scan, or a certified electronic signature according to Article 14(2bis) CO. We are not aware of any distributed ledger that would currently support such certified electronic signatures; therefore, a written form requirement can, to date, not be substituted by a transaction of tokens on a distributed ledger.
As the transfer of uncertificated securities is subject to a written form requirement, to validly transfer the rights attached to asset tokens and utility tokens representing exercisable rights against an issuer or a third party under Swiss law, a work-around is needed. One solution is the use of terms and conditions of the tokens specifying that the transfer of such tokens to a new token holder shall be construed as a transfer of the contractual relationship in which the new token holder assumes the entire contractual position from the old token holder. Such transfers may be made in the form of a three-party agreement between the issuer, the old and the new token holder. For the purpose of this transfer, it could be argued that all participants of a distributed ledger, including the old and new token holder and the issuer, implicitly agree by participating in the distributed ledger to such a method of transferring tokens. However, it would be prudent to provide, at least, that the issuer must keep a record of the current token holders and acknowledges any transfer to a transferee before any transferee may exercise any rights resulting from the tokens.
With regard to the DLT Bill, the Federal Council proposed the introduction of DLT rights as a new type of right that may be created with a registration on a distributed ledger and that could be transferred according to the terms of the respective distributed ledger without having to meet further requirements of Swiss law. Asset tokens or utility tokens could be issued as DLT rights (see Section X).iv Classification of tokens as securities
According to Article 2(b) of the Financial Market Infrastructure Act (FMIA), securities are certificated or uncertificated securities, derivatives or intermediated securities, which are standardised and suitable for mass trading. According to Article 2(1) of the Financial Market Infrastructure Ordinance, 'standardised and suitable for mass training' means, in this context, that the instruments are offered for sale publicly in the same structure and denomination, or that they are placed with 20 or more clients under identical conditions.
FINMA has clarified in the ICO Guidelines that it will apply these rules in connection with tokens constituting uncertificated securities (see Section II.i) as follows:8
- Payment tokens do not qualify as securities given that they are designed to be used as means of payment according to FINMA. Payment tokens cannot fall under the definition of securities as they do not represent any rights that are exercisable against the issuer or third parties.
- Utility tokens can qualify as securities if the platform where they can be used is not operationally ready at the time of the token sale, or if the tokens represent rights that may be enforced against the issuer or a third party. These utility tokens are deemed to have an investment purpose. FINMA further clarified that a case-by-case analysis is needed to clarify whether or not a utility token can be used for its intended purpose. In particular, it specifies that proof of concepts or beta versions of platforms or applications on which the utility tokens cannot (yet) be used would not suffice to fall outside of the definition of securities for the purposes of the FMIA. However, on the basis that the qualification of tokens may change over time, it is possible that utility tokens qualifying as securities will fall outside of this definition once the platform where the tokens shall be used becomes fully functional for its intended purpose.
- Asset tokens qualify as securities provided that they have been offered publicly or to 20 or more persons for sale.
FINMA has stated that any enforceable rights of investors to receive or acquire tokens in the future resulting from a presale, for instance under a simple agreement for future tokens, qualify as securities if the rights have been offered publicly or on identical terms to more than 20 persons. On the other hand, the rights issued in the context of a presale do not constitute securities if the terms used in the presale are not standardised or different terms are used with each investor: for example, by varying the amount of rights, the pricing or any lock-up provision.v Prospectus requirement
Regardless of the classification of tokens as securities, in respect of any tokens constituting a digital representation of rights that are exercisable against an issuer, the question arises of whether the tokens are subject to a prospectus requirement under the Swiss Financial Services Act (FinSA), which entered into force in January 2020. Under the FinSA, a prospectus requirement applies, generally speaking, for all public offerings of securities, including tokens qualifying as securities (see Section II.iv). During the transition period lasting until 1 December 2020, issuers may alternatively prepare a prospectus pursuant to the old prospectus regime that was in place prior to the adoption of the FinSA.
In addition, as regards financial instruments offered to retail investors, the FinSA introduced an obligation to prepare a key investor document as an additional disclosure document in a similar way as currently applicable in the European Union pursuant to the Packaged Retail and Insurance-based Investment Products Regulation. This new obligation will also apply to certain types of tokens qualifying as financial instruments (e.g., asset tokens with the economics of a structured product or a derivative).vi Regulatory implications of classification of tokens as securities
If tokens qualify as securities, they are subject to the regulatory framework of the FinSA and the Financial Institutions Act (FinIA). According to this regulatory framework, a licence as a securities firm is required for any brokerage activities on behalf of clients (other than institutional clients) regarding such tokens and any market-making activities regarding such tokens.9 Furthermore, underwriting such tokens and issuing tokens that qualify as derivatives are subject to a licence requirement as a securities firm or bank, if such activities are conducted on a professional basis.10 A licence requirement is triggered in each case if these activities are executed on a professional basis.
Moreover, the qualification of tokens as securities has implications on the licence requirements under the FMIA for any secondary trading platform where such tokens can be traded.