Initial Coin Offering, known as “ICO”, is a relatively new phenomenon that has quickly become the main player in the Financial Services and Crowdfunding industries, as well as being the key subject of discussion in the Blockchain communities. In essence, it is one of the most advanced methods of raising finance from the public and is becoming increasingly popular to fundraise start-ups.
While all jurisdictions are shying away from regulating this industry, Malta has recently introduced a specific regulatory framework for ICOs and has become the first jurisdiction worldwide to regulate ICOs and Blockchain Technology.
This publication in fact seeks to give an overview of the recent laws and regulations relating to ICOs.
Information relating to any ancillary services to cryptocurrencies, including the operation of platforms to exchange such cryptocurrencies, portfolio management and providing investment advice amongst others, is discussed in our brochure: “Malta – Virtual Financial Asset Services – The New Legislation”.
B. TO WHOM DOES THE NEW LAW APPLY?
The new legislation applies to anyone who in or from within Malta:
Hence, if the asset that is offered to the public or admitted on the DLT Exchange is not a VFA, the new legislation does not apply, and other Financial Services laws might be applicable.
C. DEFINITION OF VIRTUAL FINANCIAL ASSET (VFA)
By way of a definition, a VFA is any form of digital medium recordation that is used as a digital medium of exchange, unit of account, or store of value and that is not one of the following as defined below:
The following are the legal definitions of the above:
Electronic Money means electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions (as defined) and which is accepted by a natural or legal person other than the financial institutions that issued the electronic money.
Financial Instrument includes the following:
• Transferable securities, including shares and bonds;
• Money market instruments such as treasury bills and certificates of deposit;
• Units in a collective investment scheme;
• Options, futures, swaps and any other derivative contracts relating to securities, currencies interest rates, yields, commodities or those that are traded on a regulated market etc.;
• Derivative instruments for transfer of credit risk;
• Rights under a contract for difference;
• Instruments which confer property rights;
• Foreign exchange held for investment purposes; and
• Emission allowances under EU Emissions Trading Scheme.
Virtual Tokens have been defined as a form of digital medium recordation whose utility, value or application is restricted solely to the acquisition of goods or services, either solely within the Distributed Ledger Technology (DLT) platform on which it was issued or within a limited network of DLT platforms (that exclude DLT Exchanges).
It is important to note that a virtual token which may be converted into another DLT asset type shall be treated as the DLT asset type into which it is or may be converted.
The laws have introduced a compulsory Financial Instrument Test in order to classify the asset and determine whether it is a VFA, Financial Instrument, Electronic Money or Virtual Token.
D. FINANCIAL INSTRUMENT TEST
An Issuer of a VFA shall, prior to offering such asset to the public in or from within Malta, or applying for its admission on a DLT exchange, undertake the Financial Instrument Test (hereinafter “the Test”).
The test is crucial to determine whether the DLT asset qualifies to be regulated under this new regime of laws, or whether the other Financial Services Laws will apply.
The Test has to be:
The process is a two-fold test, being:
If a cryptocurrency qualifies as a Virtual Token as defined by the new law and does not qualify as a VFA, Financial Instrument or Electronic Money, then it is exempted from the ambit of applicability of the new law and the licensing requirements are not needed for its issuing or trading.
It is very important to point out that the MFSA shall rely on the determinations made by the Issuer and its respective VFA Agent. It will not make any determination of its own. In case of any disagreement between the VFA Agent and the Issuer, the matter shall be resolved between the said parties prior to a whitepaper’s submission for Registration with the MFSA.
Furthermore, the MFSA shall not be accepting any applications where the Issuer’s determination has not been endorsed by its VFA Agent.
For more detailed information on the Test, please consult our supplementary brochure: The Financial Instrument Test.
E. SALIENT FEATURES OF THE ICO PROCESS
F. STRUCTURE OF THE ISSUER OF THE ICO
The regulations stipulate the following general requirements which must be met at all times by the Issuer of the VFA.
In essence, by law, it is important that the Issuer:
All the persons listed above must have sufficient knowledge and experience in the field of I.T., DLT assets and their underlying technologies and maintain such knowledge throughout the duration of the business.
G. DOCUMENTATION TO BE SUBMITTED FOR ICO
An Issuer wishing to offer VFA to the public (i.e. ICO) in or from Malta shall prepare the following documents, which will be submitted to the MFSA through its VFA Agent:
It is important to note that:
H. ISSUING OF A VFA – REQUIREMENT OF A WHITEPAPER
The law prescribes that a whitepaper which will be registered and in effect approved by MFSA is compulsory in order for an issuer to:
Ten days before being circulated, the whitepaper has to be:
Most importantly, the whitepaper shall have the contents specified in Annex I of this publication. Non-observance with any of such requirements will automatically disqualify the whitepaper from being registered / approved.
I. BOARD OF ADMINISTRATION
The Issuer’s Board of Administration shall be responsible for ensuring that the Issuer complies with its obligations under the laws.
It is crucial that the Board of Administration has, both collectively and on individual basis, sufficient knowledge and understanding of the Issuer’s business to enable them to discharge their duties.
Amongst the duties, one finds the following:
J. FUNCTIONARIES OF THE ISSUER
By law, the Issuer is required to appoint the following Functionaries:
The identities of the Functionaries must be disclosed in the Whitepaper. These will be analyzed in more detail below:
1. VFA Agent
An issuer of a VFA is required to appoint, and have at all times in place, a VFA agent who is duly registered with the MFSA and duly approved by the same. The VFA Agent must at all times remain independent from the issuer.
The roles of the VFA Agent shall include the following:
The Issuer must provide written confirmations to the VFA Agent that:
The only 2 instances in which a VFA Agent is not required are:
2. Systems Auditor
Where an issuer has Innovative Technology Arrangements in place (e.g. Smart Contracts, DLT Platform), such Issuer has to appoint and have at all times a Systems Auditor, who needs to be approved by the MFSA. The authority may object to the appointment and may replace such Systems Auditor.
The role of the Systems Auditor shall be that of:
The regulations also specify the contents of the letter of engagement between the Issuer and the Systems Auditor. The agreement must require the latter to:
The regulations require the appointment of a Custodian, in order to be responsible for the safekeeping of the assets and investors’ funds. The MFSA consent is required prior to such appointment.
Interestingly, custody of the VFA can be performed through an Innovative Technology Arrangement (a smart contract) which is duly certified by a Systems Auditor.
In any case, the Issuer shall ensure that there are appropriate systems that provide for the reimbursement of investors’ funds should the Initial VFA offering be cancelled.
The Custodian is required to be independent and must be one of the following:
Fiat Currencies – with any of the following:
The law requires every Issuer to have at all times an Auditor that is approved by the MFSA who has to be experienced and qualified to act as such to the Issuer.
Apart from preparing the annual audit, the Auditor is also required to prepare a management letter in accordance to the International Standards on Auditing.
The regulations also specify the contents of the letter of engagement between the Issuer and the Auditor. The agreement must require the latter to:
5. Money Laundering Reporting Officer (MLRO)
The Issuer must at all times have a duly qualified MLRO who must:
The person to be appointed as MLRO must be proposed to the MFSA who prior to the approval shall be required to complete a course approved by the MFSA as well as sit for a mandatory interview with officials of the MFSA.
K. F.I.T. SYSTEMS & INFRASTRUCTURE
The regulations stipulate that the Issuer needs to have in place the following systems:
1. Cyber Security Framework
It is compulsory for the Issuer to have a Cyber Security Framework that complies with internationally recognized cyber security standards and be in line with the General Data Protection Regulations (GDPR).
It shall include as a minimum:
2. Record Keeping Facilities
The Issuer has to maintain documents for a minimum of 5 years and must be made available to the MFSA whenever required. It is important that storage is made in a manner that:
3. I.T. Infrastructure
The Issuer shall ascertain that its I.T. infrastructure ensures:
The I.T. infrastructure must be located in Malta, EEA member state or a jurisdiction approved by the MFSA. In case that the I.T. infrastructure is not located in Malta or is located in a cloud environment, the Issuer shall ensure that data is replicated real time by virtue of a live replication server located in Malta.
If the issuer maintains a website, its homepage shall contain such information and in such a format as may be required by the MFSA by means of duly published Rules.
Any type of advertisement that relates to an initial VFA offering or the admission of a VFA to trading on a DLT exchange, shall satisfy the following:
M. ADMISSION TO TRADING ON A VFA EXCHANGE
A person can apply for admission of its VFA to trading on a VFA exchange. This application can only be made through a VFA Agent.
Such an admission has to be made in accordance with the Rules duly published by the MFSA.
However, it is important to keep in mind that the offering of VFAs, or the admission to trading on a DLT exchange, in a country outside Malta shall be subject to the laws of that country.
The following prohibitions apply to acts carried out by any person concerning VFA that are admitted to trading on a VFA exchange:
N. DUTIES OF THE ISSUER
By law, the issuer shall:
In addition, the issuer shall be liable for damages sustained by a person as a direct consequence of such person having bought Virtual Financial Assets, either as part of an initial VFA offering by such issuer or on a DLT exchange, on the basis of information contained in the whitepaper, website or advertisement by reason of any untrue statement included therein.
The law also specifies that a statement in the whitepaper or advertisement shall be deemed to be untrue if it is misleading, inaccurate or inconsistent, either willfully or in consequence of gross negligence.
O. DUTIES UNDER ANTI-MONEY LAUNDERING LAWS
By law, the issuer shall be considered a Subject Person in terms of the Anti-Money Laundering laws.
In essence, this implies that the issuer has to:
P. CERTIFICATE OF COMPLIANCE & ANNUAL REPORTS
The issuer shall be required to submit on an annual basis a certificate of compliance to the MFSA which will be drawn up by the Issuer, reviewed by the VFA Agent and signed by all the members of the Issuer’s Board of Administration.
The certificate will confirm that the issuer is compliant with all the relevant obligations laid down by law and include the following confirmations by the:
In addition, the Issuer shall on an annual basis also engage an independent auditor to draw up a report to include:
Q. INVESTOR PROTECTION
One of the MFSA’s main policies is to ensure investor protection. In order to further mitigate risks and enhance investor protection, the MFSA is requiring enhanced measures, apart from the requisite of the Custodian. In fact, the laws require the following:
1. Monitoring of Milestones
The law requires the Issuer to provide a detailed description of the past and future milestones and project financing within the whitepaper. It will be the duty of the VFA Agent to ensure that the Issuer has provided investors with a roadmap setting out the milestones for the ICO and to check whether the Issuer is meeting the said milestones. In the event that these milestones are not being met, the VFA Agent would be required to inform the MFSA accordingly.
The MFSA also might require such Issuers to disclose progress, by means of public announcements, on the date set out for each milestone within the roadmap provided to investors, and in case of deviations therefrom, to highlight
such deviations in the said public announcement.
2. Maximum Investment Limit for Retail Customers
In order to limit exposures in case of failure, the Issuer shall ensure that an investor does not invest more than €5,000 in its ICO over a period of 12 months. This limitation is only applicable to retail investors as defined by MiFID.
Retail clients include all clients who are not professional clients or eligible counterparties (such as regulated financial institutions and entities).
R. POWERS OF THE MFSA
The MFSA has broad powers in relation to the issuance of the VFA, including the power to:
S. CORPORATE TAXATION
As a company resident in Malta, a License holder may also benefit from the advantageous fiscal treatment wherein a shareholder may apply for refunds equivalent to 6/7th of the income tax paid at corporate level, leaving the tax leakage to a maximum of on company profits.
The above is explained in the following basic graphical representation:
ICOs are an innovative and quick method for companies to raise capital. This new method requires ad hoc regulations, in order to maximize efficiency and investor protection. Via the introduction of the new regulations, Malta has become the first jurisdiction in the world to have specific laws on this, and this will render the island the natural choice of jurisdiction for ICO issuing companies.
One has to always proceed with caution, as there are various laws that might need to be taken into consideration before proceeding with an ICO. Hence, classification of the Token is of paramount importance. Additional legal issues might arise and hence need to be considered if an ICO targets investors globally.
Regardless of the Token structure and its classification, the issuing company needs to provide investors with full, genuine, correct and detailed information and disclose such information comprehensively and transparently to permit an average investor to make a reasonable investment decision.
Non-compliance with any of the above may result in severe legal consequences to the ICO issuer.
To this effect, it is highly advisable that all ICO intended issuers seek proper legal advice and guidance at all stages of an ICO. With such guidance and professional advice, an ICO may become a solid valuable method of financing companies and give a boost to innovative technology and infrastructure.
ANNEX I – FORMAT AND CONTENTS OF WHITEPAPER
The whitepaper shall contain the information which, according to the particular nature of the issuer and of the Virtual Financial Assets (VFA) offered to the public, is necessary to enable investors to make an informed assessment of the prospects of the issuer, the proposed project and of the features of the VFA.
This information must be presented in an easily analyzable and comprehensible form.
It must be drafted in English language and any or no additional languages.
ANNEX II – LICENSING FEES PAYABLE TO THE MFSA
The fees payable to the MFSA are as follows:
Christos P. Kinanis
Lawyer - Managing Partner
Lawyer - Partner
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