The imputability of Initial Coing Offerings (ICOs) to the public offering of financial products
Under Italian laws, the legal classification of tokens must be carried out on a case-by-case basis, having regard to the nature of the rights embedded in the token. The latter, by applying the principle of technological neutrality of the regulation and the relevant prerequisites, could alternatively be qualified as “securities”, “financial instruments” (other than securities) or “financial products”.
If the token falls into one of the above mentioned categories, the related “public offer” made in Italy would be subject, except for the application of the exemptions provided for by law, to the obligation to publish a prospectus pursuant to, as the case may be, Regulation (EU) 2017/1129 (“Prospectus Regulation”) or Article 94 of Legislative Decree no. 58 of 24 February 1998 (“TUF”), which is subject to CONSOB approval.
In particular, under Italian laws, offers of “securities” are now subject to the obligation to publish a prospectus pursuant to the Prospectus Regulation, while offers of “financial instruments” other than “securities” are subject to the obligation to publish a prospectus pursuant to the TUF.
Moreover, where the notion of “financial instruments” (and “securities”) is harmonised at EU level, Italian law covers the residual category of “financial products”, which include “financial instruments” and “any other form of investment having financial nature” (Art. 1, paragraph 1, letter u) TUF) and are also subject to the obligation to publish the prospectus under the TUF.
The regulation of digital tokens – and in particular their traceability within the above mentioned categories – presents, to date, numerous uncertainties, thus it is a shared fact that the current regulatory framework in the field of financial intermediation and protection of consumer rights is not able to adequately control the phenomenon of cryptoactivities.
In this context, CONSOB published on 19 March 2019 a consultation document entitled “Initial offers and cryptoactivity exchanges” (the “Consultation Document”). In the Consultation Document (not specifically investigated in this document), the Supervisory Authority, on the one hand, provides some useful guidelines for the legal framework of tokens and, on the other hand, proposes the introduction of the notion of “cryptoactivity” in the Italian legal system and outlines a possible regulatory approach for public offers of newly issued cryptoactivity and for subsequent trading on the secondary market. Consequently, some tokens that do not even qualify as “financial products”, could be classified as “cryptoactivity” category proposed in the Consultation Document by CONSOB and, therefore, potentially be regulated by the future legislative framework.
Before any assessment as to whether tokens can be classified as “securities”, “financial instruments” (other than transferable securities) or “financial products” for the purposes of applying the prospectus rules, the considerations concerning the existence of specific investor protection requirements underlying the whole of the discpline in question are of primary importance. In this respect, it should be stressed that the purpose of the entire prospectus rules on the sale or subscription of financial products (including securities and transferable securities) is based on the existence of a need for protection of the investors, resulting from the fact that investors transfer a certain value (a sum of money) in exchange for a financial product of less certain value.
Now, according to Article 1, paragraph 1-bis, TUF (referred to in fact by Article 2, paragraph 1, letter a)) of the Prospectus Regulation, which in turn refers to Article 4, paragraph 1, no. 44) of MiFID 2), “securities” means “the categories of securities that can be traded on the capital market, such as for example:
- companies shares and other securities equivalent to shares in companies, partnerships or other entities and share deposit receipts;
- bonds and other debt securities, including depository receipts in respect of such securities;
- any other securities which make it possible to acquire or sell the securities referred to in points (a) and (b) or which involve spot settlement determined by reference to securities, currencies, interest rates or yields, commodities or other indices or measures”.
With regard to the prospectus, it should also be noted, as mentioned above, that the relevant regulations applicable in Italy (pursuant to the combined provisions of the Prospectus Regulation and the TUF) prescribe exemptions from the obligation to publish the prospectus in relation, inter alia, to offers:
- whose total consideration, in the European Union, is less than Euro 8 million (calculated over a 12-month period);
- aimed solely at “qualified investors”, a notion which essentially falls within the definition of “professional clients” within the meaning of MiFID 2;
- addressed to less than 150 persons, other than “qualified investors”;
- whose nominal unit value is at least Euro 100,000.00.
Turning now to the analysis of the definition of securities and the possible imputability of tokens to this category, it should first be noted that the list of securities provided by the legislator includes, on the one hand, well-defined and typical categories of instruments (shares and bonds) and, on the other hand, expressions such as “other securities equivalent to shares” and “other debt securities” which, as also pointed out by authoritative doctrine, “seem to aim to make each subcategory as exhaustive as possible and therefore to reduce the risk of problems of interpretation relating to the imputability in the list of new types of instruments not expressly mentioned”. This list is therefore merely an example of the different types of “securities” that typically make up “securities”, while remaining open to capture new types of phenomena created by financial innovation that have functional characteristics similar to those of typical securities.
In this context, the assessment as to whether any type of token offered to the public is subject to the rules of the prospectus must therefore be made, in our opinion, by comparing the characteristics of tokens with those typical of “securities”, in order to verify whether the following minimum requirements are met:
- negotiability;
- standardization;
- comparability with the archetype of “financial instruments” in a “functional” and “substantialistic” perspective.
First, the requirement of “negotiability” should be understood not as actual trading, but as a concrete possibility of allocating the instrument to trading on the capital market.
Secondly, the requirement of ‘standardisation’ relates to the fact that instrument units possess similar characteristics and are fungible with each other, so that it is sufficient to refer to the type and number of units to trade them on the capital market.
Finally, with regard to the last (and often decisive) requirement of comparability with the archetype of “financial instruments” (i.e. “securities”) in a “functional” and “substantive” perspective, it is necessary to assess whether the token can be traced back to the above mentioned categories of “other securities”, as they are characterized by the typical elements of investments of a financial nature.
In this respect, the promise or expectation of a return of a financial nature, to be understood as an increase in the availability invested without the provision of services by the investor other than the provision of a sum of money, together with the assumption of a risk directly linked to the use of capital, appears to be a necessary element for the classification of an investment having a financial nature.
On this point, the “Corte di Cassazione” (Civil Section) February 5, 2013, no. 2736, clarified that “the negotiating cause is, therefore, financial, since the justifying reason for the contract, and not its simple internal reason of no qualifying relevance, consists precisely in the investment of capital (the “block” of savings) with the prospect of increasing the availability invested, without the support of services by the investor other than that of giving a sum of money”.
These guidelines have been further specified over time by CONSOB, until the following further elements of assessment can be identified in order to determine whether a transaction presents the distinctive features of an investment having a financial nature: (i) prevalence of the financial nature over that of enjoying and disposing of the asset acquired through the transaction; (ii) “effective and predetermined promise, at the time the contractual relationship is established, of a return linked to the res” such that “the expected increase in the value of the capital invested (and the risk associated with it) is an intrinsic element of the transaction itself”, different from the mere appreciation of the asset over time, thus accessing the very cause of the underlying contract (cf. CONSOB Communication no. DTC/13038246 of 6-5-2013).
Finally, it should be pointed out that, in the Consultation Document, CONSOB stated that, in the case of token offers, “returns” are often proposed which are not clearly linked to “returns of a financial nature” (the latter requirement being one of the elements characterising the “financial product” […]). The ICOs (Initial Coins Offerings), based on the characteristics of the tokens offered, can determine in the buyers expectations of returns or economic returns represented, broadly speaking, by income: (i) directly (yields parameterized to the trend of revenues, volumes of goods and services sold or profits of the entrepreneurial initiative; (ii) indirectly, related to the potential appreciation of the value of tokens traded in dedicated exchanges (which may depend on the positive performance of the entrepreneurial initiative as well as on market dynamics alone).