European financial watchdog latest to warn over ICOs

European Union financial regulator, the ESMA, has become the latest regulatory body to issue a warning about the risks of buying into — and running — ICOs, aka the crypto coin fundraising tool that has boomed in recent times to take advantage of an apparent legal grey area between issuing ‘software presale tokens’ vs a formal securities sale. (Which has also contributed to a huge boom in the value of some crypto currencies.)

Albeit, regulatory bodies have been tightening their scrutiny of ICOs for some months — and, in the case of China, the government issued an outright ban in September.

The ESMA has today issued two statements about token sales: One on the risks for investors, and one on the applicable rules for firms involved in ICOs — issuing clear warning shots in both cases.

It says it’s concerned investors “may be unaware of the high risks that they are taking when investing in ICOs”, and that firms involved in ICOs “may conduct their activities without complying with relevant applicable EU legislation”.

In its statement for investors, the ESMA sums up the main risks for investors as:

  • Unregulated space, vulnerable to fraud or illicit activities — warning, for example, that some ICOs might be being used for money laundering purposes
  • High risk of losing all of the invested capital — noting that “the vast majority of ICOs are launched by businesses that are at a very early stage of development”
  • Lack of exit options and extreme price volatility — raising potential difficulties of ‘cashing out’ of an ICO
  • Inadequate information — criticizing ICO white papers for being “in most cases unaudited, incomplete, unbalanced or even misleading”
  • Flaws in the technology — noting that blockchain tech remains “largely untested” and may be vulnerable to flaws, hacking and unreliable performance

In its statement for firms involved in ICOs, the ESMA cautions that they “must give careful consideration as to whether their activities constitute regulated activities” — warning that some of these token sales may already need to comply with existing EU regulations:

Depending on how they are structured, ICOs may fall outside of the scope of the existing rules and hence outside of the regulated space. However, where the coins or tokens qualify as financial instruments it is likely that the firms involved in ICOs conduct regulated investment activities, such as placing, dealing in or advising on financial instruments or managing or marketing collective investment schemes. Moreover, they may be involved in offering transferable securities to the public.

It goes on to list “key” rules that may apply if an ICO indeed constitutes a securities sale — namely:

  • The Prospectus Directive — and, if relevant, the publication of a prospectus is also subject to approval by a Competent Authority
  • The Markets in Financial Instruments Directive (MiFID)
  • Alternative Investment Fund Managers Directive
  • Fourth Anti-Money Laundering Directive

It also notes that additional national (EU Member State) rules may also apply.

“Firms involved in ICOs must give careful consideration as to whether their activities constitute regulated activities. If their activities constitute a regulated activity, firms have to comply with the relevant legislation and any failure to comply with the applicable rules would constitute a breach,” it warns.

“It is the duty of the firms themselves to consider the regulatory framework, seeking the necessary permissions and meeting the applicable requirements.”

So the tl;dr of that is your ICO might already be breaking EU financial rules — and your company could be on the hook for a big fat fine if it’s found to have done so.