Cleary Gottlieb on France’s New Framework for Approving ICOs

On April 11, 2019, the French parliament adopted a law (the “Loi Pacte”or “Law”)[1] that establishes a new regulatory framework for initial coin offerings (“ICOs”) of blockchain based tokens by entities established or registered in France.  At the heart of the Law’s ICO provisions is an innovative framework that will allow issuers to request an optional visa from the French Financial Markets Authority (the “AMF”) prior to undertaking an ICO.  ICOs of tokens that are not financial instruments will still be permitted without a visa, but the expectation is that issuers obtaining the visa for an offering of such tokens will have a distinct advantage relative to offers that lack such approval.  ICO issuers that do not obtain a visa also will be subject to restrictions on certain kinds of advertising and sales methods.  By “white-listing” issuers serious enough to seek and obtain an AMF visa, France hopes to give investors a new tool for screening out potentially fraudulent offers and help ICO issuers establish the investor confidence necessary to secure funding.  Many of the details of the new framework will be specified in implementing regulations to be adopted by the AMF, which are expected to be issued shortly after the Law is officially promulgated.  The AMF published an overview of its planned regulations on April 15, 2019, providing further clarity on how the regime will work in practice.[2]

While the Law provides a framework for ICOs, it will not be available for all kinds of tokens.  If a token qualifies as a “financial instrument,” it will continue to be governed by existing EU regulations applicable to financial instruments and will not be eligible for the new framework.  Accordingly, ensuring that the token’s terms fall outside the definition of “financial instrument” will be a critical first step for any issuer considering an offering under the new framework.

The new framework is part of a broader French government effort to establish France’s reputation as a leading “blockchain-friendly” jurisdiction and to make France a hub for blockchain innovation.  By adopting laws tailored to the needs of companies promoting blockchain technology and investing in the sector, France hopes to establish an attractive ecosystem that allows companies focused on blockchain technology to achieve their full potential.[3]

New Framework for Token Offerings

Eligible offerings

The new framework for token offerings generally will apply to any issuer that makes a “public offering” of tokens[4] and requests a visa from the AMF.  There are three important exceptions.  First, the Law provides that the new framework will not apply to offers of tokens already covered by specified provisions of the French Monetary and Financial Code[5] including Book II of the Code, which covers “financial instruments.”  As a result, tokens that qualify as financial instruments will not be eligible for the new regime and will continue to be governed by applicable EU regulations including the EU Prospectus Regulation.[6]  Second, the framework will not apply to offers of tokens to a limited number of persons acting for their own account.  The draft regulations published by the AMF set the threshold for such offers at 150 persons or less.  Finally, the framework will only apply to issuers that are established or registered in France.

Requesting a visa will be optional

Requesting a visa from the AMF will be optional.  In choosing to make the visa optional, the Law’s proponents argued that a law prohibiting ICOs without a visa would simply discourage issuers from offering their tokens in France, and would prove difficult to enforce in practice.  By offering issuers the marketing benefits of having an information document approved by a regulator, together with a tailored regime designed from the ground up with distributed ledger technology and tokenized offerings in mind, France hopes to attract token issuers to the French market on a voluntary basis, and to play a central role in establishing market practices for reputable “white-listed” offerings.  While obtaining a visa will be optional, the Law provides that ICO issuers that do not obtain a visa will be prohibited from engaging in solicitation (démarchage) activities in connection with the ICO.[7]

AMF review process

Under the AMF’s draft regulations, the AMF will have 20 calendar days from receipt of a complete file to review the request and decide whether to grant a visa.  The visa will be valid for the duration of the offering, not to exceed six months, and will cover only the specific offering for which the visa is granted.  Before granting its visa, the AMF will examine the information document and planned marketing materials for the offering, together with related supporting documentation.

  • Information document.  To obtain a visa from the AMF, an issuer will be required to prepare an information document that contains all information on the issuer and the proposed offering necessary to allow investors to make an investment decision and to understand the risks associated with the offer.  The document must be drafted in French, or in another language customarily used in the financial markets together with a summary in French.  To facilitate comparability of offerings and ensure adequate prominence of key information, the AMF proposes to require issuers to present the information in sections organized in a specified order.
    The information document will be required to include the following information, which must be presented in a manner that is concise, comprehensible, clear, accurate and not misleading:

    • a detailed description of the issuer, the token offering, the reasons for the token offering and the use of the proceeds raised in the offering;
    • a detailed description of the rights associated with the tokens and the means and conditions for exercising those rights;
    • a detailed description of the terms of the offering, including the number of tokens to be offered, the issue price for the tokens, the subscription terms, the minimum amount to be raised to permit the project to be realized and the maximum amount of the offer;
    • the technical details of how the tokens will be issued;
    • a detailed description of the mechanism put in place to ensure the tracing and safeguarding of funds and digital assets raised in the offering;
    • a description of the key characteristics of the issuer of the tokens and a presentation of the principal parties involved in the structuring and development of the project;
    • the risks associated with the issuer of the tokens, the offer of the tokens and the achievement of the project; and
    • information on the accounting treatment for the tokens issued and whether the issuer has or intends to have its accounts examined by an independent auditor.

At the option of the issuer, the issuer may include the source code for the issuance as an exhibit to the information document, which may at the option of the issuer be accompanied by an audit of the source code by an independent third party.

All information documents must include a required disclaimer concerning the AMF’s visa, its meaning and the limited nature of the AMF’s review, as well as a required general disclaimer related to the risks inherent to an investment in an ICO.

  • Marketing materials.  All marketing materials for the offering must be presented to the AMF for review prior to dissemination.  The AMF will review the materials to ensure they are accurate, clear, not misleading and consistent with the information document.  Marketing materials must be clearly labeled as such, indicate where the information document approved by the AMF can be obtained, contain a notice drawing attention to the risk factors described in the information document and include a general disclaimer relating to risks associated with ICOs.

Material changes arising after the delivery of a visa

The AMF’s draft regulations provide that in the event a material change arises after delivery of the visa but before the close of the offering, the issuer must file a supplement to its information document and request an AMF visa for the amended information document.

Results of the offering

Within two days after completion of the offering, the issuer will be required to publish a press release setting forth the results of the offer.  Draft regulations under preparation by the AMF will set forth the required content of the press release.

Availability of the information document

The information document approved by the AMF must be made available to the public by the issuer and will be posted on the AMF website.  The AMF will maintain on its website a “white list” of offers that have been approved by the AMF and the validity dates for the related visas.

Measures to safeguard funds raised in the offering

Prior to granting a visa, the Law requires the AMF to verify that the offering includes a mechanism for safeguarding and tracing funds raised in the offering.  The draft regulations proposed by the AMF further clarify that this obligation will apply only during the offering period – the issuer will not be required to put in place a mechanism for escrowing funds after the offering is complete.  Given the rapidly evolving nature of technology, the AMF’s draft regulations do not mandate a specific form of escrow arrangement, but instead set forth general principles that must be met by the mechanism.  These include requirements that the mechanism ensure that funds raised are held in a secure manner during the period of the offering, including during any conversion of cryptocurrencies into euros, foreign currencies or other cryptocurrencies.  They also require that the funds raised be initially retained in a dedicated bank account or cryptocurrency address established for purposes of the offering, that any party receiving the funds raised in the offering be readily identifiable and that an arrangement be put in place that ensures that the funds are not released until the minimum amount and other conditions to release of funds set forth in the information document are met.  The mechanism must also permit the refund of amounts raised in the event the conditions to the offer are not met.

The AMF’s rules will cover three specific examples the AMF considers acceptable: (i) an escrow arrangement with a bank or other professional; (ii) a blockchain based multisignature arrangement for safeguarding and releasing the funds, where the release of funds depends on the agreement of independent third parties ; and (iii) an automatic ‘smart contract’ mechanism releasing the funds.  These three mechanisms are intended as non-exclusive examples — issuers remain free to propose other mechanisms, so long as they meet the general principles set forth the AMF’s general regulation.

“Know your customer” and anti-money laundering requirements

The Law will subject any issuer that requests a visa for an ICO to France’s rules against money laundering and terrorism financing, including the related “know your customer” requirements.[8]  To enable the AMF to evaluate the issuer’s ability to respect these rules, the draft regulations require an issuer to submit documents demonstrating the implementation of appropriate procedures and restrictions.   In practice, an issuer will have the option of engaging third-party services for this purpose or putting in place its own procedures, which must include at minimum carrying out a risk assessment, implementing “know your customer” procedures and account freezing capacities that comply with the applicable rules, and designating a person responsible for reporting suspected violations to the authorities.[9]

Enforcement powers of the AMF

The Law provides the AMF with a range of enforcement powers in respect of ICOs:

  • Following the delivery of a visa, if the AMF determines that the offer no longer conforms to the description in the information document or no longer provides the requisite assurance as to the safeguarding and tracing of funds, it can withdraw the visa on a temporary or permanent basis and order the issuer to cease all communication regarding the offering that refers to the AMF visa.[10]
  • Whether or not a visa has been requested, if a person disseminates inaccurate or misleading information regarding the delivery of a visa for an offering or the significance of a visa, the AMF can release a public announcement that corrects the facts and identifies the persons responsible for the inaccurate or misleading statements, and place such persons on a “blacklist” published on the AMF’s website.
  • The Law will give the AMF the power to impose penalties against issuers that request a visa in the event of false or misleading disclosure.
  • The Law will also give the AMF the ability to seek court orders to block the Internet access of issuers that publish false or misleading information relating to an offer of tokens to the public or falsely indicate that they have obtained an AMF visa.

The Path Ahead

The Law and the AMF’s proposed regulations represent a significant step forward toward legitimizing offers of tokens that fall outside the scope of existing EU securities regulation.  Via the new framework, France offers issuers considering an offer of utility tokens an attractive and straightforward path to obtaining regulatory approval of their offerings.  While the level of disclosure required in the information document will be greater than that typically seen in most white papers today, the requirements are not particularly burdensome, are built from the ground up with distributed ledger technology and token offerings in mind and are far less extensive than the requirements that apply to offerings of transferable securities under the EU Prospectus Regulation.

A key defining characteristic of the new regime promises to be its limitation to tokens that do not qualify as financial instruments:

  • In contrast to the United States, where the Securities and Exchange Commission has issued detailed guidance on the analysis of the characterization of tokens under the Howey test,[11] there currently exists little definitive guidance on the characterization of tokens under the EU securities laws. In its discussion paper on ICOs published in the fall of 2017[12], the AMF noted that tokens rarely fall neatly into any of the three major categories of  financial instruments (equity, debt, or units or shares in collective investment undertakings) set forth in Article L. 211-1 of the French Monetary and Financial Code and concluded that none of the tokens issued in France of which it was aware at that time qualified as financial instruments.  It noted, however, that a different result could apply in the case of ICOs giving rise to tokens with the same or comparable rights to those granted by financial instruments (e.g., those with governance or financial rights).  Nor has a clear consensus emerged among EU national competent authorities as to which crypto-assets qualify as financial instruments or the criteria for making that determination.  In a recent  survey of EU regulators conducted by the European Securities and Markets Authority, of the 29 regulators that responded to the survey, eight to nine believed that three of six sample crypto-assets were financial instruments, four believed that none of the sample crypto-assets were financial instruments, and 15-16 declined to offer a view.[13]  The precise boundaries remain unclear, and the absence of clear guidance may discourage some issuers from pursuing a  
  • More broadly, recent market developments may affect the level of enthusiasm for the new regime. In the initial ICO wave, most token offerings were designed as offerings of “utility tokens” that granted their holders the right to use a particular service and/or product but sought to exclude other features (e.g., governance or financial rights) that might cause them to be considered securities or financial instruments subject to existing securities regulations.  While some jurisdictions have concluded that many utility tokens fall outside the scope of existing securities laws, others, such as the United States, have concluded that most or many such tokens are securities subject to existing regulations.  In the wake of the uncertainty and potential enforcement risk, an increasing number of more recent token offerings have instead been structured as “securities token” offerings (STOs).  In such offerings, the tokens are either designed to represent assets or include governance or financial rights that make them more closely resemble traditional financial instruments.   In an STO, the issuer typically concedes that the token is or may be a financial instrument, but structures the offering to rely on existing exemptions to avoid the requirement to prepare a prospectus under applicable regulations.  To the extent that this trend continues, it may reduce the volume of token offerings eligible for the new optional AMF visa

ENDNOTES

[1] The text of the Projet de Loi relative à la croissance et la transformation des entreprises, as adopted by the French Parliament, is available at http://www.assemblee-nationale.fr/15/ta/tap0258.pdf. The Law has been adopted by Parliament, but will not become effective until it has been signed by the French President, following the review by the Conseil Constitutionnel, which is expected to occur in the coming weeks.

[2] See Offres au Public de Jetons – Présentation des Projets de Textes d’Application de la Loi Pacte, available at https://www.amf-france.org/technique/multimedia?docId=668317ee-c806-4951-ac82-99f38af29698.  The draft regulations remain subject to change until they are adopted in final form.

[3]  Other French initiatives in the blockchain space include a new tax and accounting framework adapted to the specificities of crypto-assets, provisions allowing blockchain technology to be used to register and transfer unlisted securities, and the Law’s provisions establishing a new regulatory framework for digital asset service providers. France has also announced plans to invest €4.5 billion over the next five years to promote technologies including blockchain technology.

[4] “Tokens” are defined in draft article L. 552-2 of the French Monetary and Financial Code (the “Code”) as “an intangible asset representing, in digital form, one or more rights that may be issued, recorded, held or transferred using a distributed ledger system that allows the direct or indirect identification of the owner of such asset.”

[5] The Law provides that it does not apply to an offer of tokens that is governed by Books I to IV, or Chapter VII of Title IV or Chapter I of Book V of the French Monetary and Financial Code.

[6] For example, “security token” offerings, if and to the extent they involve offers of tokens that qualify as financial instruments, will not be eligible for the new regime.

[7] Article L. 341-1 of the French Monetary and Financial Code. The Law also amends Article L. 226-16-1 of the French Consumer Code to prohibit ICO issuers without an AMF visa from using advertisements that directly or indirectly invite a user to fill out a contact form to obtain further information about the ICO.  Similarly, Article L. 226-16-2 of the French Consumer Code has been amended to prohibit ICO issuers that have not obtained a visa from engaging in patronage (mécenat) or sponsoring (parrainage) activities.

[8] L. 561-2 of the French Monetary and Financial Code.

[9] Many ICO issuers have had difficulty opening or maintaining bank accounts due to the difficulties faced by banks in obtaining sufficient information about the subscribers in the ICO and therefore the source of funds to enable the bank to meet its KYC obligations under the anti-money laundering and anti-terrorist financing rules.  To facilitate the opening of bank accounts, the Law requires financial institutions to adopt non-discriminatory and proportionate rules to govern access to bank accounts by issuers that have obtained an AMF visa.   See the Law’s amended version of L. 312-23 of the French Monetary and Financial Code.

[10] Because obtaining a visa is optional, the withdrawal of the visa will not require the issuer to terminate the offering.  The offering can continue but the issuer must note that the visa has been revoked.

[11]  See the SEC’s “Framework for “Investment Contract” Analysis of Digital Assets” https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets.

[12]  See AMF Public Consultation on Initial Coin Offerings, available at https://www.amf-france.org/en_US/Publications/Consultations-publiques/Archives?docId=workspace%3A%2F%2FSpacesStore%2Fa2b267b3-2d94-4c24-acad-7fe3351dfc8a.

[13] ESMA survey on legal qualification of crypto-assets (January 2019), available at: https://www.esma.europa.eu/sites/default/files/library/esma50-157-1384_annex.pdf.

This post comes to us from Cleary, Gottlieb, Steen & Hamilton LLP. It is based on the firm’s memorandum, “France’s Parliament Adopts an Innovative New Framework for Approving Initial Coin Offerings,” dated April 25, 2019, and available here.

Leave a Reply

Your email address will not be published. Required fields are marked *