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FROM THE BLOG

Qualification of LIBRA under Swiss Financial Market Laws - FINMA publishes 'stable coin' guidelines

Posted by on 11 September 2019

The Swiss Financial Market Supervisory Authority FINMA (FINMA) published a supplementary guideline to the ICO guidelines February 16, 2019, where FINMA outlines on how it treats so-called ‘stable coins’ under Swiss financial market law. In addition, FINMA provides an indication on how it will apply the financial market laws to Libra, the crypto project initiated by Facebook.  

Qualification-of-libra-under-swiss-financial-market-law-finmaIndicative Classification

There are presently no particular laws governing stable coins, neither globally nor in Switzerland. The regulation of the Swiss financial market is done through a principle-based and technology-neutral approach. Its aim is to ensure the proper functioning of the financial markets and to safeguard creditors, depositors and investors alike. It therefore regulates deposit-taking (i.e. banking activities), the management, safekeeping and distribution of collective investment schemes as well as the operation of financial market infrastructures and other activities of financial intermediaries.

FINMA’s treatment of "stable coins" under financial market laws follows these principles and its existing strategy for DLT-based tokens: it focuses on the economic function and purpose of a token ("substance over form") and follows proven principle of "same risks, same rules", while taking into account the specific features of each project. FINMA has deemed that projects to create stable coins often result in potential licensing requirements under the Banking Act or the Collective Investment Schemes Act, depending in particular on how the reserve is managed and the entitlement of the coin owner to the reserve. In addition, due to their frequently intended purpose as a means of payment, the Anti-Money Laundering Act is likewise almost always applicable. If a payment system of significant importance is launched in connection with the creation of a stable coin, a licensing requirement under the Financial Market Infrastructure Act  as a payment system is probable.

Sub categories for Stable Coins

From a legal standpoint, many but not all stable coins confer what FINMA calls a redemption claim to the underlying assets. This can either be a contractual claim against the issuer or confer immediate property rights on the underlying assets.

Different financial market regulations may apply depending on the specific purpose and features of the stable coin.

Linked to currencies

Where a token is linked to a specific fiat currency with a fixed redemption claim (e.g. 1 token = CHF 1), classification as a bank deposit is likely.

Where a redemption claim depends on price developments, e.g. as a result of a token being linked to a basket of currencies, the distinction between a deposit under banking law and a collective investment scheme may become relevant. In this context, it is important to distinguish whether the underlying assets are managed for the account and at the risk of the holder of a token (indicative of a collective investment scheme) or for the account and at the risk of the issuer (indicative of a bank deposit). For the latter categorisation to apply, all opportunities and risks from the management of the underlying assets, be they in the form of profits or losses, from interest, fluctuations in the value of financial instruments, counterparty or operational risks, must be borne by the issuer of the stable coin.

Even if a stable coin does not foresee an explicit redemption claim in favour of the token holder but is based on alternative stabilisation mechanisms, this can nevertheless trigger licensing requirements under other financial market regulations (alongside AMLA requirements). In particular it can trigger the question whether the entire platform on which the stable coin is based does not qualify as the operation of a payment system of significant importance.

Linked to commodities

Where a token is linked to commodities as underlying the exact nature of the claim on the assets as well as the type of commodity (in particular whether "bank precious metals" or other commodities are involved) will determine the regulatory treatment of the token.

If a token merely demonstrates an ownership right of the token holder, it usually does not qualify as a security. This requires that

  • an ownership right and not merely a contractual claim to the underlying commodities exists, i.e. the token holder could request physical delivery;
  • the transfer of the token results in the transfer of the corresponding ownership right; and
  • the commodities are not deposited in accordance with article 481 of the Code of Obligations (CO; SR 220), which in the reading of FINMA means that any depository regime must ensure that the individual commodity can be linked to a specific owner or group of owners. In the case of fungible goods (e.g. FIAT cash reserves) the assets would have be segregated for each owner in accounts or stored in separate envelops. In the case of cryptocurrencies FINMA seems to expect separate segregation on the level of the blockchain itself without using custodial wallets and separate wallets behind the custodial wallet. A similar segregation would have to be maintained in the case of storage of fungible commodities.

Where there is simply a contractual claim against "bank precious metals" held by the issuer, it is probable that the precious metal reserves will qualify as deposits under banking law owing to the resemblance with precious metal accounts maintained by banks. Where the contractual claim is against other commodities than precious metal, the token will usually qualify as a security and potentially as a derivative – insofar as it is connected to a financial market activity. Stable coins with contractual claims on underlying assets can therefore also give rise to a licensing requirement as a derivatives house in accordance with article 3 para. 3 of the Stock Exchange Ordinance (SESTO; SR 954.11).

A collective investment system is likely to exist where there is a connection to a commodity basket (including "bank precious metals") with a price-dependent claim for redemption.

Linked to real estate

Where there is a link to individual properties or to a real estate portfolio and a redemption claim by the token holder exists, the day-to-day management of the real estate portfolio by a third party is, in itself, indicative of a collective investment scheme. In view of the legal hurdles to create ownership over real estate for token holders, tokens mostly only represent a price-based redemption claim. Therefore such projects in all probability are faced with licensing requirements as a collective investment scheme.

Linked to securities

A token that entitles to delivery of a specific security would also usually be a security. Any placement of this token will require a prospectus as of 1 January 2020 onwards. While an issuance of the tokens by the issuer (who is at the same time the issuer of the underlying security) generally does not lead to licensing requirements under the Stock Exchange Act (SESTA; SR 954.1), the underwriting and primary market offering of corresponding stable coins can constitute an activity as a securities issuing company (article 3 para. 2 SESTO).

The prospectus conditions imposed by the new Financial Services Act (FinSA; 950.1) must also be fulfilled upon entry into force on January 1, 2020, including in self-issuance instances. Where there is a connection to a securities basket with the token holder's contractual claim on a basket share, a requirement for licensing as a collective investment scheme is likely.

Conclusion

The stable coin guidelines are very welcome. FINMA is once again demonstrating its openness to new technologies. The guidelines also provide helpful information on the structuring of stable coins. Ultimately, however, as FINMA points out, it is the details that matter. Particularly important is the nature of the contractual claim, whether ownership exist or, if applicable, third-party management.

Libra Qualification – When is a stable coin a payment system?

In addition to the general stable coin guidelines, FINMA published a statement about the status of Facebook's Libra project and provided an indication about how it would apply the relevant Swiss financial market laws:

  • The project as it is presently envisaged would require a payment system licence from FINMA, on the basis of the Financial Market Infrastructure Act (FMIA).
  • Libra must comply with the Principles for Financial Market Infrastructures (PFMI). These requirements also apply to the management of cyber risks.
  • A Swiss payment system is automatically subject to the Anti-Money Laundering Act. The highest international anti-money laundering standards would need to be ensured throughout the entire ecosystem of the project. Such an ecosystem must be immune against elevated money laundering risks.
  • Under the FMIA, all additional services that increase the risks of a payment system must be subject to corresponding additional requirements. This means that all the potential risks of a Swiss payment system, including bank-like risks, can be addressed by imposing appropriate requirements in line with the maxim "same risks, same rules". Due to the issuance of Libra payment tokens, the services planned by the Libra project would clearly go beyond those of a pure payment system and therefore would be subject to such additional requirements. These additional requirements would relate in particular to capital allocation (for credit, market and operational risks), risk concentration and liquidity as well as the management of the Libra reserve.
  • The additional requirements would be based on recognised standards for similar activities in the financial markets and would need to reflect the dimension of the project. For bank-like risks, for example, bank-like regulatory requirements would apply. A Swiss payment system licence would thereby permit a combination of the strengths of banking and infrastructure regulation.
  • A necessary condition for being granted a licence as a payment system would be that the returns and risks associated with the management of the reserve were borne entirely by the Libra Association and not – as in the case of a fund provider – by the stable coin holders.

FINMA points out that the scheduled global scope of the project requires an internationally coordinated strategy. In specific, FINMA deems it necessary to develop the definition of criteria for handling the reserve and the governance around it in global cooperation. This also goes for the standards which should apply to the combat of money laundering.

This statement is certainly something that will reassure the authorities of other countries that Switzerland is taking the Libra project seriously, but it may also delay the project for a long time if global cooperation is really required.

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If you liked this article you may also be interested in reading about:

Swiss Regulation of FinTech - New FinTech Rules will enter into force on 1 August 2017, by Dr. Mark Montanari, Dr. Catrina Luchsinger Gähwiler, Dunja Koch, Benjamin Dürig, Laetitia Meier Droz

 

 

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Topics: Banking & Finance | Capital Markets | Disruptive Technologies

  
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Dr. Catrina Luchsinger Gähwiler

Catrina is a specialist in financial market law and corporate law. She has a wealth of experience advising financial market clients, including banks, asset managers and investment vehicles, as well as substantial operational knowledge. She also serves on the management boards of various com-panies, some of which are in the financial services sector. Catrina joined our firm as an associate in the year 2000. She became a partner in 2007. Catrina advises financial services clients and investment companies on regulatory issues as well as on contractual aspects relating to the financial market industry. She furthermore has considerable experience in acquisition and financing transactions, in general corporate work, both for listed and privately held companies, in mergers and acquisitions – predominantly in the financial services sector – and regularly advises in equity capital market transactions both for SIX Swiss Exchange, where she is admitted as a listing agent, and for BX Berne eXchange. Chambers Europe and Chambers Global have identified her as a Recognised Practitioner in the field of banking and finance, where clients have commended her client orientation. She is also ranked as a leading lawyer in the IFLR1000 guide for financial services regulatory and M&A. Catrina obtained her law degree from the University of Zurich in 1991 and was admitted to the Zur-ich Bar in 1995. She gained her PhD in 2004. Her working languages are German, English and French. She is a member of the Zurich Bar Association, the Swiss Bar Association, the International Bar Association (IBA) and the International Pacific Bar Association.

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Ronald Kogens

Ronald Kogens’s practice is focused on disruptive technologies. He advises Swiss and international clients as well as public entities in corporate and technology-related transactions. Ronald Kogens has in-depth knowledge of IP/IT law, in particular licensing of IP-rights, IP-transaction, financial market and contract law. He is an expert in the field of blockchain technology, crypto-currencies and crypto-tokens. He joined Froriep in 2017 as an associate and became partner in July 2019. Before that he worked for a major global consulting firm. He was also part of the legal counsel team of a public listed pharmaceutical company at the headquarters in Switzerland and worked for its subsidiary in the United States. Ronald Kogens graduated in law from the University of Lucerne in 2011 and was admitted to the St. Gallen Bar in 2012. In 2016 he was awarded a Master of Laws (LL.M.) in business law from the Chapman University, California, United States. His working languages are German and English.

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