Highlighting the risks: The Emirates Securities and Commodities Authority adds its voice to ICO concerns

by Hogan Lovells
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What you should know

The UAE's federal financial services and securities regulator, the Securities and Commodities Authority (SCA), has issued a public warning statement on 4 February 2018 in relation to initial coin offerings (ICOs).

The dual-language English and Arabic statement cites the following concerns in relation to ICOs:

  • certain ICOs are not regulated and therefore may be subject to fraud risks;
  • tracking and recovering funds in case of an ICO collapse may prove difficult in practice as ICOs may be issued abroad and subject to foreign regulations;
  • ICO trading on secondary markets are subject to opaque and volatile pricing and insufficient liquidity;
  • retail investors may not be able to comprehend the risks, costs and expected returns from investments in ICOs; and
  • ICO information disclosure to investors may be unaudited or incomplete and may present an investment case in a misleading manner by emphasising benefits over risks.

What does this mean?

The SCA's statement echoes concerns raised by 27 regulators around the world that have suggested that ICOs are highly speculative, not standardised in their legal and regulatory status, and that investors (and in particular, retail investors) are putting their entire capital at risk.

"ICOs involve the issuance of digital tokens created using distributed ledger technology and sold to investors by action or through subscription in return for cryptocurrency. The terms and features of ICOs differ in each case, as does the nature of the rights or interest (if any) that is acquired by the investor. ICOs are highly speculative and characterised by high volatility in the prices of tokens," the statement said.

The SCA warns that, "at present, [SCA] does not regulate or mandate or recognise any ICO. No legal protection is currently offered and investors are entering into these investments at their own risk."

The SCA's warning follows recent announcements from other financial regulators in the United Arab Emirates, including the Dubai Financial Services Authority (DFSA, the financial services regulator of the Dubai International Financial Centre free zone (DIFC)) and the Financial Services Regulatory Authority (FSRA, the financial services regulator of the Abu Dhabi Global Market free zone):

  1. The DFSA announced in September 2017 that ICOs and the systems and technology that support them are complex, with their own unique risks which may increase when offerings are made on a cross-border basis. The DFSA's announcement concludes by stating that ICOs are high-risk investments, that it does not currently regulate these types of product offerings or provide licensing to firms in the DIFC to undertake ICO fundraises.
  2. The FSRA published guidance on the regulation of ICOs and virtual currencies under the Abu Dhabi Global Market's Financial Services and Markets Regulation (FSMR). Under the FSRA's guidance, virtual tokens that have the features and characteristics of a "Security" (as defined in the FSMR) will be deemed to be, and regulated as, Securities under the FSMR. All financial services in relation to a Security-based ICO, such as dealing, trading, advising on, or managing investments in tokens will be subject to the regulatory requirements of the FSMR. Conversely, other virtual tokens and currencies (such as Bitcoin) which do not exhibit the features and characteristics of a Security will be deemed to be commodities and therefore not regulated as Specified Investments under the FSMR, and spot transactions in those commodities will not constitute Regulated Activities.

This statement by the SCA also follows a recent warning by the International Organisation of Securities Commissions (IOSCO). The SCA and numerous global financial regulators are members of IOSCO and the similarities between recent warnings suggest that the members of IOSCO are seeking to standardise or harmonise their approach towards regulation of ICOs. IOSCO is the leading international policy forum for securities regulators, including the US Securities and Exchange Commission (SEC), the Financial Conduct Authority (FCA) and the European Securities and Markets Authority, and sets global standards for securities regulation.

In an interesting twist with a Dubai nexus, in January 2018, the SEC obtained a court order to freeze the assets of AriseBank during its on-going ICO, in which AriseBank claimed to have raised more than US$600 million. The SEC stated that the two founders of AriseBank, based in Texas and Dubai, had illegally raised funds from retail investors without registering with regulators. As a result, the SEC froze various cryptocurrency assets received by AriseBank and appointed a receiver to return them to investors. This was the first appointment of a receiver and the most substantial action taken by any financial regulator in connection with an ICO to date, and the SEC's actions followed numerous warnings which it had issued in relation to token offerings which could be deemed to be securities under the Howey test in the United States.

Andrew Tarbuck, capital markets partner of Hogan Lovells (Middle East) LLP, commented on the SCA circular:

"The UAE is very much a part of the global conversation relating to the risks and regulatory treatment of ICOs, with three financial services and securities regulators from the country now reiterating regional concerns about ICOs. The UAE attracts tech companies and developers of innovative and disruptive solutions that may look to use an ICO to raise funds. Willing investors, particularly retail, are also concentrated in the region. The SCA's statement echoes the concerns of the likes of IOSCO, the SEC and the FCA, highlighting that this is an important global issue with a regional impact for fundraisers and investors in the Middle East."

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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