CONSOB publishes discussion paper on proposal for regulation of ICOs and exchanges of cryptoassets in Italy

The Italian supervisory authority over financial markets has proposed that cryptoassets not qualifying as financial instruments or investment products, should be considered as an autonomous asset class. This would result in issuers and offerors of true “cryptoassets” being exempted from rules on offering and distance marketing “financial products” (primarily, publishing a prospectus), to the extent that safeguards are put in place. It would also clarify that issuing, trading and post-trading activities for “security-like” tokens would be subject to the usual financial legislation. CONSOB has also proposed the establishment of an “opt-in” regime for the regulation of initial offerings and secondary trading of cryptoassets.

What’s the background to this discussion paper? 

CONSOB, the Italian financial markets supervisory authority, has published a discussion paper seeking stakeholders’ views on CONSOB’s first proposal of how to regulate initial offerings and exchanges of cryptoassets. Each section of the report is followed by specific questions to the stakeholders who are invited to provide feedback by 19 May 2019

The purpose of the DP is to launch a national debate on the topic of initial offerings and exchanges of cryptoassets, given their recent boom. CONSOB acknowledges the absence of a harmonized approach in the EU on the legal qualification of cryptoassets, especially on their potential inclusion in the categories of “financial instruments” under MiFID II or “investment products” under the legislation on PRIPs, IBIPs and PRIIPs (packaged retail investment products, insurance-based investment products, packaged retail and insurance-based investment products, respectively), yet the DP takes into account, and cross-refers to, the recent initiatives adopted by ESMA and in France, Malta and UK (see our previous posts on the Cryptoassets Taskforce’s proposals and of the FCA public consultation).

All interested stakeholders are invited to respond to this DP, in particular, persons issuing and offering cryptoassets, operators of exchanges and wallet providers, but also financial institutions and operators of trading venues (incumbents). CONSOB will use this feedback to this DP to draft a proposed regulation that would ensure high protection of customers but without hindering innovation in the financial sector.

Distinguishing features of ICOs

Section 1 of the DP provides background information on Initial Coin Offerings (ICOs) and their similarities and differences with Initial Public Offerings (IPOs). According to CONSOB, initial offerings of cryptoassets (or tokens) – whose main purpose is to raise funds for the financing of a business activity/project – share with IPOs the characteristics of (1) being addressed to an indefinite audience of potential investors and (2) involving a series of activities aimed at the promotion/advertising of the transaction.

However, distinguishing features of ICOs are:

  • the use of blockchain technology, which allows to disintermediate the typical capital markets’ infrastructures (e.g. custodian bank, placement consortium);
  • the use of virtual currencies for payments, instead of currencies with legal tender;
  • the advertising and promotion taking place exclusively via the world wide web, with no territorial constraint; 
  • the publication of a “white-paper” instead of a prospectus. 

In addition, the “tokenization” process is deemed to have certain analogies with the mechanism of creating securities (being the incorporation of rights in a certificate, which constitutes a title of legitimacy for exercising these rights but also an instrument for the easier transferability of the same).

Proposed definition of cryptoassets

Section 2 attempts to identify the defining elements of cryptoassets and their interplay with the national category of financial products (“prodotti finanziari”), that comprises financial instruments as well as “any other form of investment having a financial nature” (a notion that CONSOB regards as covering any form of investment of capital, where who invests has an expectation of a financial return and assumes  the corresponding risk that he/she might lose the capital).

In CONSOB’s view it is undisputable that at least certain types of tokens (the so-called investment-token or security-like-token), because of their characteristics, do qualify as financial instruments and/or as financial products.

That said, CONSOB proposes to regard cryptoassets as an autonomous asset class, distinct from that of financial products, that would be defined as follows:

  • digital records representative of rights linked to investment in business projects”,
  • “that are created, stored and transferred using distributed ledger technologies (allowing for the identification of the holder of the rights incorporated in the cryptoasset)”,
  • “that are intended to be negotiated or are negotiated in one or more exchange systems”. 

This approach would have the advantage of avoiding the burden of conducting every time a case-by-case analysis for identifying whether a certain cryptoasset qualifies or not as a financial product.

But above all, it would potentially allow issuers and offerors of true “cryptoassets” as defined to be exempted from the rules concerning financial products (i.e. those on offerings to the public and on distance marketing, e.g. the prior supervisory approval and publication of a prospectus), to the extent that: (i) certain other safeguards are put in place (such as the supervision of CONSOB over the platform used for the offering - see below), and that (ii) for cryptoassets in name only which clearly qualifying as financial instruments or investment products, the issuing, trading and post-trading activities would be subject to the usual financial legislation.

Regulating platforms for the offerings of cryptoassets 

Sections 3 and 4 then respectively discuss a possible regulation for the issue and initial offerings of cryptoassets and for the systems where cryptoassets are subsequently exchanged, explaining the possible benefits of a regulatory intervention and any shortcomings/challenges to those benefits.

On the first point, CONSOB highlights the need to still regulate initial offering of true cryptoassets and for these purposes it proposes, first, to introduce a definition of the venues where offerings are to be made, i.e. that of “platform for the offerings of cryptoassets”, which would be the following: “an online platform whose exclusive purpose is the promotion and realization of offerings of newly issued cryptoassets”.

As to the persons that can operate these platforms, those that in CONSOB’s view are the best placed are the authorised operators of crowdfunding portals provided they give a prior notice to the authority and they keep separate the two activities.

That said, also other persons can operate platforms for the offerings of cryptoassets, provided they satisfy the same fit&proper requirements of operators of crowdfunding portals and they accordingly obtain an authorisation by CONSOB.

In any case, CONSOB deems it appropriate if both these categories of operators were to comply with several organizational and operating requirements, i.e. if they were to:

  • implement disclosure, procedural, organizational and control arrangements, adequate to the risks inherent to this type of business;
  • ensure the business continuity and IT security of the platform;
  • comply with rules of conduct in their relationship with investors;
  • duly select (according to minimum eligibility criteria) the business projects to which are linked the cryptoassets offered on the platform;
  • request from the issuers of cryptoassets - even through standardized forms - all the information that is necessary for investors to fully assess the investments proposed.

However, CONSOB believes that if such a regime were imposed on any offering promoted at national level, this would unduly constrain the evolution of cryptoassets’ issuance mechanisms, with the risk of missing the opportunities that come with it.

Accordingly, the best approach for the authority would be to establish an “opt-in” regime, by virtue of which it would be up to the sponsor of the initiative whether or not using a dedicated platform (meeting the requirements outlined above). This regime would provide the following benefits:

  • the sponsor would get comfort that it would be acting in a regulated environment, in compliance with the special regime applicable to cryptoassets, and would benefit from an exemption from the rules on offerings to the public and distance marketing of financial products (provided that the cryptoassets do not qualify as financial instruments or investment products);
  • investors would be duly protected, because the operators and their platforms (and the offerings made there) would be subject to CONSOB’s supervision;
  • offerings made outside regulated platforms would still be legitimate (unless the tokens were to amount to financial products), but would be clearly recognizable by the public as not being covered by the same safeguards of the offerings above.

Regulating systems for the exchange of cryptoassets

Finally, CONSOB notes that also the exchanges in which, following the phase of issuance/initial offering, cryptoassets (not qualifying as financial instruments) are traded, still require adequate forms of control and regulation. However, the need to attract secondary markets of cryptoassets to a regulated area shall be balanced with that of encouraging innovation in the financial industry.

Therefore, in line with the approach adopted for the platforms, CONSOB:

  • introduces a definition of “system for the exchange of cryptoassets”, this meaning “a set of rules and automated structures which makes it possible to collect and disseminate proposals for the negotiation of cryptoassets and to implement such proposals, including through distributed ledger technologies”;
  • suggests the establishment of an “opt-in” regime, leaving to the operators the choice to register their systems in a special register held and supervised by CONSOB;
  • suggests that these types of registered systems may only be managed by (i) operators of trading venues; (ii) operators of crowdfunding portals; (iii) operators of platforms for the offerings of cryptoassets; as well as by (iv) any other person that satisfies fit&proper requirements established ad hoc by CONSOB;

To register with CONSOB, systems would have to comply with several organizational and operating conditions, including having in place appropriate procedures for:

  • the initial selection of cryptoassets and the controls over the information published by their issuers;
  • the access to the system and the identification of participants (therefore preventing permissionless DLTs, which allow anonymous accesses);
  • the execution of the trades and the measures to facilitate the settlement of trades (that would likely take place on the blockchain);
  • the identification and managements of the risks to which the system is exposed, and of any conflict of interest;
  • the payment flows and the custody of cryptoassets by the system operator;
  • the continuity and IT security of the system.

In addition, CONSOB is evaluating how to strengthen the links between regulated platforms and regulated exchange systems, with a view to encourage opting in to the regimes identified above, e.g., it is consider providing that only the cryptoassets initially offered through a regulated platform can be admitted to a regulated exchange system.

What’s happening next?

The CONSOB has invited stakeholders to give feedback on all matters in the DP and in particular on the specific questions listed therein by the 19 May 2019 deadline. Comments may be sent online or by post. It also plans to hold a Public Hearing on these topics, whose date has not been established. Feel free to contact us should you have any questions regarding providing stakeholder feedback.