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.
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 to 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.
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 exists 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.