This article is an extract from TLR The Financial Technology Law Review – Edition 6. Click here for the full guide.
I Overview
Switzerland is at the forefront of financial innovation in fintech and blockchain.2 Swiss laws do not specifically regulate cryptoassets as a distinct asset class, but instead apply existing regulatory rules to them for their issuance, trading and holding. The ICO Guidelines of the Swiss financial regulator (FINMA) provide detailed guidance on the regulatory framework for initial coin offerings (ICOs) and security token offerings (STOs) under Swiss law, including a checklist for negative clearance applications.3 FINMA reviews ICOs and STOs for compliance with anti-money laundering (AML) regulations, investor rights and technical standards.4
The regulatory framework surrounding non-fungible tokens (NFTs) and decentralised autonomous organisations (DAOs) in Switzerland is still evolving, but are actually two of the most exciting and innovative developments in the digital world.
II Regulatory Framework
FINMA has decided that the financial market regulation should be technology-neutral. Existing Swiss regulatory principles should apply, irrelevant of any new technology. It allows new technology to come into place without waiting for parliament to adjust the applicable laws and regulations5 each time there is a new development.
The principles are as follows:
- regulation must be technology-neutral: ‘same business, same risks, same rules’.6 The principle of neutral technology means that a business cannot be treated differently only based on the fact that that business uses a different sort of technology from others who do the same activity;7
- risk-based approach: Swiss regulation tends to regulate the activities of the main actors of the financial industry and the financial products in order of the degree of risk that they represent. The rules focus on governance, responsibility and risk analysis;8 and
- entity and activity related: within the licence category, the licensed entity will only be allowed to perform its licensable activity based on the business plan presented to FINMA.9 The entity-based approach pertains to rules that regulate specific aspects of a company, such as the required minimum capital. On the basis of this approach, the company itself is subject to the rules.10 In contrast, the activity-based approach pertains to rules that primarily focus on the company’s activities. Under this approach, the rules are applied to each activity itself, rather than the company as a whole.11
III FINMA’S ICO Guidelines
FINMA is an independent12 public law institution that oversees and regulates the financial markets in Switzerland to ensure their stability and integrity, as well as protect the interests of consumers.13 It supervises various financial entities and has the authority to take enforcement actions, including imposing fines and sanctions and granting or revoking licences.14
i Purpose of ICO Guidelines
FINMA’s guidelines provide market participants with specific information and principles for addressing applicability issues related to ICOs and STOs.
ii Principles applied when assessing specific enquiries
There is no specific regulation that applies to cryptocurrency as a distinct asset-class.15 In applying the principle ‘same business, same risks, same rules’, FINMA categorised the token in line with the securities regulation (asset token) and the public deposit regulation (payment token). Utility tokens do not come under the financial regulation. Given the wide range of token and ICO forms, FINMA must consider the specific details of each case, using an economic approach and relying on the actual features of the ICO to determine whether or not financial markets laws apply.16
iii Token categories
FINMA distinguishes four token categories: payment, utility, asset and hybrid tokens.
Payment tokens (i.e., cryptocurrencies)
Payment tokens are treated similarly as payment currencies by FINMA. The definition of payment tokens includes tokens that are used as a means of payment for goods or services, or tokens serving as a means to acquire those goods or services. When issuing payment tokens, there are some key points that the issuers should consider to comply with Swiss regulatory requirements.
The acceptance of deposits from the public on a professional basis is subject to the Swiss Federal Act on Banks and Savings Banks of 8 November 1934 (BA) and requires authorisation from FINMA. This type of deposit is typically only allowed for banks holding a full banking licence or a fintech licence. A person is deemed to be acting on a professional basis if they accept public deposits from more than 20 depositors from the public or solicit the public for deposits over an extended period of time. One of the mean features of a public deposit is the obligation by the depositor to reimburse the deposit.17 Therefore, a payment token booked in the balance sheet of the issuer as repayable will trigger the need for a banking licence. This is the reason why payment tokens are usually sold by the issuer (rather than issued as a loan or note), with no redemption rights.
In summary, to avoid any payment token being classified as a deposit, the token should be structured in a way that does not fulfil key features of a deposit, such as offering a guarantee of repayment or a right to withdraw funds. The holder of a payment token will only be allowed to burn his or her tokens by using them for payment or selling the tokens on a secondary market.
As long as payment tokens can be transferred on a blockchain infrastructure, the act of issuing them falls under the Federal Act on Combating Money Laundering and Terrorist Financing of 10 October 1997 (AMLA). This includes verifying the identity of token purchasers, identifying the beneficial owner and monitoring their transactions to detect any suspicious activities.
Compliance with anti-money laundering regulation requires the issuer to register with a self-regulatory organisation (SRO) or be supervised as a financial intermediary by FINMA directly.
These requirements can be satisfied by outsourcing the anti-money laundering duties to a third party financial intermediary who is already subject to AMLA in Switzerland, and who can perform the corresponding due diligence on behalf of the issuer. In such cases, the ICO issuer is not required to affiliate with a SRO or obtain a direct licence from FINMA.
According to current FINMA guidelines, converting cryptocurrency to fiat money or a different cryptocurrency, and the provision of token transfer services by a custody wallet provider who maintains the private key fall under Section 2, Paragraph 3 of the AMLA.
Asset tokens
Asset tokens usually represent asset values. They may also incorporate a debt element or a social right. Holders of asset tokens may receive a share of future revenues or cash flow in an investment. Investment tokens can be considered a type of share, bond or financial instrument. This category can also include tokens intended to make physical valuables tradable on the blockchain, similar to a digital securitisation of asset. There may be social rights linked to an asset token: any rights to vote or participate in a DAO may qualify a token as an asset token.
The emergence of tokens incorporating valuable monetary rights has led to the classification of such tokens into the following three distinct categories:
- foreign capital tokens, which entail the issuer’s formal or de facto obligation to reimburse the investment with the possibility of interest;
- investment-based contractual tokens, which do not provide an obligation of reimbursement but instead grant the investor a right to a financial performance calculated based on a specific reference data or a particular ratio of profit or liquidation results, or both, associated with the issuer; and
- investment tokens with participation rights, which represent participation rights, such as shares and participation certificates, where the right to a share of profits is regulated by the statutes.18
FINMA treats investment tokens as securities, provided that they represent a right of value and are standardised and capable of being widely distributed in the market.
According to FINMA, tokens may be classified as investment tokens if token holders can receive advantages in terms of property rights for their own account through a reward function or if the platform is not fully operational at the time of token issuance. Notably, the issuance of securities is not subject to a regulatory licence but may, depending on the circumstances, trigger an obligation to establish a prospectus in line with the requirements set forth in the Swiss Federal Act on Financial Services of 15 June 2018 (FinSA).
Activities involving the trading of securities tokens in Switzerland can trigger several legal requirements, including the need for a Swiss securities house licence under the Federal Act on Financial Institutions of 15 June 2018 (FinIA), compliance with the applicable Swiss infrastructure regulation, and adherence to prospectus rules and other regulations related to financial services under FinSA.
Unless the asset tokens are not a debt instrument granting a redemption or repayment right towards the issuer, they should not qualify as deposits.
Asset tokens are not deemed a means of payment and therefore are not subject to AMLA regulation.
While there has been no court decision at this stage, the issuance and trading of asset tokens (deemed as securities) should fall under the scope of taxable documents as outlined in the Swiss Federal Stamp Duty Act of 27 June 1973, and therefore be subject to issuing or trading stamp duties.19 A tax opinion will be required in this respect.
Utility tokens
Utility tokens do not provide monetary or investment rights but grant investors the right to access specific digital services on a decentralised platform. The funds raised can only be used for the development of these services.
According to FINMA’s practice, utility tokens are not classified as securities when they only provide a right of access to a digital service, and are only used in this way at the time of issuance. However, where the economic investment function exists wholly or partially, FINMA usually treats these tokens as securities. For example, FINMA considers a utility token when token holders can use their tokens to vote on amendment proposals concerning the platform and the tokens themselves. However, these same tokens would be considered as investment tokens if token holders can obtain benefits in terms of property rights through the reward function,or if the platform is not fully operational at the time of token issuance. Utility tokens will be considered as securities if they serve an investment purpose during issuance or later on.
Issuers can follow several tips to avoid classification as an investment token, including clearly defining the purpose of the token, avoiding promotion as an investment opportunity and establishing a fixed price that is not based on market demand. Additionally, issuers should provide transparent disclosures and avoid providing any ownership or equity stakes in the issuing company or project.
Utility tokens may not be subject to AML regulation if they primarily serve to enable the use of blockchain technology for non-financial purposes.
Hybrid tokens
Notably, tokens can belong to multiple categories. Investment and utility tokens can also be classified as payment tokens, creating hybrid tokens that serve as both a security and a means of payment.
iv Applicability of the Collective Investment Schemes Act
The relevance of the Collective Investment Schemes Act applies solely to situations where third parties manage the funds accepted within an ICO. This would be the case where an ICO will result in the pooling of money managed by a third party manager. In this case, the scheme might qualify as a collective investment, subject to a FINMA licence.
v Negative clearance applications
It is not mandatory to obtain a FINMA ruling, but this step allows the project and business model to be reviewed by FINMA and provides the issuer with a regulatory clearance. Generally, a ruling is processed within four to six months. FINMA also has a fintech desk that answers all types of inquiries regarding crypto projects.
In the case of a ruling, FINMA needs detailed information about the project, including the name, promoter or issuer’s details and involved parties, such as creators, issuers, sellers and secondary market players. They also require information on any authorised parties according to regulations in other countries.
Regarding the description of the project, FINMA requests a comprehensive description that covers its purpose, product or service, target market and investor restrictions. FINMA also needs organisational and planning details, including technologies used, accepted cryptocurrencies or fiat, fundraising goals and financial resource management.
Regarding the issuing of coins, FINMA requests information on the token issuance, technical specifications and transfer processes, as well as investor rights, documentation and terms. FINMA also requires details about the involvement of financial intermediaries in fulfilling AMLA’s due diligence obligations.
Finally, FINMA inquires about token transmission, secondary markets and utility for goods or services. They also evaluate token buyback feasibility and require a description of secondary market platforms, including acquisition or sale modalities.
IV NFTs
At the moment, there are no guidelines for NFTs. Although they share many similarities with fungible tokens, the key difference lies in their non-fungibility and non-standardisation. Therefore, the categorisation made by FINMA should not be interpreted too strictly, especially in the case of NFTs. FINMA have indicated that they will apply existing regulations to NFTs on a case-by-case basis to determine their legal qualification. Given the wide range of potential application and variations of NFTs, it is generally difficult to assign them to a specific category.
When considering the regulatory framework for NFTs under the financial market law, the key issue is whether they qualify as securities under Section 2, letter b of the Federal Act on Financial Market Infrastructures and Market Conduct in Securities and Derivatives Trading of 19 June 2015 (FinMIA). For an NFT to be considered a security under the financial market law, it must represent a register value right as defined by Section 973d et seq. of the Swiss Code of Obligations. Four conditions must be met:
- transferability;
- a transparent register;
- a register agreement; and
- registration.
An alternative approach to classifying NFTs under Swiss financial market law would be to consider them as derivatives under Article 2, letter c FinMIA, and thus as a financial instrument under Section 3, letter a of FinSA. However, for this classification to apply, the price of the NFT must be linked to an underlying asset. This is not typically the case with NFTs. Exceptions could exist, such as when an NFT includes the right to acquire a digital garment for a game-player at a specific value.
Regarding tax matters, the taxation of NFTs in Switzerland is still uncharted territory, as there is no clear distinction between cryptocurrencies and NFTs under Swiss law. The official tax position on NFTs is currently unknown and their evaluation for tax purposes remains ambiguous, especially with regards to whether they can be taxed as works of art. In the absence of clear guidance, there may be opportunities for minimising tax liability, such as potentially treating an NFT as a piece of furniture to avoid wealth tax in the canton of Geneva.
That being said, the Federal Council is closely following the most recent development in blockchain technology, specifically NTFs and decentralised finance (DeFi), which have not yet been subject to an international agreement on their regulation.20
V DAOs
DAOs are typically run on a blockchain, with decision-making processes executed through smart contracts.
In Switzerland, DAOs are currently not explicitly regulated by law, which creates a degree of uncertainty for individuals and entities seeking to establish or invest in DAOs. However, there are some legal and regulatory frameworks that may apply to DAOs in certain circumstances. For example, DAOs that issue security tokens may be subject to regulatory requirements already mentioned,21 such as prospectus requirements or AML regulations. Similarly, if a DAO engages in activities that fall within the scope of the Collective Investment Schemes Act, it may need to obtain a licence from FINMA as manager of a collective investment.
Therefore, the establishment of a DAO in Switzerland involves various legal, regulatory and technical considerations. Before setting up a DAO, the purpose of the organisation and its goals should be determined. The types of tokens that will be issued, the type of activity the DAO will engage in and the legal structure of the organisation also need to be determined.
VI Outlook and Conclusion
Digital assets and NFTs represent a dynamic and captivating area of innovation and investment, the implications of which are still unfolding. While legal and regulatory frameworks in Switzerland are continuing to evolve, the complex and nuanced issues involved require thoughtful analysis and ongoing attention.
