The term ICO has been at the epicentre

of discussions in the FinTech industry, being the main method of fundraising

used by startup companies to develop innovative ideas on the Blockchain

technology or other applications using Distributed Ledger Technology (“DLT”).

A. From

ICOs to STOs

The term ICO has been at the epicentre

of discussions in the FinTech industry, being the main method of fundraising

used by startup companies to develop innovative ideas on the Blockchain

technology or other applications using Distributed Ledger Technology (“DLT”).

Although bringing a revolutionary

change in traditional means of financing, ICOs have been criticised for their

legal uncertainty and struggled to become widely acceptable by governments due

to the increased risk for fraud.

The term ICO does not distinguish what

type of token is being offered, while most ICOs argue that their token is not a

security but rather serves a function – a utility – on the issuers’ platform.

As ICOs have faced multiple

challenges, startups and companies wishing to make a transition to the digital

world have been striving to find more satisfactory means of funding where there

is more security to potential investors, less uncertainty and less fraud.

Security

Tokens are regarded to be the game changers which will provide a more secure

path to companies seeking to raise funds.

B. STOs

– Security Token Offerings

Unlike ICOs, STOs are as their name

suggests, securities and are treated as securities from day one. They are

digital assets that are subject to security regulations and need to be

compliant with any registration and/or authorisation requirements before being

issued.

STOs are game changers for financial

and ownership models, allowing any company to offer revenue such as annual

income form the operations of the issuing company or other periodical income,

percentage on profits, equity, debt or dividends and sometimes voting rights.

It is argued that Security Tokens are

an improved model of traditional financial instruments because they are liquid,

secure, virtually incorruptible and accessible to trade by anyone with an

internet connection from all around the world. These give investors the

opportunity to acquire Security Tokens with minimum investment – a digital analogue

to the traditional term of securities such as shares or debts.

Private

and/or public offerings of security tokens enable access to a pool of investors

without sacrificing regulatory oversight. Therefore, STOs embody all the

advantages of ICOs and traditional financial instruments giving stability and

trustworthiness to the investors.

C. Security

Tokens - Definition

Although

there is not a widely approved definition or legislation interpreting what

deems a token to be a “Security Token’, transferable securities as per

Directive 2014/65/EU on markets in Financial Instruments, “MiFID II”, means those classes of securities

which are negotiable on the capital market, with the exception of instruments

of payment, such as:

shares

in companies and other securities equivalent to shares in companies,

partnerships or other entities, and depositary receipts in respect of shares;

bonds

or other forms of securitised debt, including depositary receipts in respect of

such securities;

any

other securities giving the right to acquire or sell any such transferable

securities or giving rise to a cash settlement determined by reference to

transferable securities, currencies, interest rates or yields, commodities or

other indices or measures.

Therefore,

one can argue that Security Tokens conferring similar rights to shares fall

within the “other securities” notion under sub-paragraph (a) above,

interpreting Transferable Securities as per Directive 2014/65/EU on markets in

Financial Instruments, “MiFID II”.

D. The

Obligation

As per

the EU Prospectus Regulation (the “Regulation”), any public offering of securities is prohibited without the prior publication

of a prospectus, which has to be approved by the appropriate authority under a certain

procedure, unless such public offering falls under the exemptions of the

Regulation. However, such exempted offers of securities to the public should not

benefit from the passporting regime. This means that the issuer of the STO has

to ensure that it complies with every Member State’s national requirements on

the ‘offering of securities’ before the issuance of the STO. Below that

threshold, Member States are able to require other disclosure requirements

at national level.

E. Which

are the exemptions to the obligation to draw up a prospectus provided under the

Regulation?

The

obligation to publish a prospectus under the Regulation shall not apply to any

of the following types of offering of securities to the public:

A public offering of securities where

the total consideration is less than EUR 1.000.000 in the European Union or EEA*

(expressed as the total consideration of the offer in the European Union or EEA

over a period of 12 months).

An offer of securities addressed

solely to qualified investors as defined

by the law.

An offer of securities addressed

personally to fewer than 150 natural or legal persons per EU or EEA member

state, which are not qualified investors.

An offer of securities whose

denomination per unit amounts to at least EUR 100.000.

Minimum sale price to be EUR 100.000 per unit.

An

offer of securities in the EU or EEA addressed to investors who acquire

securities for a total consideration of at least EUR 100.000 per investor, for

each separate offer.

*It

is worth noting that different thresholds apply in each Member State as the

Regulation provides that Member States are free to set out in their national

law a threshold between EUR 1.000.000 and EUR 8.000.000. In Cyprus the

threshold is currently set at EUR 1.000.000 but there is procedure in place to

increase it to EUR. 5.000.000.

Member States are electing to set up

the threshold between 1 and 8 million EUR according to the size of their

financial markets. Some examples: Germany, the United Kingdom and Italy have

elected to set up the threshold at 8 million EUR - Malta, Ireland and Lithuania

have set the threshold at 5 million EUR.

Note:

Irrespective of the above exceptions, when Securities are offered to the public

or admitted to trading on a regulated market, a prospectus should be drawn up,

approved and published.

F. Listing

of Security Tokens on Secondary markets

Certain

countries have started collaborating with token exchanges in an effort to build

the infrastructure allowing Security Tokens to be legally traded on a “centralised”

regulated security token exchange.

In order for Security Tokens to be

admitted for trading on the secondary markets, an infrastructure must be built

in order to allow for trading of Security Tokens whilst complying with KYC and

AML requirements.

Certain solutions are being explored

such as the possibility of centralizing compliance on the token issuance level by

embedding a code on tokens ensuring they can only be traded by parties who are

compliant.

Listing of Security Tokens will have

to be overseen by the regulator who will grant the license to the exchange and

permit it to operate. In effect, this will further provide investors a more

trusted way of buying and selling Security Tokens as these exchanges will have

to comply with KYC and proper systems safeguarding from cyber attacks and

fraud.

G. Final

Remarks - Comments

Yet,

despite the extraordinary success of ICOs, there is already a new model taking

prominence, this being the STO. The

latter seems to be the future of the industry, possibly because it represents a

sale of securities, rather than mere coins or utilities. Needless to say, this

attracts the more serious investors who want the comfort and guarantees of

investing in a security (be it a share, debt or other financial instrument) via

a token.

As

mentioned above, in order to offer securities to the public, one must follow

the rigid requirements of the Prospectus Directive.

However,

the numerous exemptions available at law give the proposed issuer sufficient

flexibility to be able to structure the intended STO without incurring an

unnecessary burden, whilst still selling a product under the title of security.

Through

STOs, Security Tokens provide the potential of unlocking trillions in otherwise

illiquid assets. The concept of STOs, although at its early adoption, has

proved to have the potential to be applied on any real-world asset - from an

art painting, music rights and real estate, to ships and renewable energy.

One

still needs to understand how the market will adapt in order to fully accommodate

Security Tokens to create a safe, legal and fully compliant infrastructure in

order to unlock the full potential of Security Tokens and tokenization of

assets on the blockchain.

Nevertheless,

Security Tokens have the potential to bring a number of improvements to the

traditional financial products, by removing middlemen, providing more liquidity

to the market and in the same time also offering safety to investors.

Security

Token offerings are the future.

They are a combination of the 21-century decentralised

technology along with security laws which existed for many years and are

capable of bringing the financial world as we know it to a whole new

dimension.

H. Disclaimer

This publication has been prepared as

a general guide and for information purposes only. It is not a substitution for

professional advice. One must not rely on it without receiving independent

advice based on the particular facts of his/her own case. No responsibility can be accepted by the

authors or the publishers for any loss occasioned by acting or refraining from

acting on the basis of this publication.

Authors

CHRISTOS P. KINANIS

Lawyer – Managing partner

Kinanis LLC

[email protected]

ELENA ANDREOU

Lawyer

Kinanis LLC

[email protected]

Dr. FRANCESCO SULTANA

Lawyer – Manager

Kinanis Fiduciaries Limited

[email protected]

Our

Firm

Kinanis Law

Firm is a Law and Fiduciary Firm and advises for over

35 years international investors and private clients offering legal and

consulting services since 1983.

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our firm as one of the key players in the field. Our involvement in

international financial transactions has also provided us with the extensive expertise

in representing groups, corporations, funds as well as the private client.

Kinanis LLC

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