The last year has seen a considerable growth in the international and Cayman Islands (‘Cayman’) market for investments in virtual or ‘crypto’ currencies and Initial Coin Offerings (‘ICOs’). The Cayman Islands Monetary Authority (‘CIMA’) has issued a ‘Public Advisory - Virtual Currencies’ (‘Advisory’) aimed at helping investors better understand the risks involved.
Does the advisory affect all investors?
The Advisory is addressed to members of the public who may be attracted to the quick and high returns which seem to be offered by ICOs. However, most of the issues highlighted would be those of which a sophisticated investor would already be aware.
What Cayman regulations might apply to an ICO?
There is no Cayman regulation specifically aimed at ICOs although certain types which offer rights or benefits may already come within existing securities legislation. Existing definitions in the Securities Investment Business Law (2015 Revision) (‘SIBL’) do not include ICOs but this may change in the future. ICOs may also need to navigate legislation and regulation on Electronic Transactions, Anti-Money Laundering and terrorism financing as well as Beneficial Ownership.
What are ICOs?
A start-up company looking to raise capital for a new project or business offers investors the chance to purchase virtual coins or tokens (‘Coins’). These typically use ‘blockchain’ technology similar to that used in virtual currencies as a means of ensuring that the record of purchase and ownership of these coins or tokens is maintained securely.
Are they shares or loans?
Unlike shares these Coins do not usually confer any ownership rights to the purchaser and nor are they investor loans. Virtual currencies are not legal tender in either in Cayman or most other countries, and so no-one is obliged to accept or redeem them. Exactly how a purchaser is able to 'sell' or 'cash' the Coin will be based on the terms offered by the company using them to raise money.
Are they securities?
CIMA’s advisory draws investors’ attention to the risk that the Coin may fall within existing securities regulations, or it may be classed as a ‘security’ in the future by the regulatory body in the country where the ICO is based or issued. If such a Coin has not been issued in accordance with that country’s securities legislation there is a risk that failure to follow those rules will have a negative impact on the value of the Coin or usability or on the overall value of the organisation or company which issued it.
What is the risk?
The advisory is primarily addressed to individual investors who may not be able to identify issues which would be apparent to a sophisticated corporate investor. CIMA sets out a list of risk associated with ICOs and virtual currencies, including that failure to comply with existing securities legislation means investors could lose some or all of the money they invest. There is simple general advice and some specific Red Flags for investors to watch out for.
PRA advice on risk management systems
Whilst it is not binding on Cayman entities, the United Kingdom’s (‘UK’) Prudential Regulation Authority (‘PRA’) has made suggestions for risk strategies and risk management systems appropriate to crypto-assets held or to be held by institutional investors. A 28 June 2018 letter from the PRA's Chief Executive Officer ('CEO') gave advice on crypto-assets to the CEOs of banks, insurance companies and designated investment firms. In brief, the strategies are:
- 1) Recognizing that crypto-assets represent a new, evolving asset class with risks which should be considered fully by the board and highest levels of executive management;
- 2) Ensuring that incentives provided in remuneration policies and practices do not encourage excessive risk-taking in work on crypto-assets.
- 3) Ensuring that their risk management approach to crypto-assets is commensurate to the risks of crypto-assets, i.e.:
- a. given their technical complexity, ensure access to appropriate, relevant expertise to assess any risks stemming from their exposure to crypto-assets;
- b. conduct extensive due diligence before taking on any crypto-asset exposure
- c. maintain appropriate safeguards;
- d. classification of crypto-asset exposures for prudential purposes should reflect firms’ comprehensive assessment of the risks involved;
- e. crypto-assets should not be considered as currency.
Solomon Harris has many years’ experience in the preparation of all types of Cayman investment and advising on new investment vehicles. We are able to assess and advise on regulatory or legal issues arising from the launch and management of an ICO or funds involving cryptocurrency investments. If you require any further information or advice on legal issues relating to appropriate investment vehicles or on an ICO generally, then contact Solomon Harris Partner Richard Addlestone.
The information contained in this article is necessarily brief and general in nature and does not constitute legal advice. Appropriate legal or other professional advice should be sought for any specific matter.