Prescriptive Jurisdiction in Securities Regulations: Transformation from the ICO (Initial Coin Offering) to the STO (Security Token Offering) and the IEO (Initial Exchange Offering)

As noted previously, I presented a paper on the prescriptive jurisdiction on securities regulations and ICOs at the Konkuk University (South Korea) last year (2019). Subsequently, I was invited to write an article on that theme for the Ilkam Law Review, the journal of the Konkuk University Law School. I submitted my manuscript towards the end of last year. While awaiting publication, let me share the submitted version here.

It contains some illustrations with parts highlighted in red. I have been told that the published version will be printed black and white. So those illustrations would be better understood in the version attached here.

The abstract reads:

This article examines how the ICO (Initial Coin Offering) has been impacted by the States’ assertion of prescriptive jurisdiction in securities regulations and analyzes the STO (Security Token Offering) and the IEO (Initial Exchange Offering) as alternatives to the ICO. The analysis begins with examining the principles underpinning prescriptive jurisdiction such as the territoriality principle. It then proceeds to examine the three tests – the conduct test, the effects test and the transactional test - which support the operation of the territoriality principle. Attention is then turned to the impact of the Internet which has facilitated cross-border fundraising. An analysis is given to the way the effects test is interpreted where the Internet is used for the solicitation of investment. More recently, the blockchain technology has given birth to the ICO. It has enabled borderless fundraising, a feature which contributed to the initial popularity of the ICO. While the ICO is technologically borderless, it is legally not so. To illustrate the point, the article examines the way the aforementioned three tests are to be applied in the ICO. With its borderless feature undermined by the fragmented regulatory regimes, the ICO has lately lost popularity. The article concludes by examining the STO and the IEO to see how they differ from the ICO and whether they fit better with the fragmented regulatory regimes.

A further note (8 April 2020): This paper has come out from (2020) 45 Ilkam Law Review pp.31-50. The document attached below has accordingly been replaced by the published version.

Law School course on crypto-assets and blockchain

Starting September this year, I am teaching a course devoted to the legal issues on crypto-assets and blockchain at my university (Doshisha University in Kyoto, Japan). It is a 2-credit course (90 minutes x 15 classes) and is one of a kind in Japan. The link to the syllabus (in Japanese) is here. As noted there, the course aims to cover a broad ground encompassing the law of obligations, property law, currency law, anti-money laundering, payment law, securities law, the law of negotiable instruments, private international law, procedure law, criminal law, the law of data protection and tax law. Special thanks go to two guest lecturers, Mr. Ken Kawai (partner of Anderson, Mori & Tomotsune) and Mr. Kimihiro Mine (director of bitFlyer), who have agreed to deliver one class each.

Prescriptive Jurisdiction in Securities Regulations and ICOs (A further thought)

I presented a paper on the above theme at the conference “Recent Issues on Virtual Currency in the Financial Market” held at the Konkuk University (Seoul, South Korea). The program of the conference is attached below. Many thanks to Prof. Byoung Youn Kim for his invitation.

In the paper presented, I developed my thought which I had expressed in my article written last year (and published earlier this year: See this link for a summary.). I noted the decline in the number of ICOs and attributed it partially to the fragmentation of legal regimes. While the blockchain has technologically enabled borderless fundraising in the form of the ICO, the latter is not legally borderless. 

An idea of global unification of regulations should, however, be resisted because the optimal balance between the facilitation of fundraising and the protection of investors should be sought through regulatory competition. Attempts at the international level should instead be directed towards the coordination of different regulatory regimes. In this connection, whether the conduct test should be maintained is doubtful. It is a classic test for the territoriality principle. Yet, few would support it if asked whether regulations should be applied on the sole basis that the place of the relevant conduct is in the territory of the regulating State even if the conduct only targets foreign States. The effects test, on the other hand, has a good foundation as it allows the regulator to protect the interests affected. The coordination effort on the international level should also be directed towards developing a network of assistance in cross-border enforcement of regulations, especially those of the place of effects.  

For the enterprises wishing to conduct fundraising, the choice will be either to address the investors of the whole world save specific States to avoid being captured by the regulators of such States or to address the investors of the specific States by consciously complying with the regulations of such States. The latter may be called STO (security token offering).

The powerpoint slides used in the presentation are attached below.

Choice of law issues in crypto-assets

I presented a paper entitled "Conflict of Laws in Blockchain-Based Crypto-Assets" at the Journal of Private International Law Conference on 12 September 2019 in Munich. As the time was limited, I focused on choice of law issues and discussed four broad categories of issues. They were (1) contractual issues, (2) issues of non-contractual obligations, (3) proprietary issues, and (4) issues pertaining to negotiable instruments.
The powerpoint slides prepared for the presentation are attached here. Some takeaways are set out in the last slide. It was meant to make the following points there.

The crypto-assets are unfit to be deemed to be money for the choice-of-law purposes because, inter alia, none of them is currently used as a medium of exchange and it is not possible to draw a line between the crypto-assets which are deemed to be money and those which are not so deemed.

The crypto-assets are difficult to be localised in a single country because they are contained in distributed ledgers on a borderless blockchain. The localisation may exceptionally be possible where all the nodes validating the blocks are by design located in a single country.

The crypto-assets will pose no particular difficulty in relation to the connecting factors which rely principally on real-life facts and events. Thus, for example, the country with which a contract, tort, or unjust enrichment is most closely connected may be ascertained without particular difficulty stemming from the use of crypto-assets. The ascertainment of the country with which a proprietary issue is most closely connected would be more difficult because the relevant events are mostly on-chain facts.

The crypto-assets will pose no particular difficulty in relation to the principle of party autonomy because the only question for the latter is whether to give effect to the parties' own choice. Given the difficulty of finding an appropriate connecting factor for proprietary issues in crypto-assets, it is arguable that the principle of party autonomy should be extended to proprietary issues where there is a uniform network-wide choice of law clause. How a single choice of law can be secured is, however, another question.

Symposium on MLETR and blockchains

I gave a paper in a symposium on the UNCITRAL MLETR (Model Law on Electronic Transferable Records) and blockchains (Here is link to the program) on 16 March 2019 at the Waseda University in Tokyo.
The proceedings were conducted in Japanese except the presentation by Luca Castellani, the legal officer of the UNCITRAL Secretariat who was responsible for this Model Law. So my powerpoint slides and handout (below) are also in Japanese.
I have underscored the potential of public blockchains for disrupting the society and considered whether they meet the requirements of the MLETR. Throughout the analysis, I have compared public blochains with permissioned blockchains and central registries. Each of the requirements of the MLETR poses an analytical challenge with respect to public blockchains.
I will try to write an English version of the paper once I have cleared a backlog of work on my desk.

"Prescriptive Jurisdiction in Securities Regulations and ICOs (Initial Coin Offerings)"

My article "Prescriptive Jurisdiction in Securities Regulations and ICOs (Initial Coin Offerings)" has been published ((2019) 117-4 Journal of International Law and Diplomacy pp. 1-25). It is based on my presentation in Japan and written in Japanese. The original title and citation are: 高橋宏司「証券関係法規の規律管轄権とICO (Initial Coin Offering)」国際法外交雑誌117巻4号(2019年) 1-25頁. Here is an English abstract.

The ICO is a new method of fund raising using the blockchain technology. It enables tokens to be issued on a blockchain in return for the contribution of funds in either fiat or crypto currencies. It is in vogue in recent years but has generated concern over fraud in a large number of cases. This has kindled the interests of regulators around the globe, who have been watching the space closely. While some countries have introduced an outright ban on ICOs, others have begun to see certain types of ICO tokens as securities with a view to protecting the investors. There is, however, much uncertainty as to the geographical reach of securities regulations as applicable to ICOs. As it is a question of prescriptive jurisdiction, this article begins by examining in the context of securities regulations the various principles underpinning prescriptive jurisdiction, such as the protective principle, universality principle, personality principle and territoriality principle. Since the territoriality principle is the cornerstone of prescriptive jurisdiction in securities regulations, this article proceeds to examine the various tests for the operation of the territoriality principle, such as the conduct and effects test and the transactional test to see how well they suit the regulation of securities of the traditional type. This article concludes by considering whether those tests are also fit to be applied to ICOs. Throughout this article, an intense analysis is conducted on the way the internet has affected the prescriptive jurisdiction in securities regulations and how the blockchain technology may affect it in the future.

Bahraini legislation based on the UNCITRAL MLETR

(This entry was originally posted at https://wordpress.com/view/blockchaincryptolaw.wordpress.com on 12 February 2019.)

Bahrain became the first to enact a statute based on the UNCITRAL Model Law on Electronic Transferable Records. I have been provided with an English translation of the statute by Jameel Al Alawi, Senior Legal Adviser for the Bahrain Economic Development Board, who was in charge of drafting the statute. With his permission, I post it below.

The Model Law sets out the conditions which must be met for an electronic record to be treated as a "transferable document" (Article 10). The latter is defined as a document that entitles the holder to claim the performance of the obligation indicated in the document and to transfer the right to performance by means of the transfer of that document (Article 2). Bills of lading and warehouse receipts, for example, are covered.

The Model Law adheres to the principle of technology neutrality, which means that the law should neither require nor assume the use of a particular technology for communicating or storing information electronically. Thus, the blockchain technology is not excluded from the Model Law's scope of application. It is in fact a technology well suited for creating and managing electronic records which purport to replicate transferable documents because it is capable of guaranteeing that there is a single true version of electronic records. 

The Model Law requires the use of a reliable method to establish an exclusive control of an electronic record that replicates a transferable document (Articles 10(1)(b)(i)(ii) and 11(1)(a)). In my previous work, I noted:

The reliability of the above-mentioned methods will be assessed by adjudicators on an ex post (i.e. after the occurrence of a dispute) basis. It would, however, be unfortunate if there were no foreseeability as to which methods would pass the reliability test since the use of such methods would then be deterred. A thought should, therefore, be given to the possibility of compiling a list of reliable methods on an ex ante basis. Such a list would need to be reviewed from time to time because neither the configuration of a central registry nor the algorithm of a blockchain is permanently fixed.

The Model Law lists a number of circumstances by reference to which to evaluate the reliability of a method, including the existence of a declaration by an accreditation body (Article 12(a)(vi)). But it leaves the details to the national laws.

What is interesting about the Bahraini legislation is that it provides for the accreditation of an "operator", the latter being defined as a person who operates an information system for managing electronic transferable records (Article 1(l)). It sets forth the procedure and conditions for accreditation (Articles 15 and 16), though it delegates to the competent authority to lay out the details of the conditions by means of a regulation. It also provides for the withdrawal of an accreditation. Once an operator is accredited, the reliability of the method used by the operator is to be presumed unless evidence to the contrary is adduced (Article 8(2)). Furthermore, where reliance on an electronic transferable record has caused damage and the electronic record is managed by an accredited operator, it is to be presumed that the damage was due to the operator’s intention or negligence unless otherwise proven (Article 17).

The Bahraini legislation is applicable to electronic transferable records "whether or not an operator is used in respect of these records" (Article 2(1)). Accordingly, it seems applicable to electronic transferable records managed with the use of the blockchain technology. In view of the definition of an "operator" (Article 1(l)), it seems unlikely that any accreditation will be issued with respect to public blockchains. But the administrator of a private blockchain may fall within that definition. It will be interesting to see whether the conditions for accreditation issued by the competent authority will actually cover private blockchains as well as central registries.

Postscript (15 Feb. 2019): Jameel has informed me that the Bahraini statute entered into force on 1 February 2019 but the regulation is still being debated.