We have experienced a rapid growth in Security Token Offerings (“STOs”) over the course of the last year and we have now advised on the launch of several dozen STOs (both in relation to utility tokens and tokenized investment funds).
Whilst no specific legislation has been passed by the Cayman Islands Government in connection with STOs and cryptocurrencies, it would be incorrect to say that STOs are “unregulated”. The fact is that some of the existing legislation in the Cayman Islands can, and in certain circumstances will, be applicable. We have detailed the most relevant legal considerations when structuring an STO in the Cayman Islands in a previous legal guidance note (Virtual Asset Service Providers Registration and Continuing Obligations). But below is a shorter review. We suspect that more-specific guidance will be issued by the Cayman Islands Monetary Authority very shortly and that positive legislation will eventually be created.
The Securities Investment Business Act (as Revised) (“SIBA”)
SIBA is the Cayman Islands’ primary legislation relating to the regulation of investments in ‘securities’ and associated businesses. Essentially, no person shall carry on (or purport to carry on) securities investments business unless that person is the holder of an appropriate licence or is excluded from the requirement to hold a licence.
The term ‘securities’ is defined in SIBA by reference to a list of particular types of security (including shares, stock, partnership interests, instruments acknowledging indebtedness, options, futures etc.). This definition is narrower than that used in the US Securities Act of 1933 as there is no corresponding concept of an ‘investment contract’. There is instead just a specific list of types of security which does not specifically refer to a cryptocurrency or token.
As the definitions of ‘securities’ and ‘securities investment business’ are linked (i.e. securities investment business includes dealing in, managing and advising on securities), it is generally accepted that an STO should fall outside of SIBA. As always, this depends on the particular circumstances of the STO and so specialist advice should be taken on this point at the outset.
Mutual Funds Act (as Revised) (“MFA”)
In circumstances where the STO is related to an investment fund (tokenized or otherwise) or some other form of investment vehicle, the possible application of the MFA should be considered.
In general terms, the MFA regulates “mutual funds” which is a company, unit trust or partnership that issues equity interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors in the mutual fund to receive profits or gains from the acquisition, holding, management or disposal of investments.
The MFA should not therefore be a concern where the STO is not intended to be an investment fund or engage in investment fund activity.
However, where the STO is related to an investment fund or investment fund activity, the current definition of “equity interests” in the MFA becomes critical. Currently, the MFA defines “equity interests” as a share, trust unit or partnership interest that (i) carries an entitlement to participate in the profits or gains of the company, unit trust or partnership; and (ii) is redeemable or repurchasable at the option of the investor.
Accordingly, our view is that tokens issued by investment funds would not fall within the definition of “equity interests” in the MFA by virtue of them not being shares, trust units or partnership interests. However, those STOs which are structured as tokenized funds should take specific legal advice in connection with their structure and, crucially, the rights attaching to the tokens as we expect regulatory changes to be announced by the Cayman Islands Monetary Authority (“CIMA”) imminently. We do not currently know what these changes will be but we would expect the definition of “equity interests” in the MFA to be extended to cover cryptographic tokens. Should that occur, tokenized funds which offer token holders the right to redeem would likely require registration with CIMA under the MFA and would need to also comply with the various requirements associated with such registration (including the requirement that each investor have a minimum subscription amount of US$100,000). We have several recommended solutions to address this until we have some specific legislation or guidance from CIMA.
The Hon. Alden McLaughlin, Premier of the Cayman Islands, told delegates at the 2018 Cayman Alternative Investment Summit: “the attributes that have made the Cayman Islands so attractive to the financial services sector – and the alternative investment space in particular – over the years will also ensure its relevance to the burgeoning financial technology space”. This further supports the view that the Cayman Islands Government intends to make the Cayman Islands the jurisdiction of choice for this new market.
How can we help?
We have seen a significant increase in activity in the cryptocurrency and STO sectors and are well placed to provide advice on a prospective STO and the launch of funds in this sector.
In addition to the incorporation of a Cayman Islands exempted company or limited liability company (through which the STO would be operated), we can provide a full ‘health check’ service pursuant to which we would review the terms of the STO against the Cayman Islands legislation referenced above and provide you with certainty as to which laws and regulations apply and how to operate in compliance with them.
If you would like further information please contact Chris Humphries at firstname.lastname@example.org