The French regulatory framework allows issuers to promote and develop initial coin offerings (ICOs) and so is likely to be a first test case for ICOs in Europe.
CFA Institute supports technical innovation in financial services that makes markets more efficient and capital allocation more effective. However, this cannot come at the expense of market integrity, market fairness, or investor protection.
As a result, we have several reservations about the regulator AMF’s recent attempt at creating a regulated ICO market in France.
Will This Attract High Quality ICOs to France, Or Not?
The cornerstone of the Autorité des marchés financiers (AMF) regulation is the information document that the ICO promoters must submit to the regulator if they want to obtain its approval (however, this approval is not mandatory to conduct an ICO).
In retaining a balance between providing an optional regulatory regime that provides investors with some level of regulatory approval while not excluding any issuers, the regulation is intended to attract high quality ICOs to France.
The pieces of information provided in the information document are similar to those found in a prospectus for a traditional equity IPO, although not at the same level of granularity. Notable differences include the lack of financial information and the presence of custodial information.
In its guidance, the AMF makes it very clear that any approval does not imply that the AMF has made any judgement on the appropriateness of the issuer's project or authenticated the financial, accounting or technical information presented. Neither does this approval mean that the AMF has carried out any verification of the smart contracts linked to the offering, and it has also not verified whether these smart contracts are adequate in relation to the content of the information document.
This disclaimer is very interesting because it points out two major issues with the new framework.
First, it is interesting that while there is no requirement to provide any financial information in the disclosure document, the AMF’s disclaimer clearly refers to financial and accounting information presented in the disclosure. This inconsistency illustrates the difficulty of characterising tokens, even when narrowly defined as utility tokens, without acknowledging the fact that they have a lot of similarities with traditional financial instruments.
The second issue relates to smart contracts, the small pieces of executable code that can be processed by the Ethereum blockchain. The innovation of smart contracts is that these executable functions can allow verifiable workflows between several parties to occur, without a trusted party administering the execution of these workflows. One application that these executable functions can be used for is the issuance and subsequent administration of tokens.
Smart contracts are what make ICOs different from traditional IPOs. The ability to automate the issuance process and the subsequent administration of the asset to be issued has the potential to significantly disintermediate capital markets.
For this reason, it is disappointing that the AMF’s approach largely ignores the smart contract aspect of ICOs.
Further, since the funds raised and the issued tokens are administered by smart contracts written into the ICO it is critical for investors that these contracts are free of errors or malicious intent. The information document allows for voluntary disclosures about the underlying smart contracts, a link to the code itself along with a brief overview of the code’s inner workings. A third party audit of the code is also an optional disclosure. This is insufficient because there are often significant discrepancies between the content of a white paper and the workings of the associated smart contract.
Our Position
CFA Institute has reservations about creating a regulated ICO market.
First, the proposed information document does not require the disclosure of any financial information.
Second, we believe current requirements for technical disclosures are insufficient, particularly in regard to the underlying smart contract functionality of the ICO.
Third, the importance of post-ICO secondary market trading seems to have been underestimated or overlooked as it is mostly absent from the new ICO regulatory framework.
Finally, we believe that an opportunity has been missed to integrate the EU’s sustainable finance agenda into the fintech space. We predict this issue will intersect with ICOs and other crypto assets in the near future as the realisation of their outsize energy consumption spreads.