Overview of Swiss Security Tokens
Note to the reader
Security Tokens are associating regulated financial instruments with blockchain ‘tokens’. In this paper we will expose what security token are and how they can be issued and traded.
We cover Swiss financial instruments, and in particular equity instruments issued by Swiss firms, and how such instruments can be issued and sold in Switzerland and in other jurisdictions. We won’t discuss Security Tokens which can be issued by firms incorporated in other jurisdictions.
In addition, Tokenestate has developed a Swiss compliant Security Token Offering (STO) platform (the ‘Platform’) for Swiss companies, which is part of the Tokenentreprise suite of services. Certain legal and technical aspects discussed here are specific to our Platform.
1. Generalities about the ownership of shares in Switzerland
To simplify there are historically two main types of shares: bearer shares (actions au porteur) and registered shares (actions nominatives).
Bearer shares are the property of the person or the entity owning them, historically a piece of paper issued by the company. Such instruments are easily exchangeable between investors; however, the issuing company might not be able to know who the shareholders are. Due to increased regulatory requirements with respect to anti-money laundering over the past decades, bearer shares are now seldomly used.
The owners of registered shares are listed in the shareholder register (registre des actionnaires) of the issuing company. The company maintains this register, which at minimum includes the name, address and birthdate of the investors. This allows the company to have a complete view as to who the shareholders are, and requires the company to be informed of all shares transactions. Registered shares can be certified, which means that investors receive a legal document issued by the company which attests of the ownership of a specific number of shares.
The Security Tokens issued by the Tokenestate Platform are uncertified registered shares. The ownership is of the shares is uncertified, as blockchain tokens do not qualify as a share certificate which typically refers to a paper document. However, the Platform ensures that all shareholders are known, and that each token is associated to a physical person or legal entity, hence the term registered. Unregistered certified shares are very common as most companies maintain their shareholder register using digital tools, such as excel spreadsheets.
In Switzerland, companies are free to maintain their share register using whatever technology they see fit. They can use paper, excel spreadsheets, google spreadsheets, or new and secure databases like blockchain. The only requirement is that the information is available in Switzerland. Consequently, the use of a blockchain solution to keep track of the owners of Swiss shares does not require any authorization from FINMA, the Swiss financial regulator.
2. About blockchain tokens and the ERC-20 standard
Note: The purpose of this section is to provide high-level contextual information on the notion of blockchain tokens. We don’t intend to define what a blockchain is in this section, and redirect the reader to the literature available on this topic.
At its most basic a blockchain is a distributed register of the creation and transactions of tokens, coupled with a transaction mechanism. For example, the native token of the Bitcoin Blockchain is the Bitcoin. Users of a given blockchain are using public keys and private keys to perform operations. Public keys are like accounts numbers, and are associated with a balance of tokens. Private keys are required to control the balance of tokens held by the corresponding public key, and to sign transactions. There’s a private key for each public key, and both can easily be generated independently by users at no cost.
Evolutions of this concept led to the introduction of more complex mechanisms than the processing of simple transactions. The Ethereum blockchain has popularized the notion of smart contracts which allows the execution of more complex logic while relying on a decentralized blockchain infrastructure. For example, Ethereum smart contracts can be used to create an insurance contract whereby different parties contribute tokens to a certain public address over time and receive a payoff in tokens when a certain event occurs.
As the popularity of blockchain grew, standards started to emerge for the creation of smart contracts. The ERC-20, an Ethereum standard, allows participants to easily create blockchain tokens while relying on the Ethereum blockchain infrastructure. ERC-20 tokens are supported by a large ecosystem of service providers such as custodianship solutions, mobile and hardware wallets.
In the case of securities, using a popular and dominant standard built on top of a public blockchain is of critical importance. This ensures the robustness of the database used to record and manage transactions, while enabling users to manage their tokens using a variety of 3rd party tools. As of today, the ERC-20 used on the public Ethereum blockchain is the de facto standard, and is the one used by the Platform.
3. About Security Tokens
Security tokens are associating financial securities, such as Swiss ordinary shares, with a blockchain token. Each token being associated with a public key, whoever owns the corresponding private key is the owner of the financial security.
Digitizing securities ownership is not new. Most securities are digitized today, as companies issuing them are maintaining shareholder registers using common digital tools, such as excel spreadsheets. Such digital tools are centralized in nature: they are controlled and maintained by a single central entity. In the case of an unlisted company, the shareholder register is maintained by the company itself.
The evolution with security tokens is that the register is maintained using a decentralized and transparent infrastructure outside of the control of the issuing company, an ERC-20 smart contract hosted on the public Ethereum blockchain in the case of the Platform.
Any security token owner can therefore independently assess its ownership, and the total number of security tokens issued by the company. Brokers can easily own and distribute security tokens issued by 3rd parties, and investors can independently exchange the security tokens among themselves.
Security tokens lend themselves to operational efficiencies by automating time-consuming operations, such as the issuance of shares and the maintenance of the shareholder register, compliance with securities regulation and transfer restrictions, the exchange of shares and the payment of dividends.
By blending the efficiency of blockchain tokens with the regulatory security associated with financial securities, security tokens are widely seen as major evolution in the world finance. With security tokens, private companies can efficiently manage thousands of investors across geographies, accept very small investment tickets and organize the secondary exchange of their shares while remaining private.
4. Legal aspects
Note to the reader: FINMA, the Swiss financial authority, as a technology neutral approach. Regulatory speaking, security tokens are first and foremost financial securities and the legal aspects discussed in this section are applicable to Swiss financial securities in general, and not related to the technology used to materialize the ownership of such securities.
Our focus is on equity products, and more specifically ordinary shares and participation certificates. Such instruments are simple, plain vanilla products which are widely issued by companies throughout the world. Ordinary shareholders are granted 4 main rights: dividend & liquidation rights, information rights, voting rights and preferential subscription rights. Such rights are enshrined in the Swiss Code des Obligations, and easily enforceable in court. In addition, Switzerland has signed over 120 Bilateral Investment Promotion and Protection Agreements, the world’s third largest network of such agreements after Germany and China. Such treaties protect foreign investors against discrimination by local courts, unlawful expropriation or unjustified restrictions. Compared with lightly regulated cryptocurrencies, the security tokens issued using the Tokenestate Platform are providing investors with strong and enforceable protections.
In the context of a fundraising operation, the primary concern of the regulator and of partner banks is the origin of the funds and the ultimate beneficiaries of the investment, in application to the Swiss Anti Money Laundering Act (AMLA). This requires issuing companies to perform what is commonly referred to as Know Your Customer (KYC) and Anti Money Laundering checks. Such checks are to be performed by Swiss Financial Intermediaries affiliated with Swiss Self-Regulatory Organizations (SRO). The Tokenestate Platform is seamlessly integrated via a programmable interface (a.k.a an API) with CashSentinel a Swiss Financial Intermediary. Issuing companies are therefore complying with Swiss AMLA regulation when using the Platform, which is of critical importance in the context of an STO.
Swiss and foreign securities regulation applies to the issuance of security tokens, depending on the type of investor, geographical reach and total volume of funds raised. Financial regulators role is to maintain market confidence, financial stability and to protect unsophisticated / retail investors.
There are 3 main types of investors:
- Institutional investors, such as pension funds or banks,
- Qualified and professional investors, such as financial professionals and high net worth individuals,
- Retail investors, which essentially do not fall in the previous two categories and refer to consumers (a.k.a. the ‘public’).
When a Swiss company raises capital from an investor in a given country it is required to comply with the securities regulation applicable in such a country. Securities regulation will typically govern the following aspects of a securities sale: what marketing activities can the issuer do, the type of investors the issuer can accept capital from, and the filings and disclosures that the issuer must perform.
Institutional investors are the least protected category, due to their financial sophistication. Issuing companies are typically free to raise funds without restriction or disclosure requirements from such investors in most jurisdictions.
Qualified and professional investors refer to individuals which, given their fortune or experience, are deemed sophisticated enough to ‘fend for themselves’ by their national financial regulator.
The UK for example is relatively permissive and considers that individuals with a gross income of over 100’000 £ per year are qualified investors. Switzerland on the other hand, is much less permissive and request individual to have a fortune of at least CHF 500’000 and financial sector experience.
The definition of what a qualified or professional investor is differs between jurisdictions. It is particularly complex for issuing companies to interpret and implement such checks, which is the reason why the Tokenestate platform is integrating them natively.
Retail investors are the most protected category. Typically, issuing companies willing to raise financing from the public are required to file and publish a prospectus. A prospectus is a formal document that provides details about the investment offering, and about the company proceeding to the sale. Prospectus are typically time consuming and expensive to issue.
However, several prospectus exemptions have been implemented to facilitate fundraising operations. Such exemptions typically rely on the total amount of funds being raised, or the number of individuals an investment offer has been made. In the EU for example, companies making an investment offering to less than 150 retail investors per member state, or raising less than EUR 8m, are not required to file a prospectus.2
By taking advantage of such prospectus exemptions, it is possible to grant issuing companies access to a very large pool of investors without filing a prospectus in each and every jurisdiction. With our advice and solution, issuers can raise financing from investors in Switzerland, the EU and qualified investors in the UK without having to publish a prospectus in EU member states.
The Tokenestate Platform is an interface enabling issuers and investors to interact, in the context of STO, and following the issuance of the token. We conceive our solution as the medium to digitize the relationship between issuers and investors over the long term.
STO process. During an STO, investors create a password protected investor account with the issuer. They are requested to do so to provide information, such as their email account, personal information and place of residence.
Based on this information the issuer is whitelisting them, i.e. granting them access to the offering documents in compliance with the investor’s status (i.e. qualified or not) and the investors place of residence. Once the investors have been whitelisted, they have access to offering documents (Swiss prospectus, information memorandum, executive summary) and can take the decision to purchase the offered securities.
When they do so, the Platform automatically generates an investment contract which is established between the issuing company and the investors. Once an investment contract is digitally signed by the investor, the investors information is sent via the Platform to a Swiss Financial Intermediary to perform KYC & AML checks, such as for example checking that the investor or its ultimate beneficiaries are not Politically Exposed Persons (PEP).
Once this check has been performed, the investors has access to the information required to proceed to the payment. Once the payment has been received and cleared by the Swiss Financial Intermediary, the funds are sent to the issuer’s account(s). Once the STO is completed, the issuers send to the investors Ethereum address the tokens representing the ownership of the securities.
Post issuance. Following the issuance, investors can log into their issuer’s account, and have access to information about their investment, and download proofs of ownership, which are being automatically generated by the Platform. In addition, investors can access documents posted by the issuers, in application to the investor’s information rights.
Issuers can centrally manage their investor base, establish the shareholder register in real time based on the distribution of the tokens on the blockchain, clear transactions between investors, and send notifications & documents to investors.
Technical architecture. The Tokenestate Platform is built using secure, high availability and reactive solutions. Using the public Ethereum blockchain enables investor to own tokens and monitor transactions using 3rd party services, such as the Ledger hardware wallet and Etherscan. The backend is built using high availability and secure servers hosted on Amazon Web Services in the European Union.
In the context of an STO, it is of critical importance to generate investor leads and to follow up with investors to convert early stage leads into actual investors. Investor leads can be generated by online and offline activities such as a website calls to actions, meetups, social media channels, startup pitches, social media posts, newsletters and press coverage which will lead prospective investors to connect to the Issuer’s website and create an investor profile.
The Tokenestate Platform natively includes the required filters and notification functionalities to follow up each investor depending on their stage on the investor funnel. In addition, the Tokenestate Platform is natively integrated with HubSpot, a leading Client Relationship Manager (CRM). Investors registered on the platform are visible on HubSpot, allowing issuers to execute complex digital marketing strategies, such as email automation, and to scale up their business development efforts by adding business developers on HubSpot.
7. Services Provided by Tokenestate
Tokenestate is providing two types of services: advisory and technical.
Advisory. Building on its experience structuring and issuing Swiss securities, Tokenestate provides strategic, marketing financial and high-level legal advice3 to issuers willing to raise funds by means of an STO.
Technical. Tokenestate is providing and training issuers on the tools required to perform an STO and interact with their investor base. Such tools include most notably the Tokenestate Platform, the Smart Contract and HubSpot.
8. About Tokenestate
Tokenestate is a Swiss security token issuance & management platform. It is dedicated to making investing in private companies and real estate faster, cheaper & easier.
The Tokenentreprise suite of services is dedicated to startups and SMEs willing to issue a Security Tokens.
More information on: https://www.tokenestate.io/services.html