Compared to our friends across the pond, Europe has been much more proactive with regards to building the necessary regulatory foundational infrastructure for security token offerings (STOs).
This article does not constitute legal guidance or legal opinion of the author or any entity associated with the author. This article is published to serve as a summary guide of the information currently available to the public. I'm not a qualified lawyer and anyone seeking to issue a security token should consult with their own legal counsel.
The Prospectus Regulation
Within the EU, the legal framework surrounding security offerings to the public and the admission of securities to trading on a regulated market is determined by the Prospectus Regulation. This regulation was passed in July 2017 and became legally enforceable in July 2019. These rules apply to all members of the European Union.
Financial Instruments and Security Tokens
How does the Prospectus Regulation define securities?
The Prospectus Regulation defines ‘securities’ as the transferable securities set by MiFID II, excluding money market instruments having maturity of less than 12 months. This is by far the most important piece of relevant European legislation applicable to security tokens.
Within the EU, one must therefore refer to MIFID II to determine whether or not an STO falls within the definition of a security. A transferable security is defined as any form of security that negotiated on capital markets, citing the following examples:
(a) Shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares;
(b) Bonds or other forms of securitized debt, including depositary receipts in respect of such securities;
(c) any other securities giving the right to acquire or sell any such transferable securities or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures.
NB: instruments of payment (such as Bitcoin) are specifically excluded.
Exceptions: When does the Prospectus Regulation not apply?
The following scenarios are exempt from the need to have an approved prospectus. For startups that are raising pre-seed, seed or Series A rounds, these exemptions are highly relevant.
- If the total amount raised in the EU is below 1m Euros, calculated over a period of 12 months. In theory, one may therefore continue to raise 1m Euros within each 12 month period.
- If the total amount raised in the EU is below 8m Euros and such investments are not subject to a pass-porting notification. (A pass-porting notification refers to the Article 24 disclosure regime whereby approval of a prospectus in one member state allows cross-border offers, within the EU only)
- an offer of securities addressed solely to qualified investors
- an offer of securities addressed to fewer than 150 natural or legal people per member state, which are not qualified investors
- an offer of securities with a minimum ticket of 100,000 Euros per investor.
The above exceptions don't apply to me. What's next?
If the prospectus regulation exceptions don't apply to your case, such as if you want to raise more than 8m euros, then you will need a Prospectus approved by the national financial regulator of the respective member country (as per the Prospectus Directive - 2003/71/ES). Typically this will be the national financial regulator of the EU country where your startup is incorporated.
If this national regulator approves your prospectus and you also want to market your security to investors in another EU country, a simple notification to the regulators of each of the other EU countries is sufficient (ie each national financial regulator of each member state does not need to approve it). It's a relatively straightforward process to do yourself. Alternatively, you can use a financial regulation firm to do it for you.
What is a Prospectus?
A Prospectus is a documented targeted at prospective investors that aims to educate them about your startup. This includes the business model, financial plan, management team, securities information and terms of the sale, helping prospective investors to complete due diligence on your startup and offering. Besides from being a legal requirement, the prospectus can also serve as an important marketing tool just like a pitch deck, to convince potential investors to invest in your startup. For more information on how to write a good prospectus, check out this guide by Neufund.
What else should you be aware of?
Whilst EU member states are expressly forbidden from imposing Prospectus requirements for raises below 1m Euros, they may impose other disclosure requirements. There is still therefore a duty for startups to check the disclosure requirements of each member state which is somewhat onerous given the number of states to comply with.
It should also be noted that the rules in each country of the EU differ with regards to minimum capital raise thresholds which are often higher than the 1m euros level EU-wide. For example, if you are just issuing security tokens in Cyprus and marketing to Cypriot investors, you would be able to issue securities worth 5m euros. Other examples of national limits are listed below.
- UK (5m euros)
- Luxembourg (1.5m euros)
- Poland (2.5m euros)
- Sweden (5m euros)
- Croatia (5m euros)
- Cyprus (5m euros)