Developments in Fintech in Switzerland: ICOs and Stablecoins

1. Introduction

Switzerland gained the reputation of being one of the international hot spots of the developing crypto finance scene in the past decade and is determined to continue to be a central hub in this area.

To achieve that the Swiss legislator encourages innovative business models and aimes to keep regulatory requirements at a sensible level and reduce regulatory obstacles, respectively.

However, at the same time the regulatory aims of protecting investors and ensuring the functioning of the financial markets must be kept an eye on as well. The emergence of new technologies and business models require the constant re-evaluation and adjustment of existing regulatory answers to achieve the desired balance between enabling innovation and ensuring the goals of financial market regulation.

The emergence of stablecoins and the clarification of their treatment under existing financial market regulation as well as the adjustment of the practices of the regulator in this respect shall serve as an example of this constant need for re-evalutation and as the topic of this essay.

2. Basics: The Principle of Technology Neutrality and the Sources of Swiss Financial Market law

Swiss financial market regulation adheres to the principle of technology neutrality, i.e. “same business, same risks, same rules”. This means that the same rules shall apply to equivalent activities irrespective of the underlying technology unless such technology results in a different risk structure which, in turn, requires different regulation. In simple terms, Swiss financial market law regulates business models and not technologies.

In line with this principle, other than punctual legislative adjustments Switzerland has refrained from enacting a separate, comprehensive Fintech statute. Instead, the same laws which regulate the financial industry apply also to crypto projects. In particular:

The Banking Act (BA) provides the rules for the provision of banking services, i.e. in particular lending services and accepting deposits from the public on a professional basis. Whoever accepts deposits from the public on a professional basis must obtain a banking license by the Swiss Financial Market Supervisory Authority FINMA (FINMA).

The Collective Investment Schemes Act (CISA) regulates the formation of collective investment schemes. A collective investment scheme requires a license by FINMA and must adhere to the requirements of CISA.

The Anti-Money-Laundering Act (AMLA) regulates the obligations of so-called financial intermediaries (including regulated entities such as banks, collective investments schemes but also persons who on a professional basis accept or hold on deposit assets belonging to others or who assist in the investment or transfer of such assets) in combating money laundering. Obligations include the duty to perform KYC checks, to notify the competent authorities in case of suspected money laundering and to affiliate with a self-regulatory organisation.

The Financial Institutions Act (FinIA) regulates dealing in securities, including licensing requirements for securities firms. In addition, FinIA also contains rules pertaining to further financial market participants, e.g. asset managers. The Financial Markets Infrastructure Act regulates financial market infrastructures such as stock exchanges and the Financial Services Act (FinSA) regulates the provision of financial services to clients as well as the obligation to prepare and publish prospectuses in certain cases.

The aforementioned statutes are supplemented by lower-level regulation and circulars and guidelines published by FINMA on its practice.

3. Regulation of Initial Coin Offerings (“ICO”) and Categorization of Tokens in general

To clarify its practice regarding ICOs (also initial token offerings (ITOs)), FINMA published guidelines on the regulatory treatment of different forms of crypto assets early on in 2018 (the “Guidelines”). The Guidelines are the basis of the regulatory assessment of crypto assets and ICOs.

In the Guidelines, FINMA distinguishes three types of tokens each of which triggers separate regulatory consequences:

– Payment tokens constitute means of payment for the purchase of goods or services or function as means of value transfers (e.g. “classic” crypto currencies such as Bitcoin). They qualify as means of payment under AMLA. Persons who on a professional basis accept or hold on deposit assets belonging to others or who assist in the investment or transfer of such assets qualify as financial intermediaries. This includes issuers of payment tokens who, therefore, have to comply with the obligations of financial intermediaries under AMLA.

– Asset tokens convey to their owners a claim against the token’s issuer. Consequently, asset tokens have investment character, for example equity or debt tokens. They may qualify as securities under financial market regulation, namely if they are suitable for mass trading, i.e. fungible. In this case, the issuance of such tokens will trigger the obligation to publish a prospectus under FinSA (unless an exemption applies).

– Utility tokens convey access to a digital use that already exists at the time the token is issued, e.g. the right to access a platform on a blockchain. Utility tokens are treated as services of the real economy and their issuance triggers neither the AML obligations applicable to payment tokens nor the prospectus obligations applicable to asset tokens.

In practice, the different types of tokens are not mutually exclusive but may overlap and the regulatory requirements for several types of tokens may apply simultaneously. Also, the regulatory qualification may change over time as the specific crypto project develops further.

4. Stablecoins

In the past years, so-called stablecoins have garnered increased prominence. Realizing that the high volatility of “traditional” (payment) tokens is detrimental to their use as means of payment various token projects came up with mechanisms to reduce the aforementioned volatility. The resulting increase in stability should also increase a tokens potential to store value and, in consequence, to improve its usability as a means of payment.

Because of this rise in importance, FINMA repeatedly specified its approach to stablecoins. Namely, FINMA published a supplement to the Guidelines on 11 September 2019 and, in addition, its guidance 06/2024 “Stablecoins: risks and challenges for issuers of stablecoins and banks providing guarantees” on 26 July 2024. Therein, FINMA dealt in more detail with the treatment of stablecoin projects under Swiss financial market regulation.

FINMA acknowledges that no generally accepted definition of a stablecoin has emerged so far and emphasizes that the typical characteristics it identified on the basis of various stablecoin projects it assessed are aligned to the needs and categorizations of Swiss financial market regulation. Consequently, FINMA’s approach may differ from attempts to classify and regulate stablecoins from foreign legislators or regulators.

Generally speaking, stablecoin projects attempt to increase the stability of their token by implementing a stabilization mechanism which typically includes linking the token’s value to one or more underlying assets. The most common types underlying include currencies, commodities, real estate or securities.

Nonetheless, specific designs of different stablecoin projects vary. Therefore, one will always need to assess the individual project and take into account its specifics.

5. Regulation of Stablecoins

5.1 Principle

Swiss financial market law does not provide for specific regulation of stablecoins. As a consequence, FINMA follows the principles of existing financial market regulation and applies these principles on the basis of technology neutrality. In particular, FINMA bases its assessment and qualification of stablecoin projects on the principles of “substance over form” and “same risk, same rules” while taking into account the specific features of the project in question. On this basis, the regulatory and licensing requirements of stablecoin projects are determined.

Pursuant to FINMA, typically (but not always) the stabilization mechanism of a stablecoin project either grants the token holder a claim for the underlying asset against the issuer of the token (i.e. a redemption claim on the underlying asset) or the tokens convey to the token holder direct ownership rights over the underlying assets. Such a redemption claim is crucial in determining the applicability of Swiss financial market regulation and may, in particular, lead to licensing requirements under BA or CISA:

– If the underlying assets are managed for the account and the risk of the issuer of the stablecoin this indicates that token holders’ claims under the stablecoin may qualify as deposits under banking regulation, hence, triggering the requirements of BA, namely the obligation to obtain a banking license.

– If the underlying assets are managed for the account and the risk of the token holder this is perceived as pooled management of assets for investors (i.e. the token holders) and is indicative of a collective investment scheme, hence, triggering the requirements of CISA, including the requirement to obtain a license as a collective investment scheme.

In addition, due to their purpose as means of payment stablecoins likely qualify as payment tokens, thereby triggering the obligations under AMLA.

5.2 Treatment of Stablecoins under AMLA

FINMA refers to the FATF which has determined that stablecoins are particularly inclined to be used also in the context of money laundering and financing of terrorism as well as to bypass financial sanctions namely due to their increased value as a means to also store value and their potential to be transferred anonymously.

As with any payment token, the issuance of stable coins triggers the obligations of AMLA. In particular, this includes the obligation to identify the stablecoin holder and the beneficial owner. If at any time doubt arises as to the identity of the holder or the beneficial owner the identification must be repeated.

It is worth noting that due to the legal qualification of a redemption claim, the issuer of a stablecoin likely qualifies as a regulated financial intermediary (be it a bank or a collective investment scheme). As a consequence, such issuer has to permanently fulfill the obligations of AMLA. Consequently, issuers of stablecoins are required to identify all holders of stablecoins issued by them (and their beneficial owners) adequately. FINMA concludes that, in order to be able to fulfill this obligation, anonymous transfers of stablecoins must be prevented. Consequently, contractual as well as technological restrictions for the transfer of the stablecoins are likely necessary.

5.3 Treatment of Stablecoins under Banking Regulation

As mentioned, a claim for redemption in connection with a stablecoin may qualify as accepting deposits from the public and trigger the requirement to obtain a banking license.

However, banking regulation provides for certain exemptions from this requirement. Namely, funds whose repayment and interest are guaranteed by a bank (so-called default guarantee) do not qualify as deposits. FINMA has specified certain requirements a default guarantee must fulfil in order for this exemption to be applicable. In particular:

– In the event of bankruptcy of the stablecoin issuer, each token holder must have his/her own claim against the Swiss bank which has issued the default guarantee. They must be informed accordingly.

– The default guarantee must cover at least all of the public deposits (i.e. claims of the token holders) including any interest.

– It must be ensured that the total deposits (i.e. claims of the token holders) never exceed the maximum limit of the default guarantee.

– The provisions of the default guarantee must enable the token holders to make an uncomplicated, rapid call on the default guarantee.

– Defenses and objections by the bank are permissible to the extent provided by law.

Within these boundaries issuers are free to choose the legal form of the default guarantee. An issuer may also obtain several default guarantees but, in this case, has to inform the token holders accordingly of the complex coordination which may arise when they want to call up the guarantee.

Nonetheless, FINMA urges the banks issuing such default guarantees to be cautious pointing out, namely, that providing such default guarantees may give rise to reputational and legal risks for the bank as well as cause regulatory expenses in case the guarantee is used (particularly in view of the identification obligations under AMLA).

In any case, it should be noted that even if the default guarantee exemption applies with respect to banking regulation AMLA still applies.

6. Conclusion

ICOs as well as stablecoin projects remain important initiatives within the crypto community. However, as the number of projects continues to grow and as the projects become more mature, the regulator will gain an increased understanding of the projects and will react to actual or perceived excesses or negative effects of such projects. It may do so by clarifying the scope of application of existing financial market regulation which also creates the required legal certainty for the promoters of stablecoin projects. But at the same time the legislator may also step in to address shortcomings of the existing regulation.

One potential example of the latter category concerns the possibility for stablecoin issuers to rely on a default guarantee from a bank. In 2022, the Swiss Federal Council stated in a report on the BA that this exemption (together with other exemptions) seems to be used to structure business models outside of the licensing parameters and concluded that the respective legal basis needs to be reviewed in order to ensure adequate protection of depositors and the public also in the future. FINMA already stated that it will take part in the future discussions to achieve this goal the results of which remain to be seen. In any case, promoters of stablecoin projects should be aware that the regulation relevant for their projects may change in the forseeable future and, accordingly, structure their projects to be able to address such changes in an appropriate manner.