17 Oct CVM Settles Opinions on Crypto Assets and the Securities Market
On October 11, the Brazilian Securities and Exchange Commission (“CVM”) published Staff Legal Bulletin No. 40 (“Bulletin”), which clarifies and settles key understandings on the issue, offering and trading of digital assets – referred to in the Bulletin as crypto assets – which have the nature of a security. CVM therefore clarifies its position on the classification of digital assets as securities, the relevant consequences thereof and recommendations made, in this regard.
The distributed ledger technologies (DLTs), such as the blockchain network protocols, have been increasingly used to allow for different digital assets to be created, including those used as fundraising and investment tools. Such technology, when used, has great potential to democratize access to the capital market, both by investors and clients, by removing intermediaries, increasing efficiency, diversifying products and reducing costs, without necessarily implying reduced protection for investors.
The current capital market rules, however, evidently drawn up prior to the existence and development of such technologies, and in order to ensure market operation and investor protection, set forth requirements which are partially incompatible with or even unaffordable upon use of these technologies. This is the case, for instance, of the required centralized deposit or acceptance for trading at regulated markets.
Despite the initiatives of the regulatory sandbox, such limitations not only prevent the development of technology uses that could benefit the evolution of the capital market, but also generate concerns for those willing to develop projects in the field. Several people shy away from classifying digital assets under the definition of securities to develop their projects, though the unclear application of the criteria that define securities inhibits the creation of efficient solutions for the market. This is so because the regulator may, a posteriori, deem an asset as a security, whereby the unlawful public offering thereof, or any offering made without prior CVM registration or approval, would constitute administrative and criminal violation.
CVM, by issuing the Bulletin, takes an important step towards clarifying its opinion on the matter to the market. Also, it shows that it is open to new technologies, whereby its doors are open to allow for digital assets that are securities to be offered, even within the scope of the current rules, without limiting the future draw-up of specific rules on the matter. Below is a summary of the agency’s key understandings.
Token Taxonomy
The taxonomy used is among the main challenges to the optimal regulation of digital assets. It is not uncommon for a same term to be used to designate assets of clearly different types. To this end, and for didactic purposes, CVM divides digital assets into categories: (i) e-money tokens, which are used as currency or as payment; (ii) utility tokens, which provide access to certain products or services; and (iii) asset-reference tokens, which are tokens representing one or more assets, and which also include the security tokens, in other words, those which are defined as securities, and are therefore under CVM jurisdiction.
Nonetheless, the regulatory agency accurately clarifies that the categories are subject to change and the definition of a digital asset as a security depends on the economic access thereof, and on the function it performs within a given project. In order to do so, it is therefore essential to understand the nature of the token and the relevant rights and obligations thereof, for holders or third parties.
Defining Tokens as a Security
In line with its prior opinions, CVM has once again stated that a token may be deemed a security when: (i) it digitally represents a security defined by law (such as shares, bonds, trade notes, investment fund shares and derivatives); or (ii) according to its specifications, if classified according to the open definition of security, set out in Article 2, IX, of Law 6,385/76.
Pursuant to the terms of such provision, “whenever publically offered, any other instruments or common/collective investment contracts, which result in interest, partnership or compensation rights, including as a result of service provision, whose earnings arise out of the efforts made by the entrepreneur or third parties,” are deemed securities.
The foregoing is a Brazilian adaptation of the Howey Test applied by the Securities and Exchange Commission (SEC) to determine whether an asset is a security. The legal wording may be broken down into six (6) requirements, which must necessarily be met to define a security:
(i) Investment: an investment of money or good subject to economic appraisal;
(ii) Formalization/Delivery: Instrument or contract resulting from the relationship between investor and issuer, irrespective of the legal nature or specific form thereof;
(iii) Collective nature of the investment;
(iv) Expectation of economic benefit: whether by means of the right to some type of interest, partnership or compensation, resulting from the success of the enterprise referred to in item (v) below;
(v) Derived from the efforts of the entrepreneur or third party: economic benefit resulting from the prevailing work of third parties other than the investor; and
(vi) Public offering: fundraising efforts from popular savings.
CVM has neither changed its stand as to the application of the provision, nor has provided further details on the application thereof, especially in relation to the use of examples common to tokenization projects, as it the case of receivables tokens. For instance, the agency does not clarify whether digital assets representing receivables may be deemed an enterprise, or even if the discount on the purchase of the token itself may interpreted as a compensation right depending upon the efforts of others.
Also, when referring to the expected economic benefit, CVM excessively extends the wording of the law (which speaks only of “interest, partnership or compensation right”). The acquisition of any good subject to appraisal theoretically triggers the expectation of economic benefit, without necessarily resulting in an interest, partnership or compensation right. This would not only improperly broaden the scope of CVM’s jurisdiction (and this does not seem to be the regulator’s purpose), but also violates the principle of restrictive interpretation of legal rules (considering that the provision ultimately limits the offering of common/collective investment instruments that are not registered with CVM).
In view of the foregoing, it seems clear that the application of the terms set out in Article 2, IX, of Law 6,385/76, will continue to demand substantial interpretation efforts.
Effects of the Definition as Security
Once a digital asset is defined as a security, CVM restates that the public offering thereof subjects the asset and the issuer to all the rules currently applicable to the matter. Emphasis is especially made on CVM Final Rule No. 80/22 (issuer registration and information regime), CVM Final Rule No. 160/22 (registration of public offering of securities), CVM Final Rule No. 135/22 (trading at organized markets) and the applicability of rules related to: (i) the provision of centralized deposit services for securities; (ii) the provision of securities clearance and settlement services; and (iii) the provision of securities bookkeeping services, and issue of securities certificates.
In fact, in CVM’s understanding, the fact that a given service or asset is digitally developed or offered using cryptography or based on distributed ledger technology is irrelevant for an asset to be classified as a security, or for a certain activity to be submitted to CVM regulation.
However, without limiting the information regime common to issuers and offers, CVM also provides a list of examples of recommendations on the information regime for tokens classified as security to be offered, which does not replace the current regulations. Such regime includes information on the rights of the token holders, the trading, infrastructure and ownership of the assets. The information is specific to the tokens and the technology, in order to ensure transparency and the accurate understanding of such assets, by investors.
Open Doors
Though the opinion stated is fully in line with the current regulatory framework, which may at first seem very restrictive for anyone intending to develop projects for the use of new distributed ledger technologies, CVM has been very careful in order not to close any doors to such use.
As a matter of fact, CVM always states that the implementation of the recommendations (which, as such, are not binding) of the Bulletin on the information regime will influence “CVM’s judgment on requests made, and may guide the establishment of a more flexible regime in the future, certain as it is that this is an initial approach, subject to the evolutions and development of the technology, specifications and functions inherent to crypto assets”.
In our understanding, the Regulatory Agency have left open doors for requests for dismissal of application of currently effective rules – which, in fact, has always been a possibility. Such understanding is based on the fact that in its recommendations on the provision of information on the trading, infrastructure and ownership of the tokens, CVM suggests the issuer should mention “the applicability of the centralized deposit services for securities, clearance and settlement of securities, custody of securities, and bookkeeping of securities and issue of securities certificates”, as well as “whether there will be a service provider engaged for the offering, such as an intermediary in the subscription of an offer, of a custodian or depositary”. Well, if the digital asset is a security, then, as such, all the foregoing requirements would be mandatory, as a rule. Likewise, CVM recommends the “appointment of the CVM-authorized organized market entity, or other trading platforms at which the token may or will be accepted for trade” (emphasis added). If the token is a security, as a rule, it may only be accepted for trade at regulated markets.
In so doing, CVM seems to offer potential pathways on how to render feasible the public offering and trading of tokens defined as securities within the current set of existing rules, subject to flexibility, evidently if supported by applicable exemptions. This also reveals the importance of the appropriate and reputable organization of tokenization projects, in order to develop use cases that effectively bring benefits to the market, without hindering the investors’ protection level.
On the other hand, CVM also shows that it is aware of what it has referred to as “marginal crypto assets market”, at which securities are offered without CVM approval. Such practices may be deemed administrative and criminal violations, as mentioned above. Given the Bulletin’s provisions, it is ever the more urgent to render lawful any such trades.
Also, CVM clarifies that it will continue to further study and analyze the new technologies and the application thereof in the capital market, and, if need be, it will regulate such new market within the limits of its jurisdiction, including in light of its experience within the scope of the regulatory sandbox.
Intermediaries and Investment Funds
Finally, the Bulletin also (i) briefly clarifies the role of intermediaries in digital asset offerings, irrespective whether defined as security, focused on the disclosure of their business relationship with providers of digital asset services, and on the implementation of measures to separate activities; and (ii) restates its prior understandings on investment funds and crypto assets, emphasizing the need for in-depth studies and specific interactions with the market for the regulatory agency to adequately make progress on the matter.
Please feel free to reach out to the Capital Market and Digital Law Team at VBSO Advogados for further information.