Cryptocurrency Legal Landscape in South East Asia: Malaysia-Part 2 (Proposed Regulatory Framework for ICO)

Last week, we discussed the regulatory changes in Malaysia from 2014 to the present.

Any activities related to cryptocurrencies, tokens and other digital assets will be categorised as securities henceforth and fall under the regulation of the Securities Commission Malaysia (“SC”). On 15 January 2019, the Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 (“PO”) came into force. In this regard, the SC has released the revised Guidelines on Recognized Markets pursuant to section 377 of the Capital Markets and Services Act 2007 (CMSA) to regulate the trading of digital assets at digital exchanges in Malaysia on 31 January 2019. Any entities who are interested to register as a Recognized Market Operator can submit the application to the SC by 1 March 2019. Tokenize Xchange has submitted the application to the SC and has been granted the continuation of operating in the transitional period under the conditions as per set out by the SC.

On 6 March 2019, the SC published consultation paper to seek public feedback on the frameworks for Initial Coin Offering (ICO). The consultation paper discusses the proposed framework for, among others, the eligibility of issuers, the need for transparent and adequate disclosures as well as utilisation of proceeds of the ICO.

You may access a copy of the public consultation paper on the proposed regulatory framework on ICO here.

Here is the summary of the proposed regulatory framework:

  1. The Circumstances Where a Digital Asset will be Considered as a Securities

The PO provides that a digital asset must be recorded on a distributed ledger. As such, discount cards, e-money or e-payment etc. will not be considered as securities unless it is recorded on a distributed ledger and satisfies the PO’s requirements.

In this regard, digital assets which display the characteristics below will be considered as securities:

(i) In the case of digital currency–

a. when it is used as payment to purchase goods, services or other digital assets and is traded on a digital asset platform; and

b. a person who trades such currency on the platform expects to benefit from a return or appreciation in the value of the digital currency.

(ii) In the case of a digital token, which is issued through an ICO, the token will fall under the definition of securities if–

a. investors pay monies in exchange for the token received;

b. investors’ monies are pooled and managed by the issuer; and

c. investors who purchase the token expect a return or appreciation in value from their investment. The returns to investors may be derived from either the buying or selling of assets of the issuer or from any business activities carried out by the issuer

2. The Authorisation for the Offering/Issuance of ICO

a. Initial Assessment of the ICO

  • Appointment of a host- ICO issuer will be required to approach a third party to agree to “host” the ICO and assess its Whitepaper. In this regard, the ICO issuer will be required to undergo an assessment conducted by an independent third party authorised by the SC, prior to it submitting a formal application to the SC. A host is a recognised market operator or any other person recognised by the SC. A separate framework in relation to the authorisation of the third party who will carry out this role will be introduced by the SC soon.

b. Criteria for assessment of the ICO

  • Fit and properness of an ICO issuer including its board of directors, senior management and controller. They must poss appropriate experience and a track record demonstrating the capability to manage and complete the business/project.
  • ICO’s underlying business is able to demonstrate an innovative solution/meaningful digital value proposition for Malaysia
  • Sufficient safeguards to protect the interest of existing shareholders and token holders
  • Evaluation of the business/project including risks and mitigating measures and assessment of the business/project plan of the ICO issuer
  • Adequate processes are in place to manage related party transactions and conflict of interest issues
  • Satisfactory processes in place to monitor anti-money laundering requirements
  • Valuation methodology and assumptions for price determination of the digital tokens issued are reasonable
  • Evaluation of protocol/code, platform, any other application fo the technology (i.e. cyber risk management framework)

c. ICO issuer eligibility

  • locally incorporated with its main business operations carried out in Malaysia
  • has a minimum paid up capital of RM500,000
  • is not a public listed company (Note: Public listed companies may establish a separate entity to carry out an ICO)
  • board of directors and senior management team to collectively hold 50% equity holding in the ICO issuer and cannot dispose of the stake for a period of 18 months

d. Governance requirement

  • At least half of the board of directors comprises of Malaysians
  • Appoint a responsible person as the main contact point for the SC. The responsible person must be a member of the board of directors or senior management team and is responsible to identify and report to the SC any breach of requirement or laws, material adverse change relating to the ICO/ICO issuer.

e. Limit on amount of funds to be raised through an ICO

  • The limit on the amount that can be raised through an ICO is calculated as a multiple of 10 times the shareholders’ funds and subject to a ceiling of RM100 million.

f. Requirements relating to ICO proceeds

  • At least 50% of the proceeds of the ICO must be utilised in Malaysia or 50% of the assets are based in Malaysia for asset-backed ICO
  • ICO issuer should only be permitted to withdraw or utilise investors’ monies, based on milestones disclosed in the Whitepaper. In this regard, the trustee may only allow for draw-downs pursuant to a confirmation from a third party auditor that the relevant milestones have been achieved. The issuer will also be required to provide confirmation to the SC that the draw-downs have been utilised for the purposes stated in the Whitepaper.

g. Other ongoing obligations

  • AMLA and KYC processes in place
  • a prohibition against third-party endorsement, promotion and publicity of ICO
  • annual and quarterly reporting to the SC and investors in relation to information as may be specified by the SC

h. Trust account

  • ICO issuer is required to deposit all funds raised through the ICO in a separate trust account with a licensed bank.
  • The trust account must be maintained by an independent custodian, escrow agent or entity acting in the capacity of a trustee that is registered with the SC for carrying out capital market activities

3. Registration of Whitepaper

a. Whitepaper must contain the following information below:

  • A brief description of the ICO issuer i.e. group structure and details of material entities within the group
  • Details and profile of the board of directors/senior management/promoters
  • A brief description of the shares and/or digital token held by the board of directors/senior management/promoters
  • Objective or purpose and timeline of theICO including detailed information on the underlying business/projects to be managed & operated by the ICO issuer
  • Business plan including a detailed description of the sustainability and scalability of the underlying business or project and targeted date for each major phase in the project
  • Targeted amount to be raised through ICO and a scheduled timeline for utilisation of the proceeds including the details of each utilisation
  • Any rights, conditions or functions attached to digital tokens issued from the ICO (ie. specific rights/privilege/benefit attributed to a digital token)
  • Details of the independent custodian, escrow agents or entity acting in the capacity of a trustee
  • Discussion on the determination of the price per digital token i.e. valuation methodology, reasonable assumptions adopted
  • Financial information i.e. audited financial statements or management accounts
  • A detailed technical description of the protocol, platform, application and the associated benefits of the technology
  • Details of the associated challenges, risk i.e. conflict of interest, related party transaction

It is proposed that under the ICO framework, any offering of an ICO must be accompanied by a Whitepaper. An ICO issuer will be required to submit the Whitepaper to the SC for registration. In deciding whether to register the Whitepaper or otherwise, the SC may take into consideration the pre-approval evaluation and assessment carried out by a recognised market operator or third party service provider.

To mitigate instances of fraud, ease of comparability and to facilitate understanding of the SC’s assessment process, the SC may publish the list of approved and rejected ICO applications with the relevant Whitepapers on a dedicated microsite.

The public may submit the comments on the consultation questions in the paper to by 29 March 2019.

What are your thoughts regarding the proposed regulatory framework on ICO by Malaysia authority? How would it transform the cryptocurrency industry in Malaysia?

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