2023.02.17
Organizing Measures for Regulatory System on Security Token Issuance and Distribution in South Korea
- Background
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- As securities are issued and distributed only in a specific form and method for the following three reasons in the current system, the government has adopted and is promoting the regulatory system under the Financial Investment Services and Capital Markets Act (“Capital Markets Act”) for the issuance of security tokens as a part of the list of national tasks.
- The holder of physical securities under the Commercial Act and the person registered in the electronic registration account under the Act on Electronic Registration of Stocks and Bonds (“Electronic Securities Act”) are presumed to be legitimate holders of rights. However, the issuance of securities in other ways is virtually impossible as it may cause a double transfer problem.
- Under the Capital Markets Act, in effect, beneficiary certificates and investment contract securities are excluded from securities subject to distribution.
- The utilization of private placement and small public offering is limited, and securities are circulated only in the listed stock market due to strict sales regulations.
- In response, the Financial Services Commission (“FSC”), Financial Supervisory Service (“FSS”), Korea Exchange, and Korea Securities Depository jointly issued the “Organizing Measures for Regulatory System on Security Token Issuance and Distribution” (hereinafter, “STO Organizing Measures”) and “Guidelines for Security Tokens” on February 6, 2023, as the first step in the implementation process.
- As securities are issued and distributed only in a specific form and method for the following three reasons in the current system, the government has adopted and is promoting the regulatory system under the Financial Investment Services and Capital Markets Act (“Capital Markets Act”) for the issuance of security tokens as a part of the list of national tasks.
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- Presenting Principles for Determining Which Digital Assets Shall Be Categorized as Securities
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- In the STO Organizing Measures, the financial authorities clarified that regardless of the form in which securities are issued, if they conform to the concept of “securities” under the Capital Markets Act, they must be regulated under the Capital Markets Act.
- In addition, in the case of investment contract securities, it is a concept that is applied supplementarily when it does not fall under the other 5 types of securities. Its scope of application can be widely recognized as shown in Table 1 and Table 2, including main requirements for investment contract securities and examples of digital assets that have been categorized as securities.
- Most of the requirements for investment contract securities presented in the STO Organizing Measures are similar to those from the previous discussions. However, unlike the previous ones, even if the investor's rights are fulfilled through a smart contract, it can be interpreted as a contractual right to an issuer if the issuer promised the implementation of the smart contract itself as a contract.
- The financial authorities also stated that they will prevent attempts, in the process of determining whether a digital asset is a security, to circumvent regulations by actively interpreting and applying implied contracts, the conclusion and execution of contracts implemented in smart contracts, the contents of profit distribution, and the contents of advertisements and solicitations, not limited to the contents of explicit contracts, terms and conditions, and white papers.
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Table 1. Five Main Requirements of Investment Contract Securities
| 1. Joint Business | - If there is a relationship between two or more investors (horizontal commonality) or between an investor and an issuer (vertical commonality), it is a joint business. |
| 2. Investing Fund, etc. | - The fund invested is not limited to legal currency, and the possibility of exchange with legal currency and the presence or absence of property value are comprehensively considered. |
| 3. Mainly Operated by Others |
- The efforts of others (issuers) must be undeniably significant and be essential managerial efforts that could determine the success or failure of the business. - Even if the issuer does not directly conduct all of the business, it includes cases where there is a joint and collective effort by business entities other than investors - If the issuing entity and the business entity are only formally different, they can be regarded as joint issuers. - Even if an investor conducts part of a business, if there is information asymmetry in most of the business, it can be regarded as mainly performed by another person. |
| 4. Contractual Right to Attribute Profit or Loss as a Result of the Joint Business* |
- It may also include cases where a contract is signed to receive profit or loss from business results when a certain point in the future arrives or when certain objective conditions (e.g., sales target) are achieved. - Investor rights are implemented through smart contracts, but if an issuer promises to implement the smart contract, it can be interpreted as a contractual right to the issuer. - Applicable when the issuer, etc. conducts business with investors' fund, etc., and promises to return the profits according to the performance of the business conducted. In particular, if the promised profit is in proportion to the revenue or profit generated from the business, or if a promise is made to convert and distribute the revenue or profit generated from the business, it falls under the profit or loss resulting from the joint business. - The right to claim profits under the contract between the investor and the issuer must be recognized, such as the issuer expressly or implicitly promising to distribute the business profits directly to the investor, or the issuer promising that the third party will distribute the business profit to the investor based on an agreement with a third party. |
| 5. Profit Earning Purpose | - Investor invested fund, etc. for the purpose of earning investment profit | <
