In the showdown between issuing IEO onshore and  STO offshore, one side has the edge.

by GLT Law and Celebrus Advisory

The following was published as a LinkedIn post on Feb 8, 2023 at this link. You can also download our feedback to LFSA therein.

Last month, the Labuan Financial Services Authority (LFSA) released an Exposure Draft for its Security Token Offering (#STO) Framework. It is hard to avoid comparison with its onshore counterpart, Initial Exchange Offering (#IEO), regulated by the Securities Commission (SC) in Malaysia.

Both are intended to address the usage of digital tokens to raise funds, which are commonly known as Initial Coin Offering or #ICO. But both take fundamentally different approaches to get there.

LFSA in Labuan provides that tokens can represent common securities such as shares, debentures, or unit trusts. But SC in Malaysia says they cannot. The former is known as a “tokenised security” approach – existing securities are recorded on the blockchain as tokens in digital form. The latter is a “security token” approach – these are native tokens that exist entirely on the blockchain by itself without any reference to a security offchain.

This may seem like nuance to the untrained eye, but they are worlds apart! The devil is in the details, as they say. A “tokenised security” that represents normal securities gives investors a familiar comfort that their rights are legally recognised and enforceable.

A pure “security token” on the other hand, is a legal curio. Since it’s neither a share (equity) nor debenture (debt) nor unit trust (collective interest), the investor is left with a much narrower set of recourse when things go south. As it stands, everything from perfection of security to documentation to collateralisation to claims during insolvency, et cetera, is up in the air.

In its public consultation, LFSA asks whether existing securities rules (e.g. for private placement and public listing) should apply to digital tokens.

Meanwhile in the onshore market, we are still figuring out what is a “security token” after three years of the Prescription Order. By definition, anything that moves is a security (e.g. traded with floating price). The term “utility token” doesn’t exist! The activity of “fundraising” is not defined in SC’s Guidelines of Digital Assets. There’s no guidance on the lifecycle of a security token.

LFSA steals a march from SC by making things more easily understandable and friendlier for investors. But… and this is a big ‘But’… they shouldn’t use the name “security token” when what they are really referring to is “tokenised security”.

We have appended the feedback from GLT Law and Celebrus Advisory for the crypto legal eagles out there. The link to the LFSA Exposure Draft is in the comments section, it is still open for public consultation.