Member Article

THE POSITION BEFORE THE SEC STATEMENT

The Security and Exchange Commission of Nigeria (the “SEC” or the “Commission”) on 14 September 2020, released their Statement on Digital Assets and their Classification and Treatment (the “Statement”) pursuant to the powers conferred on it by the Investment and Securities Act 2007[1](“ISA”).

Before the release of the Statement that has altered the way cryptocurrency will be treated In Nigeria, regulators warned citizens about the effects of dabbling with cryptocurrency and advised that the general public should tread cautiously.[2]

The Commission also decided to establish a Fintech Roadmap Committee in November 2018 to explore the impact of Fintech on investments and securities in Nigeria and how to properly classify and regulate cryptocurrencies and virtual assets. This led to the recommendation that SEC should classify cryptocurrency as a security or a commodity and other pertinent recommendations by the Fintech Roadmap Committee[3]. With the recommendations from the Fintech Roadmap Committee, the Commission has started putting in place a framework for virtual currency in Nigeria and the recently released Statement is the first step towards cryptocurrency regulations.

THE SEC STATEMENT

The Commission explained that the general objective of the regulation is notto hinder technology or stifle innovation, but to create standards thatencourage ethical practices that ultimately make for a fair and efficientmarket[4].

The SEC Statement Is divided into three parts which are examined below:

DEFINITION AND CATEGORIZATION OF CRYPTOCURRENCY

Cryptocurrency was not defined by the Statement, so until regulations regarding cryptocurrency have been published by the Commission, the general description of cryptocurrency still applies In Nigeria[5]. However, Crypto Assets were defined in the Statement as:

a digital representation of value that can be digitally traded and functions as:

1. a medium of exchange; and/or
2. a unit of account; and/or
3. a store of value, but does not have legal tender status in any jurisdiction.
   
   

The Statement goes further to establish that avirtual instrument or asset will qualify as a Crypto Asset if it is neither issued nor guaranteed by anyjurisdiction, and fulfils the functions aforementioned only if the community of users of the assets agree that the Crypto Asset will serve the functions mentioned above. The Commission also highlighted the fact that Crypto Assets aredistinguished from Fiat Currency and E-money meaning that there is a fundamental difference between Crypto Assets and cryptocurrency under the Nigerian regulatory landscape.

Furthermore, SEC characterized virtual assets into four categories:

1. Crypto Assets

The Statement provides that Crypto Assets will be treated as commodities If they are traded on a Recognized Investment Exchange and issued as an investment pursuant to part E of the SEC Rules and Regulations 2013 (the “Regulations”)[6]and any other relevant rules that will be Issued In the future.

We are not certain what SEC would consider as a “Recognized Investment Exchange” since most virtual assets are exchanged on crypto asset trading platforms. Hopefully, more clarity would be given in future rules and guides issued by the Commission.

2. Utility Tokens

Utility Tokens have functionalities that can be used to access a product or service built on a blockchain and can be exchanged with the use of the virtual currency native to the blockchain[7]. Utility Tokens will be treated as commodities as well but spot trading (Over the Counter) of Utility Tokens will not fall under the scope of SEC unless It Is conducted on a Recognized Investment Exchange compliant with part E of the Regulations.

3. Security Tokens

These are tokens with functionalities similar to securities such as shares. They are used to represent underlying assets and even an ownership stake in the issuing entity. They also bring in dividends or Interest payments for holders. The Commission according to the statement will treat such crypto assets as securities pursuant to section 315 of the ISA.

4. Derivatives and Collective Investment Funds of Crypto Assets, Security Tokens and Utility Tokens

Derivatives are usually contract between parties backed by an underlying asset, in this situation, the underlying asset would be crypto assets. Collective Investment Funds on the other hand are pools of Investments being managed for Investors.

Section 153 of ISA defines Collective Investment Schemes as a scheme in whatever form, including an open-ended investment company, in pursuance of which members of the public are invited or permitted to invest money or other assets in a portfolio. The Collective Investment Funds envisaged by the SEC Statement would be schemes used to pool money to invest In crypto assets.

According to the Statement, Derivatives and Collective Investment Funds involving crypto assets would be regulated as Specified Investments under the ISA and the Regulations. Capital Market Operators dealing with the aforementioned need to be approved by the Commission.

WHAT WILL BE REGULATED?

The Statement sets out the position of SEC regarding virtual assets. The Commission will now treat crypto assets as securities unless the issuer or sponsor of the virtual asset proves otherwise.

This burden of proof will only be satisfied if the Issuer or Sponsor makes an Initial Assessment Filing with the SEC to enable it determine whether the assets are under its regulatory purview. Where the findings of the Commission Is that the virtual assets are indeed securities, the sponsor must register the assets as securities.

The effect of this is that all virtual assets will now be registered by the Commission with any of the following approaches:

Option 1: An Initial Assessment Filing to determine whether the assets are securities and to satisfy the burden of proof on the sponsor.

Where the Commission believes the crypto asset is under the regulatory scope of SEC and is a security, a subsequent filing will be carried out by the issuer to comply with the SEC rules.

OR

Option 2: the issuer can directly register the virtual assets with SEC without the Initial Assessment Filing.

Also, all Digital Assets Token Offerings (“DATOs”), Initial Coin Offerings (“ICOs”), Security Token ICOs and any offering of digital assets on a blockchain;

1. within Nigeria or;
2. by Nigerian Issuers or;
3. foreign Issuers targeting Nigerians,
   
   

will be regulated by the Commission. Existing offerings or ICOs currently ongoing have three months to either submit their Initial Assessment Filing or documents for registration.

WHO WILL BE REGULATED?

Any person, (Individual or corporate) whose activities Involve any aspect of Blockchain related and virtual asset services must be registered by the commission and as such, will be subject to the regulatory guidelines. The services envisaged by the Commission that will have to comply with the guidelines are:

1. Reception;
2. Transmission;
3. Execution of orders for crypto assets on behalf of potential Investors;
4. Dealers in crypto assets;
5. Portfolio management with crypto assets making up the portfolio;
6. Investment advice regarding crypto assets; and
7. custodians or nominees Involved with virtual assets.
   
   

The services to be regulated by the Commission are not limited to the ones aforementioned.

Issuers will also be regulated by the Commission and SEC may require a foreign or non-residential Issuer to establish an office in Nigeria. However, if there is a reciprocity agreement in place, foreign issuers need not establish an office and they will be recognized by the Commission.

A recognition status will also be given, where the foreign issuer Is a member of the International Organization of Securities Commissions (“IOSCO”).

CONCLUSION

The classification and categorization of crypto assets In Nigeria is a step in the right direction as the nation seeks to tap into the digital economy and believes that there is a promising future for blockchain In Nigeria[8]. Since crypto assets and the use of blockchain is becoming increasingly popular within the Nigerian populace, the SECs position is a guide for all stakeholders in the crypto Industry as there was no regulatory framework to hold the growing crypto economy in Nigeria. It is expected that in the coming months, the Commission will release more robust guidelines that will shape the Fintech ecosystem.

 

Footnotes: [1] Section 13 of the Investment and Securities Act 2007. [2] The Central Bank of Nigeria on 12 January 2017, issued a Circular stating that because transactions with cryptocurrencies or virtual currencies are almost untraceable making them susceptible to abuse by criminals and terrorists, there is a need to protect the integrity of the Nigerian financial framework. Read our article on Cryptocurrency and Initial Coin Offerings to understand the Nigerian regulatory landscape on cryptocurrency before the SEC Statement. [3] the Final Report of the Fintech Roadmap Committee of the Nigerian Capital Market by the SEC, lists out recommendations that the Capital Market Community should take into consideration regarding Initial Coin Offerings as well. Please read the second part of our article on Cryptocurrency and Initial Coin Offerings on our analysis of the Fintech Roadmap Committees recommendations. [4] The Introductory Paragraph of the [5] Read our article on Cryptocurrency and Initial Coin Offerings to understand the general description of cryptocurrency. [6] Part E of the Regulations are the rules for the Regulation of Securities Exchanges and Transactions on Exchanges, Capital Trade Points and other Self-Regulatory Organizations [7] Read our article on Cryptocurrency and Initial Coin Offerings to understand how tokens work. [8] See the National Blockchain Strategy released by the Federal Ministry of Communications and Digital Economy.