Malaysia Subjects Digital Assets Exchanges to Securities Law

Digital currency and digital token issuances have been a topic of public interest for some time now with increased interest and participation in the production and mining of cryptocurrencies, initial coin offerings, and the operation of cryptocurrency exchanges. While this innovative form of crowdfunding and capital raising has the potential of disrupting existing financial ecosystems and reducing costs of transactions, it also carries with it risks of fraud, money laundering, security breaches, price volatility, and liquidity risks.

The Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 was recently gazetted and came into force on 15 January 2019, prescribing digital currency and digital tokens (“digital assets”) as securities to be regulated by the Securities Commission of Malaysia (“SC”). Further, on 31 January 2019, the SC amended its Guidelines on Recognised Markets to introduce new requirements for digital asset exchanges, including criteria for registration as a digital exchange operator.

These are welcomed developments that provide greater clarity, and sets the stage for the SC to put in place guidelines to regulate the offering and trading of digital assets.

Regulatory stance in the earlier phase

On 19 January 2018, the SC and Bank Negara Malaysia (“BNM”) issued a joint cautionary statement that initial coin offering (“ICO”) schemes may involve activities that are subject to laws administered by the SC and BNM and carrying on such activities without proper authorisation is an offence.

At a press conference on 16 March 2018, the SC stated that it was in discussions with several companies that were looking to conduct ICOs.  At that time, it was reported that 12 companies were in talks with the SC though the number may have increased at the time of this publication.

Alerts and regulatory actions taken by SC and BNM provided examples of what the regulators considered risky or permissible. These include the following cases:

• Based on The Edge news report dated 27 August 2018, the SC was in the midst of reviewing the newly launched cryptocurrency known as LaVida Coin to determine whether there had been any breach of securities law. LaVida Coin claimed to be a private funding initiative to raise development funds for three projects. On 5 September 2018, the SC issued a notice directing the promoters of LaVida Coin to cease all promotional activities in relation to LaVida Coin with immediate effect, pending further review. DSV Crypto Club, LUX Galaxies and VI Profit Galaxy, who were found to be promoting LaVida Coin, were also added to the SC’s Investor Alert List.
• ECObit was launched in April 2017, and claimed to be a Green Blockchain Project with the goal of preventing climate change. ECObit uses the tried and tested NEM (New Economic Movement) distributed ledger platform. Notwithstanding, in June 2017, BNM added ECObit to its Financial Consumer Alert list which tracks entities that are neither authorised nor approved by the regulator.
• CopyCash Foundation, a Singapore-registered foundation which planned to establish a social trading and investment or “social travesting” platform. SC directed CopyCash Foundation to immediately cease and desist all its proposed activities relating to its plan to launch an ICO on 10 January 2018 in Malaysia, including any related roadshows, seminars or promotional events. The shutdown was because SC found that there was a reasonable likelihood that disclosures in CopyCash Foundation’s white paper and representations to potential investors will contravene requirements under securities laws.

Introduction of new framework

The Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 (“Prescription Order”) that came into effect on 15 January 2019, has provided significant clarity on the treatment of digital assets. Digital currencies and digital tokens as defined and prescribed as securities under the Prescription Order are subject to the provisions of securities laws falling under the purview of the SC.

According to the Finance Minister, any person found offering an ICO or operating a digital asset exchange without the SC’s approval will face an imprisonment term not exceeding 10 years and a fine not exceeding RM10 million.

The Prescription Order seems to have provided blanket treatment of digital currency or digital tokens as securities for the purposes of securities laws.  However, it is possible that certain digital currency or digital token may not carry any feature of conventional “security” or for that matter “capital market product”. Perhaps the new guidelines on ICOs and other changes to be introduced by the SC and BNM will clarify this issue.  Hence, do watch this space.

Revised Guidelines on Recognised Markets

On 31 January 2019, the SC further published its revised Guidelines on Recognised Markets (“Revised Guidelines”) to introduce a new segment on licensing for digital asset exchanges.

The Revised Guidelines introduced new requirements for electronic platforms and requirements to be complied by a person interested in operating a Digital Asset Exchange (DAX). Criteria for registration as a DAX operator include:

• Eligibility and financial requirements
• Independent director
• Managing conflict of interest
• Prohibition of financial assistance
• Risk management
• Internal audit
• Trading of digital assets
• Obligations of Digital Asset Exchange Operator
• Client’s asset protection
• Settlement and custody
• Transaction fee or levy
• Market integrity comprising elements of trading operations, market transparency and market making.

SC has stipulated that persons interested to operate a digital asset platform, including those operating within the current transitional period, have to submit an application to the SC by 1 March 2019. Until then, platform operators will not be permitted to accept new investors and will only be allowed to facilitate the withdrawal or transfer of client assets with the written instruction of the investor.

What happens next?

In order to implement the regulatory framework, both SC and BNM are working together to ensure compliance with the laws and regulations that are under their purview as regulators. The relevant regulatory framework is expected to be launched by the end of the first quarter of 2019.

The SC will be issuing a separate guideline on the offering of digital assets via an ICO by the end of March 2019.  In the meantime, no person is allowed to conduct an ICO without prior authorisation and those currently offering ICOs are advised to cease all activities and return all monies and digital assets back to the investors.

It is hoped that the framework will usher in an orderly environment for the issuance and trading of digital currency and digital token with sufficient disclosure requirements and protection for the investing public.

If you have any questions relating to application to SC to be a recognised market operator or require any additional information, you may contact Tan Wooi Hong or the ZICO Law partner you usually deal with.

This alert is for general information only and is not a substitute for legal advice.