We explore these further below.

A debt security means a right to be repaid money or paid interest on money that is, or is to be, deposited with, lent to, or otherwise owing by, any person.[1] Debt securities explicitly include debentures, bonds, notes, convertible notes and redeemable shares.

Central to whether a token is a debt security is whether “money” is given or received in respect of the token, and that it is repaid at some point. Case law in respect of the definition of debt security, under the previous Securities Act 1978, determined that “money” was a broad concept.[2] However, the definition of money under that legislation included “money’s worth” (i.e. something valuable that isn’t money).

Money’s worth is expressly excluded from the FMC Act definition of money, as it relates to debt securities. This deliberate drafting change indicates that “money”, in respect of debt securities, should be read more narrowly under the FMC Act. Money itself if not defined, but in the ordinary parlance it can mean a medium of exchange or store of value. It may include cash, sums standing to credit in a bank account or possibly even sums invested in securities. This narrower definition suggests that, in respect of the definition of debt security under the FMC Act, money would not include a token.

Where a token holder has not paid fiat (Government or central bank issued) currency, or had fiat currency contributed on their behalf, for a token, it is unlikely the token will be a debt security. An example may be where the token holder has paid by way of another token. In this case, because a token will likely not be “money” (see our discussion above), there will be no debt security.

Usually, User and Asset Backed Tokens do not give the holder a right to be repaid money, or to be paid interest on the contribution given to acquire the token. This means they are unlikely to be debt securities.

The same is typically the case for Intrinsic Tokens. However, in some cases an Intrinsic Token could be backed by a fiat currency or another token. An example of this could be a token that is pegged to the value of a fiat currency and whose terms promise the holder repayment of fiat currency upon request.[3] In this case, the token could be a debt security.

Similarly, an Enterprise Token, paid for in fiat currency, that promised repayment of and/or interest on the fiat currency contributed to acquire the token, will likely be a debt security. Interest is not defined in the FMC Act and it is possible that the Courts could consider this to be a wider concept than a monetary interest (for example, to include other consideration such as tokens). Issuers of Enterprise Tokens with any such terms will need to consider carefully whether the token could be characterised as a debt security.

What terms of a token will make it an equity security?

An equity security means a share in one of a company, an industrial and provident society or a building society, but does not include a debt security.[4] A share is issued by an entity by entering the name of the shareholder on the entity’s share register, which will not typically be the case for tokens (note that a blockchain-based share register, would still be a share register for the purposes of the legislation). It is therefore unlikely that any tokens will be “shares” and therefore not equity securities.

An exception to this would be an Enterprise Token that gives the holder an option to acquire, by way of issue, an equity security.[5] We are not aware of any such tokens having been issued.

What terms of a token will make it a managed investment product?

A managed investment product means an interest in a “managed investment scheme” but does not include an equity security or a debt security. A “managed investment scheme” means a scheme to which each of the following applies:[6]

the purpose or effect of the scheme is to enable persons taking part in the scheme to contribute money, or to have money contributed on their behalf, to the scheme as consideration to acquire interests in the scheme; and

those interests are rights to participate in, or receive, financial benefits produced principally by the efforts of another person under the scheme (whether those rights are actual, prospective, or contingent, and whether they are enforceable or not); and

the holders of those interests do not have day-to-day control over the operation of the scheme (whether or not they have the right to be consulted or to give directions).

The first limb of the definition requires the contribution of money. Unlike in the definition of debt security, for managed investment schemes “money” is defined to include “money’s worth”. Case law under the previous Securities Act 1978 defined “money’s worth” broadly, including a contractual commitment to purchase apartments.[7] Therefore, it is possible that the Courts may consider almost any valuable consideration, including other tokens, as “money” for the purpose of the managed investment scheme definition. Where this consideration is provided in exchange for tokens, it will likely be provided “to acquire interests in the scheme”.

The second limb requires there to be a right to participate in, or receive, “financial benefits”. “Financial benefits” means capital, earnings or other financial returns. Due to this limited definition of “financial benefits”, in our view there should be a financial or monetary element to the benefit. Where tokens are purchased as financial investments, i.e. in the expectation of receiving something of financial value in return such as fiat currency or a valuable token, then it is likely that this element will be met.

Where there are financial benefits, these must be produced principally by the efforts of another “person”. Attributing an issuance of a token to a “person” can be complicated as tokens can be issued by an entity, a group of associated persons or even a decentralised autonomous organisation.

This issue was considered in the recent Securities and Exchange Commission (SEC) report on its paper on the DAO, where the SEC found that the creators of the DAO could constitute a person for the purposes of US securities law. “Person” is defined inclusively under the FMC Act and includes any entity, which in turn includes an unincorporated body. Given this broad definition, it seems likely that New Zealand law would similarly recognise the creators of decentralised autonomous organisations as “persons” under the FMC Act.

Token holders will generally not have day-to-day control over the operations of the enterprise as required by the third limb of the definition. For example, even if a token gives voting rights (e.g. as was the case for the DAO), this would not be considered to be day-to-day control.

User Tokens, Asset Backed Tokens and Intrinsic Tokens are unlikely to be managed investment products as it is not likely there will be a financial benefit provided principally by the efforts of another person. For User Tokens, it is unlikely that the user rights will be financial benefits (although this should be tested against the facts in each case). Amongst other reasons, Asset Backed Tokens and Intrinsic Tokens are unlikely to be financial products because there is no enterprise being managed by the token issuer that produces a financial benefit. Further, for Asset Backed Tokens with rights to require the delivery of property, previous case law indicates these would not be financial products.[9]

In contrast, many Enterprise Tokens will be managed investment products. The efforts of the creators and operators of the relevant enterprise/project will be engaged towards providing a financial return to token holders, who will have no day-to-day control over the enterprise. However, for certainty on this point the particular terms of an Enterprise Token will need to be reviewed.

What terms of a token will make it a derivative?

“Derivative” is defined comprehensively in the FMC Act. Essentially, for a derivative to exist there must be an agreement which requires a party to provide consideration at a future time and the consideration must be determined by reference to the amount of something else (for example, an asset, a rate, an index or a commodity). Derivatives do not include an agreement for the future provision of services or a debt security, equity security or a managed investment product.

The value of an Intrinsic Token does not typically change by reference to something else. Typically, Asset Backed Tokens will not include an agreement for the provision of consideration at a future time.

User Tokens will also not usually be derivatives, because:

where a User Token gives the holder access to services, it will likely be an agreement for the future provision of services, and therefore excluded from the definition of derivative; and

where a User Token gives the holder access to products, neither the amount of product (consideration) provided nor the value of the token are determined, derived from, or varied by reference to, the value or amount of something else.

Typically, Enterprise Tokens would not be derivatives because they do not provide for variable future consideration. However, this will need to be assessed against the terms of each Enterprise Token. For example, an Enterprise Token could provide for payment of royalties that vary depending upon the value of the project at a point in time. Provided that this token is not a managed investment product (which is higher in the FMC Act definitional hierarchy) then it could be a derivative.

Are tokens captured by the residual category of securities?

Under the FMC Act a “security” is an arrangement or a facility that has, or is intended to have, the effect of a person making an investment or managing a financial risk, and includes:

a financial product;

any interest or right to participate in any capital, assets, earnings, royalties or other property of any person;

any interest in, or right to be paid, money that is, or is to be, deposited with, lent to, or otherwise owing by, any person (whether or not the interest or right is secured by charge over any property); and

any renewal or variation of the terms and conditions of any existing security; but

does not include any interest or right declared by regulations not to be a security for the purposes of the FMC Act (no tokens have yet been declared not to be securities).

Given the broad definition of security it is likely that any of the four token classes could, depending on their terms, fit within the definition. For example, a User Token could give the holder an interest or right to participate in the assets of a person. More broadly, tokens are clearly being marketed as an investment.

The effect of a token being a security is that the FMA can designate a particular security to be a financial product, which would bring that type of security within the requirements of the FMC Act (as discussed below).

What are the consequences of a token being a financial product?

If a person carries out an ICO of a token that is a financial product, and that token is offered to retail investors in New Zealand, the issuer must comply with the relatively onerous requirements for “regulated offers” in the FMC Act. These include, among a number of others:

disclosure requirements such as providing a product disclosure statement and having in place a register entry on the Disclose website (operated by the Registrar of Financial Service Providers);

if the token is a debt security or managed investment product, compliance with the governance requirements including appointing an independent supervisor and operating under a trust deed;

if the token is a managed investment product, a derivative or a certain type of debt security, the need to obtain a licence for the issuer from the FMA or the Reserve Bank of New Zealand; and

the need to comply with financial reporting requirements, that include registering publicly available audited accounts.

There are many difficulties in applying the current FMC Act regime to regulated token issues. For example:

Tokens which are managed investment products must have an independent supervisor that must hold legal title to the tokens. However, it is uncertain whether supervisors are in a position to supervise token issuers effectively, or to hold title to tokens.

Offers of tokens to retail investors will require a product disclosure statement, the contents of which are highly prescribed in regulations. It is unlikely that token offers could meet these requirements, without exemptions granted by the FMA.

If a decentralised autonomous organisation is the “entity” issuing the tokens, it is not clear how the governance and financial reporting requirements would apply to the participants in the DAO, and who would obtain the licence required to be granted by the FMA.

If, however, the offer is limited to certain types of qualifying (e.g. wholesale) investors in New Zealand only, obligations will be limited to complying with the fair dealing requirements of Part 2 of the FMC Act (e.g. not to be misleading or deceptive, or make unsubstantiated representations).