Before any assessment of the need for a prospectus or an information document for a offer of securities, it must first be established whether the instrument that is being offered should be treated as a security. Qualification as a security does not depend only on the name of the instrument but rather on the actual nature of it, the rights given to investors, its transferability and standardisation, and the reason capital is being raised.
Why should the question of whether or not it is a security be answered first?
Qualification as a security is decided by whether the capital raised by the instrument or the offer of the instrument may be subject to securities market regulations including the Prospectus Regulation, the Securities Market Act, and other rules governing the financial market.
If the instrument is classed as a security, then the services related to it may be classed as investment services, the organisation of the offer may require a prospectus or information document, and the organisation of the trading environment may be subject to additional requirements for licensing or supervision.
Legal basis
The concept of a security is defined in Estonian law in § 2(1) of the Securities Market Act. The definition in MiFID 2 of a transferable security is also important for the type of prospectus in European Union law and focuses on the tradability of the security in the capital market.
The assessment needs to distinguish between tradable in the capital market and freely tradable. Tradable in a capital market refers to the general characteristic of securities as being transferable or tradable in a capital market, while freely tradable is a narrower definition of the place of trade that could be important for the admission of securities to trading on a regulated market for example.
Whether the issuer has established a secondary market or trading platform is not decisive for the assessment of whether an instrument is a security. What matters is whether the instrument is by its nature transferable, standardised and tradable in a capital market.
The main characteristics for qualifying as a security
Qualification as a security must assess the instrument from all sides. No single characteristic is necessarily decisive, but the total effect of the characteristics may indicate that an instrument is indeed a security.
1. Economic right, liability or contract (click to open)
A security may express an economic right, an obligation or a contract. An economic right is a right that is generally assessed financially and that gives or may give the holder of the right a financial benefit.
2. Transferability (click to open)
Transferability means that the instrument or the rights derived under it may be disposed of or assigned. Contractual, temporary or technical limitations do not necessarily prevent disposal if the transfer of rights is not actually made impossible or extremely difficult.
Assessment of transferability must consider the law that applies to the specific legal relationship.
3. Tradability in the capital market (click to open)
Tradability in the capital market should be understood more broadly than simply trading in the regulated market or place of trade. The capital market also covers cases where the company raises capital from investors and the investors own a transferable and standardised economic right.
4. Standardisation (click to open)
Standardisation means that the rights offered to investors are comparable in content and are uniform. If the only difference between the investors is the amount invested but the rights they have are the same, it may indicate that the instrument is a security.
5. Similarity to typical securities (click to open)
Loan contracts and rights of claim
A usual loan contract that is individually negotiated is not a security simply because it creates a monetary right of claim. The question of whether it qualifies as a security may arise though if the company is raising capital from a lot of people using uniform or standardised loan conditions.
If the investors are offered rights of claim on essentially the same conditions with the same interest rate, maturity, repayment schedule, collateral structure, and other main conditions for example, and the only difference lies in the amount invested, then this may be considered similar to a bond issue.
Calling a contract or claim a loan does not prevent it qualifying as a security if the economic content and the organisation of the offer match the characteristics of a security.
Typical securities
| Instrument | Essential description |
|---|---|
| Shares | Grant participation in a business and the related economic and membership rights. |
| Bonds | Represent securitised debt or rights of claim against the issuer. |
| Subscription rights | Give the right to acquire shares or other securities. |
| Convertible instruments | May give the right to exchange an instrument for shares or other securities. |
| Depositary receipts for securities | Indicate the right to the underlying security or the related economic position. |
Edge cases and new instruments
Tokens and crypto assets (click to open)
A token or crypto asset may be a security if it gives the investor transferable and standardised rights that are similar to those of shares, bonds, profit sharing, rights of claim or other investment instruments. Of key importance is not the technical form in the blockchain, but whether the token gives the investor an economic position against the issuer, project, asset or income.
Profit sharing and income-based rights (click to open)
If an investor is given the right to receive part of the income, profit, assets, or return on projects of a company, it must be considered whether the right is transferable and standardised and is similar to an equity or debt instrument.
Convertible and hybrid instruments (click to open)
Convertible or hybrid instruments may combine the characteristics of debt and equity. If an instrument gives the right to acquire securities or the value of it depends on securities, particular attention must be paid to whether it is considered a security.