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NON-FUNGIBLE TOKENS (NFTs): REGULATORY CONSIDERATIONS IN NIGERIA

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By Seun Timi-Koleolu and Karo Isiorho

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A survey conducted by Finder.com in 2021 revealed that Nigeria ranked 6th amongst 20 countries in the world that have adopted Non-Fungible Tokens (“NFTs”). The reason for this is not far-fetched. As a result of the continued devaluation of Naira, Nigerians are constantly on the lookout for new ways to stay above inflation. One of such ways appears to be delving into the acquisition and sale of digital assets – NFTs.

Given the rapid growth of the NFT ecosystem in Nigeria, we have provided useful information to guide NFT transactions in Nigeria.

  1. What is a Non-Fungible Token?

An NFT, also known as a Non-Fungible Token is a digital asset that represents real-world objects like art, music, in-game items and videos which are typically logged and authenticated on cryptocurrency blockchains, primarily Ethereum.

  1. What is the difference between a Fungible Token and a Non-Fungible Token.

Fungible tokens or assets are divisible and non-unique assets that store value such as a $1 note or 1 Bitcoin whilst Non-Fungible Tokens are unique and non-divisible assets that store data like digital artworks, tweets, music composition, digital shots, etc. They are similar to a deed of title for assets. In 2021, Twitter CEO, Jack Dorsey, sold his first-ever tweet for $2.9 million dollars as an NFT.

  1. Who are those that can benefit from NFTs?

Artists, buyers, collectors and marketing platforms can benefit from NFTs.

NFTs create a medium for artists to showcase and monetize their work on a broader spectrum. Artists get to retain their intellectual property rights in the works after it is sold and receive royalties on subsequent sales of the digital works. For buyers/collectors, acquiring an NFT gives a right of ownership to a unique asset that cannot be easily replicated and holds the potential for good future profit where the NFT increases in value. NFT marketing platforms, where artists can offer their NFTs for sale, also provide good business opportunities.

 

  1. What are the Regulations affecting NFTs in Nigeria?

Since NFTs are quite new in Nigeria, there has been no law or regulation specifically enacted in respect of it. There are, however, certain laws that might affect its operations in  Nigeria which are worthy of note as highlighted below:

  1. Copyright Act: Under the Copyright Act, literary works, musical works, artistic works amongst others are eligible for copyright. Accordingly, authors of digital works – NFTs will be deemed to have copyright in such works (unless as otherwise agreed in writing) and will therefore have the right to seek relief in connection with violation of their intellectual property rights in the NFT.
  2. Cybercrime (Prohibition, Prevention, etc) Act: Creators of NFTs can seek relief or claims over infringement of their NFTs under the Cybercrime Act where they are able to prove unauthorized use of their unique words or phrases that form the basis of their NFT. There are several penalties the law prescribes for those found guilty of these offenses.
  • The Securities and Exchange Commission: The Securities and Exchange Commission ( “SEC”) is the body empowered to regulate securities and investments in Nigeria. SEC through its statement on digital currencies suggests that virtual assets including blockchain based offers of digital assets- within Nigeria; or by Nigerian issuers; or sponsors; or foreign issuers targeting Nigerian investors- shall be subject to the regulation of  SEC. In view of this, it is likely that NFTs will be subject to the regulation of SEC unless issuers can prove otherwise.
  1. Central Bank of Nigeria (the “CBN”):The CBN is yet to release any circulars particularly on the use of NFTs. It has, however, repeatedly prohibited the use of virtual currencies as a legal tender by banks and other financial institutions in Nigeria. The fact that NFTs are traded using blockchain technology such as Ethereum, creates uncertainty as to whether the CBN will fully welcome its operations in Nigeria.  There is, however, no indication that Peer to Peer sale of NFTs will be affected by CBN regulations.

Other legal considerations also exist in areas such as taxation and data protection.

Conclusion

Despite the growth of the NFT amongst Nigerians, it remains a novel concept. A large number of the population are still unaware of its operations. Also, the government is yet to provide an elaborate and uniform regulation to guide its usage in Nigeria. It is important for current investors to stay vigilant in their dealings in NFTs in order to protect their assets.

SETTING UP A FINTECH COMPANY IN NIGERIA

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By Seun Timi-Koleolu and Eustace Aroh

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Introduction

With the rapid growth of technology, Start-ups have continually found ways to improve financial services. This trend has been matched by the growing appetite of consumers globally, for faster and more convenient financial services. The financial sector in Nigeria has witnessed a growth in FinTechs with their revenue expected to reach $543m in 2022.

In this article, we have set out below the process of setting up a fintech company in Nigeria.

1. Licences
For promoters seeking to set up a FinTech, it is generally advised that they understand the existing regulatory space before proceeding to incorporate the business. This will help promoters to understand the acceptable organisational structure, share capital requirements and financial implications attached to any business they seek to engage in.

Fintechs in Nigeria are generally categorized and regulated as follows:

Fintech categories Regulators
i Payment service providers, mobile money operators, digital bank, switch companies Central Bank of Nigeria (CBN)
ii Lending CBN; State Ministry of Home Affairs
iii Savings, investment and funding CBN; Securities and Exchange Commission (SEC)
iv Cryptocurrency CBN; SEC
v Insurtech National Insurance Commission

Notwithstanding the above, some regulators cut across all sectors due to their general regulatory function such as the National Communications Commission (NCC) (for FinTechs providing value added services) and the National Information Technology Development Agency (NITDA) (for users of data, amongst other things).

2. Incorporation
Once there is a clear understanding of the regulatory terrain, the next step is to incorporate the company for the FinTech service. Although the minimum share capital for incorporating a private company in Nigeria is 100,000 naira, the share capital requirement for FinTechs usually exceeds this amount. Promoters must consult the regulators and relevant laws (via their legal advisers) to determine the adequate minimum share capital and shareholding requirement for their FinTech.

There are also capital deposits required by relevant regulators such as CBN for setting up FinTechs, to find out more, click here.

3. Documentation
Upon incorporation, it is pertinent for the founders to ensure that all relevant contracts are in place to properly protect the business. The founders are generally advised to execute the following: a Founders’ Agreement (to regulate the relationship of the founders of the business); a Shareholders’ Agreement (to regulate the relationship between all shareholders including present and future shareholders); Loan Agreements (to evidence and detail all capital injections including investments by founders and friends into the business); and Employee Stock Option (granting an option of share purchase to key employees).

4. Protecting the Intellectual Property

Founders of FinTechs are advised to ensure that intellectual property developed in the cause of the business are protected. It is important that the company’s logos are registered as trademarks at the Trademark Registry; and the software and codes are registered at the National Copyright Commission or Patent Registry (if it qualifies). Although software and codes are automatically copyrighted under Nigerian law, it is useful to carry out the registration of the software at the relevant registry.

It is pertinent to note that intellectual property rights automatically vests in the developer (which could be employees or contractors of the company) under Nigerian law. To ensure that the rights vest in the company/founder, it is advisable that the FinTech enters into an agreement with the developer assigning rights in the software to the company/FinTech either through an employment contract or a Copyright Agreement.

5. Financing

Founders may choose to first source for funds from family and friends, after which they may need to progress to venture capital and other institution.

The CBN and the SEC recently launched programs to aid FinTechs in test running their software under-regulated spaces. Click here to find out more about these programs.

Conclusion
With the population of unbanked Nigerians currently calculated at above 50% of the adult population, there are great growth opportunities in the FinTech ecosystem. It is, however, recommended that professional advice is obtained by emerging and existing FinTech founders from the inception of the FinTech, to properly guide the business.

 

 

REGULATORY REQUIREMENTS FOR OBTAINING A DIGITAL SUB-BROKER LICENCE; SEC RULES & FINTECH IN NIGERIA

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By Aderonke Alex-Adedipe and Eustace Aroh

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Over the last decade, technology has continued to disrupt the financial sector while regulators have struggled to keep up. The capital market sub-sector has not been spared as fintech companies facilitate transactions in Nigerian and foreign listed securities through digital platforms.

In a move to maintain oversight over all activities within the Nigerian capital market, the Securities and Exchange Commission (“SEC”) obtained an order from the Investment and Securities Tribunal directing Chaka Technologies Limited (a Fintech company that offers Nigerians the opportunity to purchase Nigerian and foreign quoted shares through a digital platform) to refrain from facilitating investment in securities. Consequently, on April 22, 2021, the SEC issued the Major Amendments (“Amendment”) to the Securities and Exchange Commission Rules and Regulations, 2013 (“Rules”), making significant changes to the provisions relating to Sub-Brokers.

Who is a Sub-Broker?
The Rules define a Sub-Broker as a person or company who is not a member of an Exchange but acts as an agent of a sponsoring broker/dealer or assists investors in buying and selling securities through the sponsoring broker/dealer. The Amendment now recognises that a Sub-Broker may utilize a digital platform to engage investors and interact with sponsoring brokers (“Digital Sub-Broker” or “Sub-Broker Serving Multiple Brokers Through A Digital Platform”).

In effect, Digital Sub-Brokers such as Chaka, Bamboo and Rise now fall within the ambit of the Rules and are required to be registered with the SEC, provided the requirements for registration are complied with.

What can a Sub-Broker do?
A Sub-Broker may purchase and sell securities on behalf of investors through the sponsoring broker. The Sub-Broker is required to remit any fund, certificate and warrants supplied to it by the investor to the sponsoring broker within two (2) working days of receipt.

What are the obligations of a Sub-Broker?

Records of transactions
Under the Rules, a Sub-Broker is required to keep adequate records of transactions for and on behalf of investors. The records should include: (i) the mandate form; (ii) proof of payment for the purchase of shares; (iii) all communications with the investors, amongst others.

Risk Management

Specifically, all Digital Sub-Brokers are required to implement a risk management practice which includes the implementation of the following:

  1. procedures and controls to monitor and test the algorithms on a regular basis;
  2. internal policies to address technology risks;
  3. adequate cyber-security mechanism;
  4. an anti-money laundering/combatting financing of terrorism (AML/CFT) policy in line with applicable regulation;
  5. operational and technical controls systems to manage the risks;
  6. ensuring that all electronic communication is digitally signed, encrypted and secured with a backup stored in soft and secured form;
  7. a complaint management policy in compliance with SEC Rules; and
  8. complying with the SEC technology risk guidelines, amongst others.

What are the requirements for obtaining a Digital Sub-Broker license?
In addition to fulfilling all the requirements applicable to a Sub-Broker, Rule 67(4) of the Rules, specifically contains provisions that are clearly tailored towards fintech businesses. Some of the requirements for obtaining the Digital Sub-Broker license include:

  1. providing a detailed description of the technology infrastructure to be used by the proposed Sub-Broker;
  2. evidence of adequate KYC processes in respect of investors;
  3. evidence of notice of potential risks and obligations of parties issued to investors; and
  4. evidence of minimum paid-up capital of Ten Million Naira and current fidelity insurance bond covering twenty per cent (20%) of the minimum paid-up capital.

Conclusion
The development of fintech in Nigeria has provided the average Nigerian with multiple investment opportunities within the capital market sub-sector and consequently, required regulators such as SEC to provide adequate protection for investors through regulation. This effort is indeed commendable. Chaka Technologies Limited became the first company to obtain the Digital Sub-Broker licence as announced in its public statement of June 23, 2021.
In anticipation of continuous innovation and disruption, a holistic review of the SEC Rules to include, where applicable, provisions permitting digital involvement is advised. In addition, an integration of all current amendments into the Rules will prove most helpful and unambiguous to investors seeking to penetrate the Nigerian market.

The Central Bank Of Nigeria’s Regulatory Sandbox Operations Framework

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by Seun Timi-Koleolu and Olawale Atanda

 

In July 2020, the Central Bank of Nigeria (CBN)[1] released a draft Framework for Regulatory Sandbox Operations[2] aimed at establishing a controlled environment where disruptive technology in the financial services can be tested under the supervision of the CBN.

The CBN has now issued an approved Framework for Regulatory Sandbox Operations in Nigeria (the “Framework”). The CBN has now issued an approved Framework for Regulatory Sandbox Operations in Nigeria (the “Framework”). The Framework is expected to give eligible fintech innovators an opportunity to test their products, services, or solutions without the need to acquire a CBN license.

What is the scope of the Framework?

The Framework is targeted at innovations that can improve the Nigerian payments system. It applies to proposed products, services or solutions that are either not contemplated under the prevailing laws and regulations, or do not precisely align with existing regulations.

Eligibility of Sandbox Participants

The Framework allows for CBN licensees and local companies (including financial sector companies and telecom companies) to participate in the sandbox operations. Innovators whose proposed payment solution involves technologies that are currently not covered under existing CBN regulations are also welcome to participate.

Entities that apply to participate in the sandbox operations must show evidence that the product, service or solution is innovative, useful and functional; and associated risks have been identified. The entities should also have a business plan to show that the product, service or solution can be successfully deployed after they exit the sandbox.

Application Requirements and Approval Process

When the CBN is ready to receive applications, it will place an invitation on its website and local newspapers. Once the invitation is placed, applications are to be sent to the CBN’s official email address – sandbox@cbn.gov.ng.

Applications should be submitted with a cover letter signed by an authorized signatory of the applying entity and addressed to the Director, Payments System Management Department, Central Bank of Nigeria, Abuja. The applicants are to state the initial timeline (in months) for the proposed test of the product, service, or solution.

Applicants will be informed of the CBN’s approval to participate in the sandbox, 45 working days after the closure of the application window.

Sandbox Cohorts

The Sandbox will consist of Cohorts (which are groups of innovators that share the characteristic of having been allowed to enter the sandbox at the same time for the same period).

There will be one Cohort per year. Upon the completion of the sandbox test, the CBN will decide whether the product, service or solution should be introduced into the market.

Conclusion

The Framework is a plus for innovation in Nigeria. It signals that regulators are willing to better understand and develop more suitable regulations for innovations in the fintech space. The success of the sandbox can only be determined over time as implementation will be a key factor.

 

[1] Pavestones has written several articles on CBN regulations and licenses. You can view them at https://pavestoneslegal.com/tag/cbn/

[2] You can read our analysis of the draft framework here https://pavestoneslegal.com/fintech-regulatory-update-the-central-bank-of-nigeria-regulatory-sandbox/

Setting Up a Venture Capital Company for Startup Investment in Nigeria

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By Seun Timi-Koleolu and Olawale Atanda

Startups require funding for their operations and to scale.[i] This is where venture capital companies (VCs) come in. VCs (as a subset of private equity) provide early or late stage financing to startups. VC funding is booming in Nigeria and has led to startups receiving increased financing year-on-year. Nigeria attracted $747 million in VC funding in 2019 with a majority of investments going to fintech companies. Although, a large number of these VCs are foreign, there is an increasing number of local VCs such as Ventures Platform, EchoVC, and Microtraction which invest in Nigerian startups. In this article, we list important points to consider when setting up a VC fund in Nigeria.

 

Company Structure

In Nigeria, VCs may be registered[ii] as a Limited Liability Partnership or a Limited Liability Company under the Companies and Allied Matters Act 2020.[iii] VCs may also register as limited partnerships under the Partnership Law of Lagos State but would however need to register as business names by the Corporate Affairs Commission to operate outside the state.

 

Regulation

The Securities and Exchange Commission (SEC) mandates private equity funds (such as VCs) to register with the commission where investor funds are above ₦1 billion. Registered VCs are prevented from soliciting funds from the public and may only privately source funds from qualified investors. They may also not invest more than 30% of their assets in a single investment. Under SEC regulations, the fund manager of a registered private equity fund must have a minimum paid-up capital of ₦20,000,000.00.

 

Raising Funds

VCs raise funds from a variety of sources which consist of banks and other financial institutions, insurance companies, pension funds, (“institutional investors”) high net worth individuals, etc. However, regulations that cover institutional investors may restrict the extent to which they may invest in VCs. For example, the Banks and Other Financial Institutions Act limits investments to the extent that such investment does not at any time exceed 10% of the bank’s shareholders funds and not more than 40% of the investee company’s paid up share capital. Foreign VCs who bring in funds into the country are guaranteed the transferability of interests on dividends and repatriation of investments in startups. Funds should be brought in through authorized dealers (usually banks) who then issue a Certificate of Capital Importation (CCI) as proof of the importation of capital. The CCI allows foreign VCs to repatriate funds without restriction.

Taxes

Taxes payable by VCs are dependent on the structure of the fund. Where a VC is registered as a Limited Liability Company, the company will be liable to pay income tax on its profits as provided under the Company Income Tax Act (CITA). Funds registered as business names will not subject to corporate income tax, instead, each partner would be taxed based on its individual income from the business. The investee company is however required by the CITA to withhold 10% of the interest on dividends due to investors. Where a VC is a resident of a country that Nigeria has a double tax agreement with, the withholding tax rate is pegged at 7.5%.

 

Conclusion

Nigeria is a profitable market for VC funds which is evidenced by the impressive growth of startups and tech companies over the years. VCs who intend to set up shop in Nigeria or as foreign VCs, invest in Nigerian startups must be conversant with the rules on investing in Nigeria. This is important to ensure adherence with regulatory rules and conformity to proper business and corporate governance procedures.

[i] You can access our article on startup funding here https://pavestoneslegal.com/startup-funding-raising-capital-as-a-startup-in-nigeria/

[ii] Although, the Companies and Allied Matters Act 2020 has been passed into law, the Corporate Affairs Commission is yet to begin the registration of Limited Liability Partnerships.

[iii] You can read our analysis on the Companies and Allied Matters Act 2020 here    https://pavestoneslegal.com/tag/cama-2020/

Loan Recovery in Nigeria – The Recent Central Bank of Nigeria Policy

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Access to credit in Nigeria has been low for a while, with the Central Bank of Nigeria affirming that only 5.3% of the adult population have access to finance. There are many reasons for this including high interest rates deterring borrowers and high rates of default on loans deterring creditors.

In a bid to reduce the high rate of defaults by borrowers, enhance loan recovery by financial institutions and generally improve creditor confidence in Nigeria, on July 13, 2020, the Central Bank of Nigeria (CBN) released Guidelines[i] on Global Standing Instruction (the “Guidelines”). Below are key points from the Guidelines.

What is a Global Standing Instruction? Global Standing Instruction (GSI) is a mandate or an instruction to be executed by a borrower authorizing financial institutions to recover a borrower’s debt from any or all accounts maintained by that borrower across various participating financial institutions through a direct set-off from deposits/investments held in those financial institutions.

What Financial Institutions can offer a GSI to a Borrower? All financial institutions in Nigeria licensed by the CBN including commercial banks, microfinance banks, finance companies, mortgage banks, and investment banks (“Financial Institutions”).

Does it apply to Individuals or Companies? The current guidelines apply to borrowers who are individuals and not companies. We expect that guidelines for company debtors would be issued by the CBN in due course.

How does the GSI work? Borrowers are to execute a GSI mandate/authorization in hard copy or digital when taking a loan from a Financial Institution. Where the Borrower defaults on the loan, the Financial Institution would be entitled to deduct the money owed plus interest due from any other personal account, joint account or child account in any other Financial Institution, linked to the borrower’s BVN (Bank Verification number)[ii].

When can a GSI be triggered? Where a Financial Institution is unable to recover debt through other means, the institution may trigger the GSI and the Nigerian Inter-Bank Settlement System will proceed to debit the Borrower’s accounts across various Financial Institutions. A GSI is to serve as a last resort by a Financial Institution and can only be used to recover the principal loan amount and accrued interest only (not penalty interests).

Can a GSI be triggered over a joint account? Yes. However, the CBN may need to clarify how GSIs are to work in relation to joint accounts. Where a GSI is triggered over a borrower’s joint account with a third party, how would the rights of the third party to the funds in the account be protected?

What happens if a GSI is triggered in error? The Guidelines provide for penalties where it is established that a Financial institution breached the provisions of the Guidelines. For example, where a Financial Institution activates a GSI in error, the bank will pay a flat fine of ₦500,000.00 and bear all liability from such erroneous GSI activation.

When will the GSI take effect? The Guidelines are to take effect from August 1, 2020 and will be applicable on all loans granted from August 28, 2019.

Conclusion.

The GSI is a good initiative which should help improve creditor confidence in the Nigerian credit system. It would also be beneficial to fintechs in Nigeria who utilize microfinance bank licences[iii] to offer credit facilities such as payday or small business loans. Fintechs/creditors who offer loans with the use of a moneylender’s license[iv]  are, however not permitted to use GSIs. Since such money lenders play a major role in improving access to credit in Nigeria, particularly to individuals, it would be useful for similar regulations to be put in place for their benefit.

[i] You can access our articles on previous guidelines issued by the CBN by clicking on this link https://pavestoneslegal.com/tag/central-bank-of-nigeria/

[ii] The CBN had previously indicated that BVNs would be utilized to assist in the recovery of loans. Please access our articles on this here https://pavestoneslegal.com/tag/bvn/

[iii] Find more articles on microfinance banks in Nigeria here  https://pavestoneslegal.com/tag/microfinance-banks/

[iv] Please access our article on Money lending services here https://pavestoneslegal.com/tag/money-lending/