On 6 June 2022, the Securities and Futures Commission (the “SFC”) published a reminder on the risks associated with non-fungible tokens (“NFTs”). Given the exponential rise in NFTs in markets all around the world, this reminder is much needed, especially for businesses and investors who are unfamiliar with Hong Kong’s regulations, or those who have the impression that virtual assets are simply unregulated in Hong Kong.
The SFC observes that a majority of NFTs are intended to represent a unique copy of an underlying asset such as a digital image, artwork, music or video. The SFC explicitly states that generally, where an NFT is a genuine digital representation of a collectible, the activities related to it do not fall within the SFC’s regulatory remit.
What should businesses look out for?
That said, issuers of NFTs should take note that NFTs which bear structural features of a financial asset in Hong Kong, such as securities and collective investment schemes, should take extra caution and ensure that their product offerings are not in breach of any laws in Hong Kong.
Securities are defined in Section 1 of Part 1 of Schedule 1 to the Securities and Futures Ordinance (“SFO”) as, inter alia:-
- shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a body, whether incorporated or unincorporated, or a government or municipal government authority
- rights, options or interests (whether described as units or otherwise) in, or in respect of, such shares, stocks, debentures, loan stocks, funds, bonds or notes
- certificates of interest or participation in, temporary or interim certificates for, receipts for, or warrants to subscribe for or purchase, such shares, stocks, debentures, loan stocks, funds, bonds or notes
- interests in any collective investment scheme;
- interests, rights or property, whether in the form of an instrument or otherwise, commonly known as securities;
Collective investment schemes are also defined in Section 1 of Part 1 of Schedule 1 to the SFO. It generally has four elements: (1) it must involve an arrangement in respect of property; (2) participants do not have day-to-day control over the management of the property; (3) the property is managed as a whole by or on behalf of the person operating the arrangements or the contributions of the participants and the profits or income from which payments are made to them are pooled; and (4) the purpose or effect of the arrangement is for participants to participate in or receive profits, income or other returns from the acquisition or management of the property.
Issuers should also take note of the risk of conducting a regulated activity in Hong Kong without the requisite licence from the SFC. The list of regulated activities under the SFO are as follows:-
- Type 1: Dealing in securities
- Type 2: Dealing in futures contracts
- Type 3: Leveraged foreign exchange trading
- Type 4: Advising on securities
- Type 5: Advising on futures contracts
- Type 6: Advising on corporate finance
- Type 7: Providing automated trading services
- Type 8: Securities margin financing
- Type 9: Asset management
- Type 10: Providing credit rating services
Issuers of NFTs should also bear in mind that offering of investments may require the authorisation of the SFC. Per Section 103(1) of the SFO, subject to certain exemptions, a person commits an offence if he issues, or has in his possession for the purposes of issue, whether in Hong Kong or elsewhere, an advertisement, invitation or document which to his knowledge is or contains an invitation to the public (i) to enter into or offer to enter into an agreement to acquire securities/structured product or to (ii) acquire an interest in a collective investment scheme.
What can businesses do?
If businesses are unsure of the nature of their virtual asset, they may consider reaching out to the SFC via the Fintech Contact Point, which was established to enhance communication with businesses involved in the development and application of financial technology which intend to conduct regulated activities in Hong Kong.
Alternatively, businesses can consider seeking legal advice from a law firm familiar with the virtual asset landscape in Hong Kong.
Hauzen LLP is ready to assist you. To learn more about virtual assets in Hong Kong, please feel free to contact us today.