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According to the Consultation Conclusion published by the FSTB in May 2021, a 'virtual asset' is a digital representation of value that:

1. is expressed as a unit of account or a store of economic value;
2. functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; and
3. can be transferred, stored or traded electronically. ¹

Nevertheless, it does not cover digital representations of fiat currencies (including digital currencies issued by central banks), financial assets already regulated under the SFO, or certain closed-loop, limited-purpose products.¹

SFC stated in a statement dated 5 September 2017 that three types of terms and features in ICOs (another term for token sales) might constitute securities:

1. tokens may be regarded as 'shares' if they represent equity or ownership interests in a corporation; for example, where the token holders are given shareholders' rights, including the right to receive dividends and the right to participate in the distribution of the corporation's surplus assets upon winding up;
2. tokens may be regarded as 'debentures' where the digital tokens are used to create or to acknowledge a debt or liability owed by the issuer; for example, an issuer may repay token holders the principal of their investment on a fixed date or upon redemption, with interest paid to token holders; and
3. tokens may be regarded as an interest in a CIS if the token proceeds are managed collectively by the ICO scheme operator to invest in projects with an aim to enable token holders to participate in a share of the returns provided by the projects. ¹

The SFC issued a statement on 28 March 2019 that further confirms its approach to virtual assets that fall within the definition of 'securities' under the SFO (security tokens), and confirmed that the marketing and distribution of security tokens must be conducted by a person licensed or registered for Type 1 regulated activity (dealing in securities) (Type 1 intermediary). The SFC relies heavily upon Type 1 intermediaries in adhering to its regulations and newly issued advice, as well as abiding by other applicable laws, to ensure purchasers of security tokens are fully safeguarded. This includes limitations on offering security tokens exclusively to professional investors, conducting comprehensive due diligence concerning the tokens, its personnel, the resources underlying the tokens and all pertinent details, while also providing buyers with clear and intelligible information. The SFC has stressed the need for compliance with the suitability requirements in Paragraph 5.2 of the SFC Code of Conduct, along with Paragraph 5.5 of the SFC Code of Conduct (the Complex Products Regime), which took effect on 6 July 2019.¹

As part of its Circular to Intermediaries on the Distribution of Virtual Asset Funds, dated 1 November 2018, the SFC has also highlighted the following key requirements:

• security tokens should only be offered to persons who qualify as 'professional investors' under the SFO and the Securities and Futures (Professional Investor) Rules;
• intermediaries distributing security tokens need to understand the security token offerings (STOs) and conduct proper due diligence, covering the background and financial soundness of the management, development team and issuers of the security tokens as well as the rights attached to the underlying assets of the security tokens. Intermediaries should also review the white papers and marketing materials in respect of the STOs; and
• intermediaries should give clients information relating to STOs in a clear and easily comprehensible manner and should give clients prominent warning statements covering potential risks associated with virtual assets. These potential risks include risks of insufficient liquidity, volatility, opaque pricing, hacking and fraud. ¹

The Joint Circular of 28 January 2022 issued by the SFC and HKMA updates regulations concerning the distribution and providing of services related to virtual assets, which includes security tokens. It affirms that these products (including security tokens) are highly likely to be labelled as complex, hence subjecting them to demands from the Complex Products Regime. Intermediaries are only able to provide complex virtual asset-related products to professional investors, and must take a virtual asset knowledge test prior. Only registered Type 1 intermediaries can introduce their clients to SFC-licensed Virtual Asset Trading Platforms (VATPs) or put together an omnibus account for the VATP provider. As of this moment, OSL is the sole SFC-approved VATP available, thus becoming the exclusive choice of Type 1 intermediaries wishing to give dealing services related to virtual assets.¹

On 28 January 2022, the HKMA issued its own circular (the HKMA Circular), stating that, provided adequate risk-management controls are in place, authorised institutions are not prohibited from investing in, lending against, or allowing their customers to acquire virtual assets (including security tokens) using credit cards or other payment services.¹

By recording the assets digitally, tokens can be linked to the underlying assets and provide a graphically secured representation of value that can be stored and transferred.¹

For certain securities in Hong Kong, paper certificates are issued and paper instruments of transfer are used. In accordance with Section 144 of the Companies Ordinance (Cap 622), a company must issue share certificates once shares have been allotted. Over the last two decades, movements towards a paperless securities regime in Hong Kong have been rampant and this is set to become a reality with the enactment of the Securities and Futures and Companies Legislation (Amendment) Ordinance 2021 by the government on 11 June 2021. The new regulation will introduce an uncertificated – or paperless – securities market (USM) regime, which will allow investors to hold their securities in their own name without physical documents. It is anticipated that USM will be launched in stages starting from late 2022.¹

A licensing regime for virtual asset exchanges is set out in the Consultation Conclusion released by the FSTB in May 2021, as discussed above. In the 2021/22 legislative session, the amendment bill is expected to be presented to the Legislative Council.¹

Digital assets in Hong Kong

Fintech in Hong Kong

Fintech in other countries

Notes

1. https://thelawreviews.co.uk/title/the-financial-technology-law-review/hong-kong