Fintech Market Overview

This article does not constitute legal advice.

Virtual currencies in Hong Kong

Fintech Software

Under the Consultation Conclusion published by the FSTB in May 2021, 'virtual asset' is defined as 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

It does not, however, 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 items.1

In its statement dated 5 September 2017, the SFC outlined three types of terms and features of digital tokens in ICOs (another term for a token sale) that 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 intermediaries). The SFC places substantial reliance on Type 1 intermediaries in complying with its existing codes of conduct and its new guidance, as well as other laws and regulations to ensure that purchasers of security tokens are fully protected, including: restricting the offering of security tokens to professional investors only; conducting thorough due diligence against the security tokens, its team, the asset backing the security tokens and all other materials relevant to the security tokens; and providing all information to the purchaser in a clear and easily comprehensible manner. The SFC has emphasised the need for compliance with the suitability requirements in Paragraph 5.2 of the SFC Code of Conduct, as well as the requirements for 'complex products' in Paragraph 5.5 of the SFC Code of Conduct, which came into effect on 6 July 2019 (the Complex Products Regime).1

The SFC has also highlighted key requirements of its Circular to Intermediaries on the Distribution of Virtual Asset Funds, dated 1 November 2018 (that would apply equally to the distribution of security tokens):

  • 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 SFC and HKMA's Joint Circular of 28 January 2022, which sets out an updated regulatory framework on matters including the distribution of virtual asset-related products and the provision of virtual asset dealing services, also applies to security tokens. In it, the SFC and HKMA have reiterated their view that virtual asset-related products (including security tokens) are very likely to be considered complex products so that their distribution would be subject to requirements of the Complex Products Regime. With limited exceptions, intermediaries may only offer these complex virtual asset-related products to professional investors and are required to conduct a virtual asset knowledge test on clients beforehand. Further, only Type 1 intermediaries are allowed to offer virtual asset dealing services by introducing clients to an SFC-licensed VATP or setting up an omnibus account for the SFC-licensed VATP. At the time of writing, only one VATP, namely OSL, has been licensed by the SFC and is therefore currently the only option for Type 1 intermediaries that wish to offer virtual asset dealing services.1

Separately, the HKMA also issued its own circular (the HKMA Circular) on 28 January 2022, in which it has made it clear that authorised institutions would not be prohibited from investing in, lending against or allowing their customers to use credit cards or other payment services to acquire virtual assets (including security tokens) provided adequate risk-management controls are in place.1

Tokens can be linked to the underlying assets through recording the assets digitally and providing a graphically secured representation of value that can be stored and transferred within a distributed ledger.1

The current system in Hong Kong requires the issuance of paper certificates and the use of paper instruments of transfer for certain securities. Under Section 144 of the Companies Ordinance (Cap 622), a company must complete and issue share certificates after an allotment of shares has been completed. Nevertheless, there have been movements towards a paperless securities regime in Hong Kong over the past two decades; the Securities and Futures and Companies Legislation (Amendment) Ordinance 2021 (gazetted by the Hong Kong government on 11 June 2021) includes provisions introducing an uncertificated (therefore paperless) securities market (USM) regime, where investors will have the option of holding securities in their own names and without paper documents. The USM regime is expected to be introduced in phases commencing in late 2022.1

As mentioned above, the Consultation Conclusion released by the FSTB in May 2021 sets out a licensing regime for VASPs, which mainly covers the licensing of virtual asset exchanges. The amendment bill is expected to be presented to the Legislative Council within the 2021/22 legislative session.1

Digital assets in Hong Kong

Fintech in Hong Kong

Fintech in other countries

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Hong Kong Fintech Lawyers

Ilya Druzhinin

Ilya Druzhinin

I have over 22 years of experience in legal practice, most of which is accompanied by e-com and fintech projects

Languages: RU EN

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