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Financial Services Alert - October 2017
Submitted by // K Bowers, Partner / Solicitor Advocate
10 October 2017


Securities and Futures Commission Issues Statement on Initial Coin Offerings 

Introduction

On 5 September 2017, the Securities and Futures Commission ("SFC") issued a statement on initial coin offerings ("ICOs"), cautioning the public that depending on the circumstance of the case, the SFC may intervene and regulate ICO related activities. This comes just one day after a joint statement was issued by seven Chinese financial regulators on 4 September 2017, banning ICOs in the PRC. The SFC's statement clarifies that whilst ICOs have not been banned in Hong Kong, the SFC may step in as a regulator in certain circumstances.

Background

An ICO is a type of fundraising which utilises blockchain technology to issue digital tokens to investors. In an ICO, the offeror, or scheme operator, offers digital tokens in exchange for legal tender or cryptocurrencies such as Bitcoin. The digital tokens issued in an ICO commonly represent some form of utility in the product or service being developed by the offeror, but can be programmed by the offeror to have other features, including the distribution of earnings or assignment of voting rights. As some ICOs incorporate features that resemble financial securities, they have recently attracted scrutiny from financial regulators, including the SFC.

SFC's statement on ICOs

In Hong Kong, digital tokens offered in an ICO are considered virtual commodities and are not currently regulated by the SFC. However, the SFC's statement clarifies that depending on the facts and circumstances of an ICO, digital tokens may fall within the definition of "securities" under the Securities and Futures Ordinance, (Cap. 571) ("SFO"). Specifically, the SFC's statement says that digital tokens in an ICO may constitute shares, debentures, or an interest in a collective investment scheme ("CIS"). The SFC says that this may occur where:-

  • token holders are given shareholders' rights, such as the right to receive dividends and the right to participate in the distribution of a corporation’s surplus assets upon winding up;
  • the issuer repays token holders the principal of their investment on a fixed date or upon redemption, with interest paid to token holders; or
  • token proceeds are managed collectively by the ICO scheme operator to invest in projects, with an end goal of enabling token holders to participate in a share of the returns generated by the project.

The classification of digital tokens as "securities" means that ICO-related activities may constitute "regulated activities" within the meaning of the SFO, which means that persons involved in ICO-related activities (such as trading or advising on ICOs) will fall within the licensing regime of the SFC. Additionally, where an ICO involves an offer to the Hong Kong public to acquire "securities", the prospectus requirements under the Companies (Winding Up and Miscellaneous Provisions) Ordinance, (Cap. 32) may also be triggered.

The SFC's statement warns that as the digital tokens involved in an ICO are transacted or held on an anonymous basis, there are inherent money laundering and terrorist financing risks involved. The SFC reminds Licensed Corporations and Associated Entities (as defined under the SFO) to comply with the anti-money laundering and counter-terrorist financing ("AML/CTF") requirements as set out in the SFC Circular dated 16 January 20141.

Approach in other jurisdictions

A number of regulators in other jurisdictions have also commented on ICOs. In the US, the Securities and Exchange Commission ("SEC") published a report in July 2017, stating that ICOs involving US investors will be considered as securities offerings and subject to the SEC's enforcement jurisdiction.  Further, in June 2016, the US Commodity Futures Trading Commission brought an enforcement action against Bitfinex, a Hong Kong based cryptocurrency exchange, confirming that US commodity laws can apply to virtual currencies.

Meanwhile, the Financial Conduct Authority ("FCA") in the UK has also stated that depending on the structure of an ICO, it may fall within the regulatory regime of the FCA. The Canadian Securities Administrators and the Monetary Authority of Singapore have also published statements on the topic of ICOs. More recently, South Korea's Financial Services Commission announced on 29 September 2017 that it will move to ban ICOs in the country, which may influence the approach of other regulators in Asia.

Comment

The SFC clarifies through its statement that it is prepared to treat digital tokens offered in an ICO as "securities" as defined under the SFO. As a result, and depending on the nature of an ICO, issuers and other persons involved in ICO-related activities can fall within the SFC's licensing and regulatory regime. However, as can be seen from developments in other jurisdictions, ICOs remain a highly volatile topic. It remains to be seen whether the SFC will take a stronger stance towards ICOs in Hong Kong. Parties concerned should meanwhile be aware of all the relevant risks and comply with the applicable SFC requirements on AML/CTF in relation to virtual commodities (including the SFC Circular dated 16 January 2014).

 


Circular to Licensed Corporations and Associated Entities Anti-Money Laundering / Counter-Terrorist Financing Money Laundering and Terrorist Financing Risks Associated with Virtual Commodities dated 16 January 2014.


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