TO LAUNCH OR NOT TO LAUNCH
Whilst Hong Kong is welcoming of financial technology, or Fintech, initiatives, the financial services regulators continue to be cautious about some aspects of Fintech that involve investments by the public, namely cryptocurrencies and ICOs. For example, they have warned investors to proceed with caution due to the uncertain and currently (mostly) unregulated nature of the assets.
Digital tokens that are issued through an ICO and cryptocurrencies are generally characterised as virtual commodities by the regulators in Hong Kong. This means that tokens are generally not subject to Hong Kong laws that regulate the issue and use of currency and money. However, this is not the end of the matter as there are a myriad of other financial services and other laws that may apply. For example, digital tokens may be regarded as a "security" as defined in the Securities and Futures Ordinance ("SFO") in certain circumstances. A "security" is widely defined and catches most forms of investment products including shares, bonds, futures and forwards, derivatives and collective investment schemes; there are limited exclusions. The categorisation of a token as a security will have licensing implications for issuers, unless an exemption or exclusion applies. The carrying on of unlicensed activities in Hong Kong is a serious offence and can involve criminal sanctions.
In anticipation of ICO regulations that are expected to be drafted and implemented in the near future, this alert discusses some practical considerations that issuers may want to consider when thinking of conducting an ICO in Hong Kong.
Show me the money
A token issuer looking to open a bank account in Hong Kong may face some difficulty, as the Hong Kong Monetary Authority has published a guideline reminding banks to exercise "prudent risk management" in relation to services involving virtual commodities. Issuers therefore should be prepared to provide evidence of their good standing and the legitimacy of their business operations in Hong Kong.
Do you know your client?
Issuers should, from the outset, adopt a robust know-your-client procedure when on-boarding participants, so as to mitigate risks of being exposed to money laundering, terrorist financing or fraudulent transactions. The facilitation of such criminal activities, depending on the circumstances, may amount to "aiding and abetting", an offence where the aider or abettor is treated as culpable as the main perpetrator.
Nothing is certain but death and taxes
Hong Kong corporations are subject to tax on all profits arising in or derived from Hong Kong. Currently, it is unclear as to whether virtual currency raised from an ICO would be regarded as an assessable profit. Further, whether profits are regarded as being derived from Hong Kong is a question of fact and therefore is very dependent on factors including the nature of the profits and the operational structure of the issuers' business.
In preparing the ICO documents, issuers should consider the scope of the disclaimers, the current regulatory landscape in other jurisdictions if they foresee that the ICO will attract interest from participants in other jurisdictions as well as Hong Kong privacy data laws. The disclaimers in the ICO document should cover the risks associated with the issuer's operations and more importantly, underscore the risks for participants to take part in an ICO. We do not recommend disclaimers in fine print; they should be clear and prominent.
It's a gamble
Beyond the SFO, an ICO issuer should also be mindful of other relevant laws that may apply. Depending on the operational arrangement underlying the tokens, other financial services regulations may be relevant such as the Payment Systems and Stored Value Facilities Ordinance, the Pyramid Schemes Ordinance, the Money Lenders Ordinance, the Gambling Ordinance and the Betting Duty Ordinance.
The focus of this article has been common pitfalls and practical considerations from an ICO issuer's point of view, but we briefly mention in this section some questions that investors should consider before investing in an ICO. For example, who is the investor contracting with? What rights come with the investment? Is it possible for the investor to sell his or her token, and if so, how and when and at what cost?
The regulatory minefield needs to be navigated carefully, if an ICO is to be successful. Our key takeaways are:
• Does your virtual token have features that may make it an investment product that is regulated?
• Who are your target participants?
• What measures should you implement when on-boarding the ICO participants?
• What additional corporate steps should be taken when setting up an entity in Hong Kong?
• What information should you obtain from the participants?
• How should such information be handled?
• How should your operations be structured, taking into account Hong Kong tax implications?
Howse Williams Bowers is an independent law firm which combines the in-depth experience of its lawyers with a forward thinking approach.
Our key practice areas are corporate/commercial and corporate finance; commercial and maritime dispute resolution; clinical negligence and healthcare; insurance, personal injury and professional indemnity insurance; employment; family and matrimonial; property and building management; banking; financial services/corporate regulatory and compliance.
As an independent law firm we are able to minimise legal and commercial conflicts of interest and act for clients in every industry sector. The partners have spent the majority of their careers in Hong Kong and have a detailed understanding of international business and business in Asia.
Disclaimer: The information contained in this article is intended to be a general guide only and is not intended to provide legal advice. Please contact firstname.lastname@example.org if you have any questions about the article.