Hong Kong Regulation of Securities
Hong Kong Regulation of Securities
Dealing in or advising on digital coins regarded as “securities” under the SFO, or managing or marketing a fund investing in such digital coins may constitute a “regulated activity”. Parties carrying on a business in a “regulated activity” in Hong Kong must obtain a licence from the SFC. The prohibition on carrying on a regulated activity without a licence also catches entities which actively market business activities which constitute a regulated activity from outside Hong Kong to the Hong Kong public. There is a limited exemption from the requirement to be licensed to deal in securities where a person, as principal (which in the case of an ICO would be the ICO issuer), deals with institutional professional investors who include licensed investment intermediaries, authorised financial institutions, regulated insurance companies, regulated collective investment schemes, governments and multilateral agencies.
ICOs involving the offer of shares or debentures to the public are subject to the detailed prospectus requirements under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO), unless an exemption applies. The main exemptions which may be available are for:
- offers to not more than 50 persons;
- offers only to professional investors:
- institutional investors including authorised banks, licensed investment intermediaries; authorised funds; authorised insurers; authorised pension schemes etc.; and
- “high net worth investors” who include:
- individuals who have a securities portfolio of HK$8 million or more;
- corporations or partnerships with:
- a securities portfolio of HK$8 million or more; or
- HK$40 million in total assets; and
- investment companies owned by an individual, corporation or partnership who qualify as professional investors where the investment company’s sole business is to hold investments;
- Small offers where the total consideration payable does not exceed HK$5 million; and
- Offers where the minimum consideration payable (for shares) or the minimum principal amount to be subscribed (for debentures) does not exceed HK$500,000.
ICOs involving an offer to the Hong Kong public to participate in a CIS or to acquire other securities require SFC authorisation, unless an exemption is available, e.g. for offers made only to Hong Kong professional investors and offshore investors.
Are cryptocurrencies money or currency?
E-currencies/ Electronic Money
The Hong Kong Monetary Authority (the HKMA) has stated that it regards Bitcoin not as legal tender but as a “virtual commodity”. According to its 11 February 2015 press release,  “As Bitcoin does not have any backing – either in physical form or from the issuer – and its pricing is highly volatile, it does not qualify as a means of payment or electronic money. Bitcoin and other similar virtual commodities are not regulated by the HKMA”. In its statement, the HKMA also reminded the public of the risks involved in Bitcoin trading, and that cases have been reported to the police which may involve fraud or pyramid schemes.
In March 2015, the Secretary for Financial Services and the Treasury of the Hong Kong Government (the FSTB) stated  in the Hong Kong Legislative Council (Legco) that Bitcoin and other kinds of virtual commodities do not qualify as e-currencies, having regard to their nature and circulation in Hong Kong at that time. The Secretary further stated that the Hong Kong Government did not then consider it necessary to introduce new legislation to regulate trading in such virtual commodities or to prohibit people from participating in such activities.
A further statement by the Secretary for Financial Services before Legco in November 2017  provided that digital tokens offered in ICOs which are not “securities” within the SFO, are typically virtual commodities. As such, they are not regarded as currencies, electronic currencies or a means of payment. The statement also confirmed that Hong Kong does not have any targeted regulatory measures on virtual commodities specifically in terms of their safety or soundness, and the trading platforms or operators of such commodities, provided that they are not “securities” under the SFO.
Retail Payment Systems and Stored Value Facilities
The Payment Systems and Stored Value Facilities Ordinance (Cap. 584 of the Laws of Hong Kong) (PSSVFO) put in place a regulatory framework for RPS. The PSSVFO defines an RPS as a “system or arrangement for the transfer, clearing or settlement of payment obligations relating to retail activities (whether the activities take place in Hong Kong or elsewhere), principally by individuals, that involve purchases or payments”; and “includes related instruments and procedures”. The term “system or arrangement” intends to apply the definition broadly; not only will it capture a “system”, such as a computer system, or network, or other physical system infrastructure, but also business arrangements. RPS under this definition include, but are not limited to, electronic fund transfer systems and payment card schemes.
The PSSVFO provides that the HKMA can designate an RPS in order to impose various requirements on it. Under section 4(1) of the PSSVFO, an RPS may be designated if the HKMA is of the opinion that:
- the system is, or is likely to become, an RPS whose proper functioning is material to the monetary or financial stability of Hong Kong, or to the functioning of Hong Kong as an international financial centre; or
- the system should be so designated, having regard to matters of significant public interest.
Once designated, an RPS would be subject to requirements including safe and efficient operation of the system, establishment of appropriate operating rules, existence of adequate compliance arrangements and the availability of sufficient financial resources. In August 2017, the HKMA designated as RPS the systems operated by Visa, Mastercard, UnionPay International and American Express for the processing of payment transactions involving participants in Hong Kong.
HKMA is also entitled under PSSVFO to declare a thing to be a medium of exchange for the purposes of the Ordinance.
A “stored value facility” under PSSVFO, in general terms, is a facility which can be used to store the value of an amount of money (which includes any declared medium of exchange) that is paid into the facility from time to time under the rules of the facility. The facility can be used to make payments for goods or services and/or to make payments to another person. As noted above, the HKMA has stated that it does not currently regulate Bitcoin or other virtual commodities.
Anti-Money Laundering (AML) and Counter-terrorist Financing (CTF)
A significant issue is the application to cryptocurrencies of the comprehensive requirements under AML/CTF laws, such as know your client and C&ED reporting obligations. Hong Kong’s financial regulators, including the SFC, the HKMA and the Customs and Excise Department (C&ED), require financial institutions to assess stringently money laundering and terrorist financing risks associated with virtual commodities in accordance with the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO). Financial institutions (which include banks and SFC licensed corporations) are required to comply continuously with customer due diligence and record keeping requirements when establishing or maintaining business relationships with customers or clients who are operators of any schemes or businesses relating to virtual commodities.
In January 2014, the HKMA , SFC  and C&ED  issued circulars (to authorised institutions, licensed corporations (LCs) and associated entities (AEs), and money service operators, respectively) reminding them to ensure that proper safeguards exist to mitigate the money laundering and terrorist financing (ML/TF) risks associated with virtual commodities. The circulars note that virtual commodities transacted or held on an anonymous basis present significantly higher ML/TF risks. The regulators thus require increased vigilance in the case of customers that are operators of schemes related to virtual commodities (such as entities operating virtual commodities exchanges, brokerages or transaction processing services (including the provision of machines/channels that facilitate the sale and purchase of virtual commodities) (VC Operators) in assessing the ML/TF risks and the monitoring and detection of unusual or suspicious transactions. ML/TF risks assessments should consider whether a VC Operator has effective controls against ML/TF involving virtual commodities.
There are a number of other laws which companies and other entities must comply with even if they are not a bank or SFC-licensed corporation. Under the applicable ordinances, any persons (including financial institutions, virtual commodity dealers or operators) are required to report any suspicious activities in relation to money laundering or terrorist financing to the Joint Financial Intelligence Unit (JFIU) set up by the Police and the C&ED in Hong Kong. A failure to disclose such suspicious transactions to the JFIU may amount to an offence. The applicable ordinances include:
- the Organised and Serious Crimes Ordinance (Cap. 455);
- the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap. 405);
- the United Nations (Anti-Terrorism Measures) Ordinance (Cap. 575);
- the United Nations Sanctions Ordinance (Cap. 537); and
- the Weapons of Mass Destruction (Control of Provision of Services) Ordinance (Cap. 526).
Regulation of Crypto Trading Exchanges
Exchanges which provide for the trading of cryptocurrencies which are securities will typically be required to be licensed for Regulated Activity Type 1 (dealing in securities). They may also need to apply for recognition as an exchange company under Part III of the SFO or to be licensed for Regulated Activity Type 7, providing automated trading services. The SFC noted in its February 2018 statement that it had written to seven cryptocurrency exchanges in Hong Kong or connected to Hong Kong notifying them that they should not trade cryptocurrencies which are “securities” as defined under the SFO unless they are licensed by the SFC. Most of the cryptocurrency exchanges contacted by the SFC apparently either: (i) confirmed that they did not trade cryptocurrencies which are “securities” under the SFO; or (ii) immediately rectified the position and ceased trading in cryptocurrencies that are securities.
Otherwise, exchanges trading cryptocurrencies that are not securities, would appear to be unregulated in Hong Kong. In an April 2014 statement, the Money Service Supervision Bureau of the C&ED said that Bitcoin or other similar virtual commodities are not “money” for the purposes of the AMLO, and do not fall within the regulatory regime administered by the C&ED.
A trading platform which operates in Hong Kong whose transactions involve money changing or remittance services is however required to apply to the Commissioner of Customs and Excise in Hong Kong for a “money service operator” (MSO) licence under the AMLO. That licence does not however grant any approval or recognition in relation to the business conducted by the platform in relation to virtual commodities. A “remittance service” is defined as arranging for the sending of money to a place outside Hong Kong, or arranging for the receipt of money from a place outside Hong Kong. Thus a trading platform operated in Hong Kong which sends or receives fiat currency to or from another jurisdiction, for example in relation to a purchase of cryptocurrencies, could be conducting a remittance service. The C&ED will check whether platforms trading cryptocurrencies are involved in unlicensed money service business. A money changing service is defined as a service for the exchanging of currencies. Since Hong Kong’s regulators generally regard cryptocurrencies as “virtual commodities” (if they are not securities) and not as “currencies”, the trading of cryptocurrencies should not require an MSO licence.
Many crypto trading exchanges in Hong Kong are however generally adopting best practices which include the conduct of know your client procedures and anti-money laundering and counter-terrorist financing checks.
The Hong Kong Fintech Association has published “Best Practices for Token Sales”  with suggested practices for the conduct of Hong Kong ICOs which provides a useful starting point for anyone considering conducting an ICO in Hong Kong.
The Way Forward
The difficulty in classifying digital tokens or coins is the fact that even if coins’ primary purpose is to provide access to goods or services via a platform, once they are listed on a trading exchange, they may also be traded by speculators for the purpose of profit taking. Whether that alone should bring a coin within the definition of “securities” is arguable.
There are clearly risks associated with ICOs. Quite apart from the risks of fraud and theft, the project may never be completed and coin holders stand to lose their investment. Coins would not in most cases give holders any contractual rights against the coin issuer or any rights on its insolvency. Offers are not generally restricted to professionals deemed sufficiently sophisticated to assess the risks of investment. The disclosure made in white papers is not subject to any particular standards or scrutiny. Whether regulators choose to clamp down on coin offers will probably depend on the perceived risk to retail investors in particular jurisdictions.
There are clearly arguments both for and against regulation of ICOs. While greater legal certainty would be welcome, there have been calls to ensure that any regulation imposed should not be overly onerous. Many, although not all, ICOs are involved in the development of blockchain-based technology and applications which will offer substantial improvements in efficiency. The danger of over-regulation is that technological innovation may be stifled and there have already been criticisms of China’s clampdown on cryptocurrencies as stifling their development and diminishing China’s once dominant position in the cryptocurrency revolution. 
Other concerns relate to money laundering and terrorist financing. Since most exchange operators in Hong Kong are currently unlicensed, one possibility would be to impose AML and CTF obligations on exchange operators since this is the point at which the worlds of fiat currencies and cryptocurrencies intersect.
Many ICO issuers and crypto exchanges are adopting best practices which are both in the best interests of potential coin purchasers and also serve to distinguish legitimate players from the Ponzi schemes and fraudulent exchanges which have dogged the industry in some jurisdictions. Self-regulation is all well and good, but it fails to provide sanctions for those who do not comply. Many in the crypto market, both exchanges and issuers, would welcome balanced regulation as a means of giving cryptocurrencies legitimacy. Investment in cryptocurrencies remains dominated by individual investors. If cryptocurrencies are to attract institutional investors, they probably require the legitimacy that regulation would provide.
Note: The above represents Charltons’ current understanding of the regulation of ICOs in different jurisdictions. Charltons advises only on Hong Kong law and while the above represents our understanding of the legal position in certain other jurisdictions, legal advice from qualified lawyers in the relevant jurisdictions should be sought in relation to any particular transaction or situation. Further, this note is intended for educational purposes and it does not constitute Hong Kong legal advice. Specific advice must be sought in relation to any particular situation.
- HKMA. Press Release. “The HKMA reminds the public to be aware of risks associated with Bitcoin”. <https://www.hkma.gov.hk/eng/key-information/press-releases/2015/20150211-3.shtml>
- Financial Services and Treasury Bureau. Press Release. “LCQ4: Regulation of trading activities of bitcoins”. 25 March 2015. <https://www.fstb.gov.hk/en/docs/pr20150325b_e.pdf>
- Financial Services and Treasury Bureau. Press Release. “LCQ15: Regulation of offering and trading of digital tokens”. 8 November 2017.<https://www.fstb.gov.hk/en/docs/pr20150325b_e.pdf>
- HKMA. Circular “Risks associated with virtual commodities”. 9 January 2014. <https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2014/20140109e1.pdf>
- SFC. “Circular to Licensed Corporations and Associated Entities – Anti-Money Laundering / Counter- Terrorist Financing: Money Laundering and Terrorist Financing Risks Associated with Virtual Commodities”. 16 January 2014. <https://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=14EC2>
- C&ED. “Circular to Money Service Operators: Money Laundering and Terrorist Financing Risks Associated with Virtual Commodities”. 30 January 2014. <https://www.customs.gov.hk/filemanager/common/pdf/circular_VC_30012014_en.pdf>
- Fintech Association of Hong Kong. “Best Practices for Token Sales”. December 2017. <http://hkfintech.org/wp-content/uploads/2017/12/FTAHK-Best-Practices-for-Token-Sales-December-2017- final.pdf>