Despite the widespread popularity of initial coin offering (ICO), the volatility of the cryptocurrency market earlier this year has however highlighted the murky status of ICOs, particularly when it comes to regulation.
Although there is limited regulatory oversight at this moment, different jurisdictions are considering how to regulate ICO activities, with some already banning ICO operations entirely.
Regulations and the Law in Hong Kong
Regulatory bodies all around the globe are on their way to establishing legal frameworks for ICOs. In the US, offerings of security tokens are restricted by regulations of the Securities and Exchange Commission (SEC). In contrast, China and South Korea have imposed a complete ban on ICOs.
Similar to the US (whilst unlike China - which has imposed a strict ban against ICO), Hong Kong has, pursuant to the “One Country, Two Systems” policy, been able to adopt and implement a more moderate approach. This in turns places Hong Kong in a unique position within the ICO market in the greater Chinese markets (being part of the same country).
As explained in Part 1 of this series, digital tokens offered in ICOs may, depending on their individual circumstances, be regarded as securities as defined in the Securities and Futures Ordinance (Cap. 571). Within the scope of the Ordinance, tokens may be seen as:
- shares where they represent equitable interests in a corporation;
- debentures where they create or recognise a debt or a liability; or
- interests in a collective investment scheme (CIS) that entitle token holders to a portion of returns from investments.
Therefore, ICOs, especially issuers of security tokens, can be subject to the securities laws in Hong Kong, and operators may be required to obtain a licence from the Securities and Futures Commission (SFC).
However, despite clarifications made by the government, the SFC has not set out any formal regulations to provide perspective ICO operators with solid guidelines. This has led to concerns where some ICO operators may present security tokens as “utility tokens” so as to get around the restrictions.
For instance, issuers may offer “utility tokens” of limited supply, and give obscure hints to interested buyers about the potential speculative income they may bring about. Currently, there are no clear rules to distinguish between the two types of tokens.
As blockchain technology is continuously evolving, it would be beneficial for the SFC to establish comprehensive regulations for ICOs in the near future. The 1 November SFC Circular signals a good start.
Impact Assessment: 1 November SFC Circular
During Hong Kong Fintech Week 2018, on 1 November 2018, SFC released a circular outlining new measures that will impact both fund managers and distributors.
Fully aware of the risks associated with investing in virtual assets (or crypto-assets), such as volatility, liquidity, fraud and money laundering, the SFC acknowledged its limited capacity to address those risks with the current regulatory regime in Hong Kong.
Firms distributing funds that invest in and manage virtual assets will be subject to SFC supervision, as they are now required to be licensed by or registered with the SFC.
Because of the risks associated with investing in virtual assets, the SFC has decided to bring “a significant portion of virtual asset portfolio management activities into its regulatory net.”
Under this new regulatory regime, even if firms manage funds that solely invest in virtual assets (that are not defined as securities or futures contracts), so long as they distribute those funds in Hong Kong, then they will be subject to a licensing regime.
The new rules that had been announced targeted both funds that invest in digital currencies as well as the platforms on which they are traded with a key stipulation providing that funds that invest more than 10 per cent of their assets in virtual currencies will need to be licensed by the SFC, ending the previous laissez-faire landscape in Hong Kong. This is however not a ban of ICO in Hong Kong.
Accordingly, this latest development is in fact a significant step forward for Hong Kong in securing its unique position within the market which, as elucidated by the words of Ashley Adler, “It will boost investor protection and hence attract more mainlanders to trade cryptocurrency assets in Hong Kong”, hence, cementing yet another success story in Hong Kong’s “One Country, Two Systems” policy.