On 5 September 2017, the Securities and Futures Commission (SFC) issued a statement on initial coins offerings (ICOs), in which it explained:
- features which may make digital coins in an ICO become “securities” under the Securities and Futures Ordinance (SFO);
- potential authorisation and licensing obligations for ICOs and their operators; and
- risks arising from ICO activities.
Following the publication of the SFC statement, the People’s Bank of China issued public notice to ban fundraising through ICOs in China with effect on 7 September 2017. Asset managers investing in unregulated ICOs should review the legality and risks of their ICO investments. Entities engaging in ICO related business should consider the potential regulatory implications for their activities.
Below is a summary of the SFC statement.
Features of “securities”
Digital tokens offered in an ICO are usually considered as virtual commodities not subject to the SFC’s regulation. However, they may be treated as securities in some circumstances, for example as:
- shares where tokens represent ownership interests or rights in companies which allow the token holders to receive dividends or participate in the distribution of the companies’ surplus assets upon winding-up;
- debentures where issuing terms of the tokens create obligations on the issuer to repay the token holders their principal (i.e. their investment in the tokens and interest); or
- interests in a collective investment scheme where proceeds of tokens are used to make investments which are managed by an ICO scheme operator collectively with an aim to enable token holders to participate in a share of the returns provided by those investments.
Potential SFC regulatory obligations
The meaning of “securities” under the SFO includes shares, debentures and interests in a collective investment scheme. Unless an exemption applies, an ICO of “securities” to the Hong Kong public will require the SFC’s authorisation. An SFC licence will also be required for persons:
- dealing in, advising on or managing a portfolio of digital coins which are “securities” in Hong Kong; or
- targeting Hong Kong investors for such services outside of Hong Kong.
Cryptocurrency exchanges or platforms may be subject to additional requirements relating to automated trading services and recognised exchange companies.
Risks of ICOs
Investing in ICOs may expose investors to fraud, liquidity and volatility risks. When dealing with digital tokens transacted or held on an anonymous basis, SFC licensed corporations need to carefully discharge their AML/CTF obligations as set out in the SFC circular of 16 January 2014.