On 28 March 2019, the Securities and Futures Commission (SFC) issued a statement (Statement) reminding market participants about the legal and regulatory requirements relating to security token offerings (STOs). The Statement notes STOs typically refer to specific offerings which are structured to have features of traditional securities offerings, and involve security tokens which are digital representations of ownership of assets (e.g. gold and real estate) or economic rights (e.g. share of profits or revenue) utilising blockchain technology.
We have summarised the Statement below.
Discuss with the SFC before engaging in activities relating to STOs
The Statement reminds intermediaries that they should discuss with the SFC before engaging in any activities relating to STOs. In addition to the requirements noted below, the SFC will expect intermediaries to implement adequate systems and controls to ensure compliance with the applicable requirements, before they commence distribution of STOs.
Ensure you have the right licence
A person who markets or distributes “securities”, as defined in the Securities and Futures Ordinance (SFO), is required to be licensed or registered for Type 1 (Dealing in Securities) regulated activity under the SFO, unless an applicable exemption applies. Where security tokens are “securities” for SFO purposes, the person marketing or distributing security tokens (whether in Hong Kong or targeting Hong Kong investors) will likely need a Type 1 licence.
Comply with ongoing requirements
In the Statement, the SFC emphasises compliance with the suitability requirement in paragraph 5.2 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct), as well as the new requirements for complex products in paragraph 5.5 of the Code of Conduct which will come into effect on 6 July 2019. Please click here for our client alert on the suitability requirement and click here for our client alert on the complex products requirement.
The SFC also highlights key requirements of its circular to intermediaries on the distribution of virtual asset funds dated 1 November 2018 (as summarised in our client alert available here) that will apply equally to the distribution of security tokens:
1. Security tokens should only be offered to persons who qualify as “professional investors” under the SFO and the Securities and Futures (Professional Investor) Rules.
2. Intermediaries distributing security tokens need to understand the STOs and conduct proper due diligence, covering the background and financial soundness of the management, development team and issuers of the security tokens as well as the rights attached to the underlying assets of the security tokens. Intermediaries should also review the white papers and marketing materials in respect of the STOs.
3. Intermediaries should give clients information relating to STOs in a clear and easily comprehensible manner and should give clients prominent warning statements covering potential risks associated with virtual assets. These potential risks include risks of insufficient liquidity, volatility, opaque pricing, hacking and fraud.