Hong Kong: Blockchain

Hong Kong has embraced blockchain and distributed ledger technology (“DLT”), reflected in the breadth of industry sectors across which its practical uses can be seen. The 2019 Blockchain Summit Hong Kong covered 18 industry sectors, namely: banking and finance; supply chain and logistics; insurance; energy; healthcare and pharmaceuticals; government; transport; telecoms; HR; marketing and advertising; retail; entertainment and content; property and construction; regulation and policy; charity; legal; investor and ICO; and developer. The Hong Kong Blockchain Week 2020 saw the global blockchain community converge in a virtual setting to discuss the latest developments and insights into the evolving, real-world applications of blockchain technology in finance, investment, enterprise, socially important projects and the global payment industry.

Fintech and Insurtech have been particular areas of focus for the Hong Kong Government and the key Hong Kong financial regulators, the Hong Kong Monetary Authority (“HKMA”), the Securities and Futures Commission (“SFC”) and the Insurance Authority (“IA”), reflecting Hong Kong’s long-held position as one of the world’s leading international financial centres.

According to a 1 June 2020 report (the “2020 FSTB Report”) by the Financial Services and the Treasury Bureau of the Hong Kong Government (“FSTB”), in 2019, blockchain firms accounted for 39% of the new Fintech firms brought in to Hong Kong by Invest HK, the Hong Kong Government department responsible for foreign direct investment. This was up from 27% the previous year, representing the biggest growth of any Fintech sub-sector. Of these new blockchain firms: 45% were enterprise solutions using blockchain technologies; 27% were trading platforms for digital assets; 14% were involved in custody of digital assets, 9% in trade finance settlement; and 5% in security tokens.

In addition, according to a June 2021 report (the “2021 IMF Report”) by the International Monetary Fund (“IMF”), Fintech companies more than doubled to 600 in 2019, compared to 230 in 2017, among which 12% focused on blockchain.

Virtual assets (“VAs”) and tokens are a growth area. The 2020 FSTB Report (as noted in the response to question 1 above) states that of the new blockchain firms brought into Hong Kong by Invest HK in 2019, 27% were trading platforms for digital assets, 14% were involved in custody of digital assets and 5% in security tokens.

2020 saw the first SFC licensing and approval of an advisor and distributor of a Hong Kong cryptocurrency fund. In December 2020, OS Digital Securities Limited (“OSL”), a subsidiary of BC Technology Group Ltd (an investment holding company listed on the Stock Exchange of Hong Kong Limited (“HKEX”)) announced that it was the first firm to become licensed by the SFC to conduct Type 1 (dealing in securities) and Type 7 (automated trading service (ATS)) regulated activities, which permits OSL to operate regulated brokerage and automated trading services for digital assets for professional investors. In addition, in April 2022, HashKey Group secured an ‘approval-in-principle’ from the SFC for its application for Hash Blockchain Limited to operate a VA trading platform, which is proposed to offer trading of cryptocurrencies and virtual commodities such as Bitcoin and Ether, as well as stablecoins and security tokens.

As described in the response to question 11 below, Hong Kong had emerged as a leading Asian (and indeed global) hub for initial coin offerings (“ICOs”) in recent years. An example of a successful practical application of token / VA technology was the launch in March 2019 by Hong Kong’s sole physical gold and silver exchange, the Chinese Gold & Silver Exchange, of a new digital gold certificate trading platform, GoldZip, backed by physical gold reserves. The platform is powered by blockchain technology and allows investors to trade in amounts smaller than the current minimum trade on the exchange. However, consistent with the global trend, ICO activity in Hong Kong has significantly declined since its peak in 2018.

Whilst there have been no widely publicised major failures of the application of token / VA technology in Hong Kong, the SFC has issued a number of statements and circulars concerning cryptocurrencies and other VAs, one of the focuses of which has been to warn investors of the risks inherent in investing in such assets and of participating in ICOs and securities token offerings (“STOs”). These are discussed in further detail in the responses to questions 9-15 below.

Interest in non-fungible tokens (“NFTs”) has also grown in Hong Kong, especially in the field of art and collectibles. 2021 saw the first NFT art shows being held in the city. A local football club, Resources Capital FC, released a series of limited-edition collectibles through NFTs, becoming the first Asian football club to do so. Local celebrities and film directors have also launched NFT projects including the sale of NFTs based on behind-the-scenes footage and new music videos. A local digital asset exchange also has plans to launch an NFT platform in Hong Kong.

From a regulatory perspective, in June 2022 the SFC issued a reminder of risks associated with NFTs (the “2022 SFC Reminder”). In the 2022 SFC Reminder, the SFC highlighted that there are risks associated with investing in NFTs. The SFC noted that where an NFT is a genuine digital representation of a collectible, the activities related to it do not fall within the SFC’s regulatory remit; however, if an NFT crosses the boundary between a collectible and a financial asset, it may constitute “securities” or, in particular, a “collective investment scheme” (“CIS”) under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (“SFO”). Where an NFT constitutes a CIS, the SFC noted that marketing or distributing it may constitute a regulated activity, which, if in Hong Kong or targeting Hong Kong investors, requires a licence from the SFC unless an exemption applies. Additionally, where an arrangement in relation to an NFT involves an offer to the Hong Kong public to participate in a CIS, authorisation requirements under the SFO may be triggered.

Utilising blockchain technology’s unique features in providing a secure platform for data entry and recording, certain companies have offered blockchain-enabled technology systems to support ESG reporting requirements. For example, Diginex (a software as a service (SaaS) provider) launched the DiginexESG platform, which is able to support users with Diginex’s compliance requirements under the ESG Reporting Guidelines of the HKEX. HKEX listed companies could make use of the DiginexESG software to streamline their ESG data reporting process while simultaneously confirming compliance with the latest HKEX ESG guidelines.

Cyberport, the digital technology business park backed by the Hong Kong government, has a number of community members firms that use blockchain technology to develop diversified solutions in the financial and non-financial industries. Cyberport has also launched the Cyberport Incubation Programme which supports entrepreneurs and start-ups by offering a range of business and professional services and HK$500,000 in support over 24 months. One of the incubatees, Block Aero, has built a blockchain platform aimed at airlines and aircraft maintenance companies. The blockchain of assets contains records of maintenance and repair work and supply chain information with the aim of facilitating information consolidation, documentation and verification to increase efficiency and lower operating costs. Another incubatee, Block Dynamics, built a sourcing platform for a French waste management company based on blockchain technology that allows material suppliers to submit quotations in real-time during sealed-bid auctions to assist the company in lowering its supply costs. Block Dynamics is also developing a blockchain platform to assist corporates and individuals in monitoring their carbon footprint.

Blockchain technology can also be deployed for funding allocation and to lower administrative costs. For example, Shanzhai City, another Cyberport incubatee, provides a blockchain platform to social welfare organisations to record information on funding, grants and internal administrative costs such that government grants and charitable donations can be better allocated.

The HKMA and the Bank for International Settlements (“BIS”) Innovation Hub Hong Kong Centre announced on 24 August 2021 that they are joining forces with the technology industry to build a prototype digital infrastructure that enables green investments, improves transparency on the use of proceeds, and thereby helps meet regional and global environmental and sustainability goals. The purpose of this project, named Project Genesis, was to explore the tokenisation of green bonds to enable investment in small denominations, combined with real-time tracking of environmental outputs. The HKMA welcomed the collaboration with the BIS Innovation Hub on the novel experimentation on the symbiosis of sustainability and tech with the goal that technologies such as blockchain and smart contracts, combined with the internet-of-things, could streamline the bond issuance process, improve efficiency in distribution and facilitate reporting on the use and environmental impact of green bond proceeds, thus enhancing transparency to green bond investors.

On 4 November 2021, Project Genesis was successfully concluded, with the development of two prototype digital platforms that aim to enable investment in green bonds with higher transparency and greater access to retail investors. The platforms combine smart contracts, blockchain, internet-of-things and digital assets and allow retail investors to continuously track coupon payments and the positive environmental impact that the financed projects achieve in terms of reduced carbon dioxide emissions.

There is no blockchain-specific legislation or regulatory frameworks in Hong Kong. However, blockchain and DLT technology invariably engage existing legal and regulatory regimes to some extent, depending on the particular technology in question.

In the Fintech space, on 25 October 2017 the HKMA published the ‘Whitepaper 2.0 on Distributed Ledger Technology’ (the “Second DLT Whitepaper”). This identified seven broad legal issues arising from the use of DLT, namely: (i) legal basis (validity and enforceability); (ii) data protection and privacy (accessibility, immutability and cross-border considerations); (iii) cross-border and localisation issues (cross-border data flow, legal enforceability and localisation law); (iv) smart contracts (legal basis and effects); (v) liability (governance model and liability of participants); (vi) competition / anti-trust laws (fair competition and anti-trust practice); and (vii) legal issues in specific applications (asset management, mortgages / e-conveyancing, trade finance and digital ID management).

To date, the HKMA has granted licences to eight virtual banks in Hong Kong, granting three licences on 27 March 2019, one license on 10 April 2019 and four licences on 9 May 2019. From a legal and regulatory perspective, virtual banks are subject to the same set of supervisory requirements applicable to conventional banks (albeit that some of these supervisory requirements are adapted to suit the business models of virtual banks under a risk-based and technology-neutral approach).

To date, the IA has granted four virtual insurance company licences under its Fast Track pilot scheme for applications for authorizations of new insurers owning and operating solely digital distribution channels. However, like virtual banks, virtual insurers are subject to the same set of supervisory requirements applicable to conventional insurers (including solvency, capital, and local asset requirements).

The SFC has issued a number of statements and circulars concerning cryptocurrencies and other VAs. These include, among others, a statement on a regulatory framework for VA portfolio managers, fund distributors and trading platform operators and a circular on the distribution of VA funds, each issued on 1 November 2018 (the “November 2018 Statement”, and the “November 2018 Circular”, respectively), a publication on 6 November 2019 of a position paper (the “SFC 2019 Paper”) setting out a new regulatory framework for VA trading platforms and a joint circular issued with the HKMA on 28 January 2022 (the “SFC-HKMA 2022 Circular”), setting out an updated guidance for intermediaries which wish to engage in VA-related activities, which replaced and superseded the November 2018 Circular. See the responses to questions 9-15 below for further detail.

On June 24 2022, the Hong Kong Government gazetted the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “AML Amendment Bill”) which introduces changes to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615 of the Laws of Hong Kong) (“AMLO”), bringing in a licensing regime for VA service providers (“VASPs”) and imposing statutory anti-money laundering (“AML”) and counter-terrorist financing (“CTF”) obligations on VASPs in Hong Kong (see the response to question 9 below for further detail).

The Hong Kong Government and the key Hong Kong regulators have each launched various initiatives aimed at promoting the use of blockchain and DLT (see the response to question 6 below). Equally, the Government and the key regulators have each expressed caution as to the risks that come with such technology.

This balanced approach is reflected in the HKMA’s Second DLT Whitepaper (described in the response to question 4 above and the response to question 7 below), which on the one hand stresses the importance and value of DLT technology, whilst on the other hand emphasising the attendant operational and legal / regulatory risks.

Similarly, whilst the SFC has developed a new regulatory approach for VAs (referred to in the response to question 4 above), it has also expressed caution in a number of circulars and statements warning investors about the risks of investing in cryptocurrencies and other VAs and of participating in ICOs and STOs (see the responses to questions 9-15 below for further detail). In its 2021 annual report, the HKMA indicated that it will continue to facilitate the digitalisation of banks’ operations and adoption of Regtech, strengthen its research efforts on wholesale and retail central bank digital currency (“CBDC”), explore next-generation data infrastructure to enable more efficient financial intermediation, and enhance the Fintech talent pool. The HKMA also stated that, to explore the application of new technologies in financial services and facilitate financial innovation, it will continue its research into emerging technologies such as federated learning and blockchain, and maintain close collaboration with its strategic partners and key stakeholders both locally and abroad. In addition, the HKMA stated that it will draw up an appropriate regulatory regime in Hong Kong for cryptoassets particularly payment-related stablecoins, considering, among others, the feedback received on its Discussion Paper on cryptoassets and Stablecoins released in January 2022 (the “2022 Stablecoin Discussion Paper”).

Please refer to question 2 above for further detail in relation to the regulatory approach in respect of risks associated with NFTs as set out in the 2022 SFC Reminder.

Please refer to the response to question 3 above for further detail in relation to Project Genesis, a collaborative project between the HKMA, the BIS Innovation Hub Hong Kong Centre and companies in the technology industry.

The Fintech Facilitation Office (FFO), established by the HKMA in 2016, facilitates the development of the Fintech ecosystem in Hong Kong and promotes Hong Kong as a Fintech hub in Asia. In September 2017, the HKMA announced seven initiatives to prepare Hong Kong to move into a “new era of smart banking”, namely: (i) the Faster Payments System (supporting the use of mobile phone numbers or email addresses for payments in Hong Kong dollar and Renminbi anytime and anywhere); (ii) an enhanced Fintech Supervisory Sandbox (originally launched in September 2016); (iii) the promotion of virtual banking; (iv) the ‘banking made easy’ initiative (through a new taskforce set up to work with the banking industry); (v) open application programming interface (API) for the banking industry (a computer programming approach for facilitating exchange of information and executing instructions between different computer systems); (vi) cross-border collaboration with regulators in other jurisdictions; and (vii) enhanced collaboration with the Hong Kong Applied Science and Technology Research Institute, Science Park and Cyberport to promote the introduction of new technology and processes.

The SFC has established a Fintech Advisory Group in order to: (i) obtain information on the latest trends of Fintech; (ii) collect stakeholders’ input on specific Fintech themes; (iii) identify the opportunities, risks and regulatory perimeter implications of Fintech; and (iv) broaden the understanding of Fintech as an evolution of the financial services industry. The SFC has also established the SFC Regulatory Sandbox to provide a confined regulatory environment for qualified firms to operate regulated activities under the SFO before Fintech is used on a larger scale. The SFC has also entered into a number of Fintech cooperation agreements with its counterparts in other jurisdictions.

The IA has launched various initiatives to promote Insurtech development in Hong Kong, including: (i) the Insurtech Sandbox; (ii) a fast track for applications for authorization of new insurers owning and operating solely digital distribution channels; (iii) the Insurtech Facilitation Team (to enhance communication with business involved in the development and application of Insurtech in Hong Kong, as well as to promote Hong Kong as an Insurtech hub in Asia); (iv) the Working Group on Embracing Fintech in Hong Kong under the Future Task Force (focusing on promoting the application of Fintech in the insurance industry); and (v) the entry into cross-border cooperation agreements with regulators in other jurisdictions.

The HKMA, the SFC and the IA are members of the Global Financial Innovation Network, to which firms can apply to conduct cross-border tests of innovative financial products or services.

The HKMA and the BIS Innovation Hub Hong Kong Centre have joined forces with the technology industry through Project Genesis to explore the tokenisation of green bonds enabling investment in small denominations, combined with real-time tracking of environmental outputs. The project will experiment on the symbiosis of sustainability and tech with the goal that technologies such as blockchain and smart contracts, combined with the internet-of-things, will streamline the bond issuance process, improve efficiency in distribution and facilitate reporting on the use and environmental impact of green bond proceeds, thus enhancing transparency to green bond investors (see the response to question 3 above for further detail).

In June 2021, the HKMA commenced Project e-HKD, a retail or general-purpose CBDC project that aims to study the feasibility of e-HKD. The project comprises of two components: (i) a technology experimentation study; and (ii) a comprehensive study of other issues, including legal and policy considerations. On 4 October 2021, the HKMA released a technical whitepaper on retail CBDC, titled “e-HKD: A technical perspective” (the “White Paper”) as of part of the technology experimentation study under Project e-HKD. The White Paper explores potential architectures and design options that could be applied to the construction of the infrastructure for distributing e-HKD, and reports the initial thoughts and findings. The proposed architecture consists of two layers: (i) a wholesale system for the central bank to issue and redeem CBDC; and (ii) a retail system for commercial banks to distribute and circulate either retail CBDC or CBDC-backed e-money. Based on an initial, preliminary analysis of the proposed architecture, the HKMA has identified a number of areas for further discussion and has invited comments from academia and the industry on the proposed architecture by making reference to the seven problem statements listed in the White Paper. Subsequently, on 27 April 2022, the HKMA released a discussion paper titled “e-HKD: A policy and design perspective” which focused on the policy and design aspects of introducing the e-HKD. The issues examined in the study include the potential benefits and challenges, design considerations such as issuance mechanism, interoperability with other payment systems, privacy and data protection and legal considerations, as well as use cases.

In October 2021, the HKMA and the People’s Bank of China (the “PBoC”) jointly announced that the two authorities have signed the “Memorandum of Understanding on Fintech Innovation Supervisory Cooperation in the Guangdong-Hong Kong-Macao Greater Bay Area (GBA)”. By signing the Memorandum of Understanding, the two authorities have agreed to link up the PBoC’s Fintech Innovation Regulatory Facility with the HKMA’s Fintech Supervisory Sandbox in the form of a “network”, aiming to provide a “one-stop platform” to allow eligible financial institutions and technology firms to conduct pilot trials of cross-boundary Fintech initiatives, concurrently in Hong Kong and Mainland Greater Bay Area cities.

In December 2021, the HKMA launched a new Fintech module under the Enhanced Competency Framework for banking practitioners, covering practical skill sets such as Fintech application, artificial intelligence, big data, blockchain technology and regulatory technology, to enhance the professional competence of Fintech practitioners.

The HKMA commissioned ASTRI to conduct an in-depth and open-minded research project on the deployment of DLT. ASTRI delivered the first stage of the project results on 11 November 2016 with the publication of the first ‘Whitepaper on Distributed Ledger Technology’ (the “First DLT Whitepaper”). The First DLT Whitepaper introduced the technology in detail and described three Proof-of-Concept (“PoC”) projects on which the HKMA had worked with ASTRI and five leading banks, namely Bank of China (Hong Kong) Limited, The Bank of East Asia Limited, Hang Seng Bank Limited, the Hongkong and Shanghai Banking Corporation Limited, and Standard Chartered Bank (Hong Kong) Limited, and their progress. It further reflected on a number of issues relating to governance, risk management, compliance, security and privacy, and legal matters that were identified during the PoC projects.

The Second DLT Whitepaper, published on 25 October 2017, provided an update and overview of the development of DLT and outlined lessons taken from the three PoC projects. It also suggested some key principles relating to issues of governance, control measures and security management for DLT, and described common legal and compliance issues encountered when deploying DLT, along with some possible steps to address these issues. The HKMA received professional input from Deloitte and PwC in relation to issues of governance, control measures and security management in the deployment of DLT, as well as professional contributions from The Law Society of Hong Kong and academic input from law professors Dirk Zetzsche, Ross Buckley and Douglas Arner dealing with the privacy and legal issues identified.

The HKMA noted in its concluding remarks in the Second DLT Whitepaper that the HKMA has always adopted a risk-based, technology-neutral approach to regulation, with its goal for the two Whitepapers being to help the industry better understand the specific potential of DLT as well as related issues surrounding its implementation. Finally, the HKMA reminded individual organisations deploying DLT that they have a responsibility to strike the right balance between innovation, customer protection and risk management.

The Second DLT Whitepaper confirmed the promising nature of DLT, whilst acknowledging that it cannot be a universal solution for all financial applications. The HKMA noted on its publication that the experts taking part in the research had confirmed that the issues identified in the first whitepaper are valid and that many of them would need new thinking to overcome. Whilst the HKMA noted that the solution will depend on the precise application in question, the Second DLT Whitepaper nonetheless provides broad advice in areas such as the importance of governance structure and its implications on the level of control and liability acceptable to participants, how a hybrid model of DLT and traditional database may be used to resolve the immutable nature of DLT in the storage of personal data, the limits of smart contracts, and the need of adequate security and controls over the operating environment of DLT.

The HKMA sees the next step as being for it to work with the banking industry and the Fintech community to turn the findings and advice in the Second DLT Whitepaper into a set of practical guidelines for the use of DLT in the banking sector in the future.

In its 2022 Stablecoin Discussion Paper, the HKMA set out its thinking on the regulatory approach for cryptoassets particularly payment-related stablecoins. The approach has taken into account, among other things, the international recommendations, the market and regulatory landscape locally and in other major jurisdictions, and the characteristics of payment-related stablecoins. The HKMA has indicated that it aims to introduce the new regulatory regime for stablecoins no later than 2023/24 after receiving feedback and assessing the need to issue further documents on specific aspects of the regulatory framework in 2022/23.

In addition, in the 2022 SFC Reminder the SFC highlighted that there are risks associated with investing in NFTs. See the response to question 2 for further detail.

As noted in the response to question 2 above, the SFC has issued a number of statements and circulars concerning cryptocurrencies and other VAs. These are discussed further in the responses to questions 9-15 below.

Financial regulation

The Hong Kong Government and the major Hong Kong regulators, as well as the Hong Kong Police Force, have issued numerous public warnings concerning cryptocurrencies and other VAs.

These began with a warning published by the Hong Kong Police Force in 2014 concerning virtual commodities trading and, specifically, Bitcoin. The warning referred to advice from the HKMA that Bitcoin falls outside the regulatory ambit of the HKMA on the basis that it is not considered as legal tender but as a virtual commodity, which is not backed by any physical items, issuers or the real economy, so has no fixed value. The warning noted that: virtual commodities pose considerable security risks to consumers; the possible cyber-security loopholes of Bitcoin trading platforms may lead to the loss of virtual commodities; due to the anonymous nature of virtual commodities transactions, there have been criminals using Bitcoins as a means of money laundering; as Bitcoin is not money, but rather a highly speculative virtual commodity, people should pay more attention to the risk when trading or engaging in related investment activities; and where people come across any property, which they know or suspect to be crime proceeds, they should make a suspicious transaction report (STR) to the Joint Financial Intelligence Unit (JFIU).

This was followed by a statement published on 26 April 2014 by the Money Service Supervision Bureau of the Customs and Excise Department, which is responsible for the regulation money service operators, comprising remittance agents and money changers, under the AMLO. The purpose of the statement was to remind money service operator licence applicants and members of the public that, for the purposes of AMLO, Bitcoin or other similar virtual commodities are not “money” and do not fall within the regulatory regime administered by the Customs and Excise Department.

Next came a press release from the HKMA published on 11 February 2015, noting that the HKMA had reminded the public through the media about the risks involved in Bitcoin trading. The press release reiterated that Bitcoin is not a legal tender but a virtual “commodity” and that as it 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. The press release concluded that Bitcoin and other similar virtual commodities are not regulated by the HKMA and that given the highly speculative nature of Bitcoin, the HKMA would like to remind the public to exercise extra caution when considering making transactions or investments with Bitcoin.

In a circular to authorized institutions published on 18 March 2018 (the “HKMA BCBS Circular”), the HKMA endorsed the statement on cryptoassets issued by the Basel Committee on Banking Supervision (“BCBS”) on 13 March 2019 (the “BCBS Statement”), setting out the BCBS’ prudential expectations regarding banks’ exposures to crypto-assets and related services in jurisdictions where banks are involved in such business activities. The HKMA circular noted that as the BCBS explains its statement: cryptoassets do not reliably provide the standard functions of money and are unsafe to rely on as a medium of exchange or store of value; such assets are not regarded as legal tender and are not backed by any government or public authority; and the BCBS is of the view that the continued growth of cryptoasset trading platforms and new financial products related to cryptoassets has the potential to raise financial stability concerns and increase risks faced by banks. The HKMA statement emphasised that it expects authorized institutions to take note of the BCBS’ statement and its prudential expectations, and that authorized institutions planning to engage in activities relating to cryptoassets should discuss with the HKMA and demonstrate that they have put in place appropriate systems and controls to identify and manage any risks associated with such activities. The HKMA’s statement followed similar remarks made by its then-Chief Executive, Norman T.L. Chan, in his keynote speech on 21 September 2018 at the Treasury Markets Summit 2018: “Cryptoassets and Money” (the “HKMA Cryptoasset Keynote Speech”).

The Hong Kong Government has also expressed concern over the risks to the Hong Kong public posed by investments in cryptocurrencies and ICOs. This was reflected in the joint launch, on 29 January 2019, by the FSTB and the Investor Education Centre (IEC), a subsidiary of the SFC, of a public education campaign aimed at providing the public with an understanding of the potential risks of participating in ICOs and cryptocurrency transactions.

The SFC had also expressed caution in a number of circulars and statements warning investors about the risks of investing in cryptocurrencies and other VAs and participating in ICOs and STOs, details of which are set out below. However, we note that based on the 2021 IMF Report, given the general decline in ICO activity, the SFC does not currently consider ICOs to be a significant source of risk to investors.

The first was a circular published on 16 January 2014, providing guidance to licensed corporations and associated entities on measures to mitigate the money laundering and terrorist financing risks associated with virtual commodities such as Bitcoin. This was followed by another circular on 21 March 2014, drawing attention to the press statement issued by the Hong Kong Government on 14 March 2014 warning the public of various risks associated with any trading or dealing in virtual commodities.

These were followed on 5 September 2017 by the SFC’s statement on ICOs, the purpose of which was to explain that, depending on the facts and circumstances of an ICO, digital tokens that are offered or sold may be “securities” as defined in the SFO, and therefore subject to the securities laws of Hong Kong. More specifically: (i) where digital tokens offered in an ICO represent equity or ownership interests in a corporation, these tokens may be regarded as “shares” (for example, token holders may be given shareholders’ rights, such as the right to receive dividends and the right to participate in the distribution of the corporation’s surplus assets upon winding up); (ii) where digital tokens are used to create or to acknowledge a debt or liability owed by the issuer, they may be considered as a “debenture” (for example, an issuer may repay token holders the principal of their investment on a fixed date or upon redemption, with interest paid to token holders); (iii) if token proceeds are managed collectively by the ICO scheme operator to invest in projects with an aim to enable token holders to participate in a share of the returns provided by the project, the digital tokens may be regarded as an interest in a CIS. Shares, debentures and interests in a CIS are all regarded as “securities”.

The statement went on to explain that where the digital tokens involved in an ICO fall under the definition of “securities”, dealing in or advising on the digital tokens, or managing or marketing a fund investing in such digital tokens, may constitute a “regulated activity”; and that parties engaging in a “regulated activity” are required to be licensed by or registered with the SFC irrespective of whether the parties involved are located in Hong Kong, so long as such business activities target the Hong Kong public. In addition, where an ICO involves an offer to the Hong Kong public to acquire “securities” or participate in a CIS, registration or authorisation requirements under the law may be triggered unless an exemption applies. The statement also noted that parties engaging in the secondary trading of such tokens (e.g. on cryptocurrency exchanges) may also be subject to the SFC’s licensing and conduct requirements; and that certain requirements relating to automated trading services and recognised exchange companies may be applicable to the business activities of cryptocurrency exchanges.

This was followed on 11 December 2017 by an SFC circular on Bitcoin futures contracts (“Bitcoin Futures”) and cryptocurrency-related investment products, the primary purposes of which were to remind intermediaries of the legal and regulatory requirements for providing to Hong Kong investors any financial services in relation to Bitcoin Futures and other cryptocurrency-related investment products, as well as to remind investors of the risks associated with these products. The SFC also issued, on 6 November 2019, the 2019 SFC Paper, warning investors about the risks associated with the purchase of VA (e.g. Bitcoin) futures contracts, focusing on the fact that they are largely unregulated, highly leveraged and subject to extreme price volatility. The 11 December 2017 circular and the 2019 SFC Paper are discussed further in the response to question 14 below.

On 9 February 2018, the SFC released a statement again alerting investors to the potential risks of dealing with cryptocurrency exchanges and investing in ICOs. The statement disclosed that the SFC had sent letters to seven cryptocurrency exchanges in Hong Kong or with connections to Hong Kong warning them that they should not trade cryptocurrencies which are “securities” as defined in the SFO without a licence. The statement disclosed that the SFC had also written to seven ICO issuers. Finally, the statement noted that whilst the SFC may not have jurisdiction over cryptocurrency exchanges and ICO issuers if they have no nexus with Hong Kong or do not provide trading services for cryptocurrencies which are “securities” or “futures contracts” as defined in the SFO, if there is suspicion of fraud the SFC is open to refer cases to the Hong Kong Police Force for investigation.

On 28 March 2019, the SFC published a statement on STOs, again reminding investors to be wary of the risks associated with VAs, but this time focusing on tokens which are the subject of STOs (“Security Tokens”). This is discussed further in the response to question 14 below.

Whilst some have expressed the view that the SFC has at times overreached in its proclamations concerning types of VAs or ICOs / STOs which fall outside the scope of its regulatory jurisdiction, the general consensus is that it has acted in a manner consistent with its functions as a front-line financial regulator in Hong Kong, in particular that of investor protection. The SFC’s approach to the regulation of activities relating to VAs falling within the scope of its regulatory jurisdiction is discussed below.

As mentioned in the response to question 4 above, on 1 November 2018 the SFC published the November 2018 Circular and the November 2018 Statement, which together set out a regulatory approach for VAs. The measures aim to regulate the management and distribution of VA funds so that investors’ interests are protected at either the fund management level or distribution level or both. The measures do not, however, amend the law or the definitions of “securities” or “futures contracts”. Instead, they clarify then existing requirements and impose new requirements primarily in the form of licensing conditions on intermediaries.

The November 2018 Circular has been replaced and superseded by the SFC-HKMA 2022 Circular (as further detailed below).

The primary purpose of the November 2018 Statement is to provide guidance on the regulatory standards expected of VA portfolio managers and fund distributors, in order to address the significant risks associated with investing in VAs. The key takeaways are summarised below. The November 2018 Statement explains that the SFC supervises the following types of VA portfolio managers: (i) managers who manage and distribute a Fund that invests in VAs (including managers who do not require a Type 9 (asset management) licence because the Fund does not invest in “securities” or “futures contracts” as defined under the SFO, but who distribute the Fund and hence require a Type 1 (dealing in securities) licence, unless an exemption applies); and (ii) managers who are asset managers of a Fund that holds “securities” or “futures contracts” as defined under the SFO (and who therefore require a Type 9 (asset management) licence to manage such securities or futures contracts). Where such managers falling within (i) or (ii) above manage portfolios which invest solely or partly in VAs that are not “securities” or “futures contracts” as defined under the SFO, such management will be subject to SFC oversight through the imposition of licensing conditions. This oversight is subject to a de minimis threshold that the Fund has a stated investment objective to invest in VAs, or there is an intention to invest 10% or more of the gross asset value of the Fund portfolio in VAs (the “De Minimis Threshold”). The managers falling within (i) or (ii) above should observe essentially the same regulatory requirements, regardless of whether or not the Fund invests in VAs. With this in mind, the SFC has developed a set of ‘Terms and Conditions’ for licensed corporations, capturing the essence of the existing requirements, adapted as needed in the context of VAs. They will likely be imposed as licensing conditions, subject to minor variations depending upon the particular asset manager. As well as the De Minimis Threshold exemption, the Terms and Conditions will also not apply to licensed corporations which only manage fund of funds that have portfolios investing in VA funds. Some of the key Terms and Conditions are set out in Appendix 1 to the November 2018 Statement.

The November 2018 Statement also set out (in Appendix 2) details of a conceptual framework to explore the regulation, on a voluntary basis, of VA trading platform operators. Those platforms that become regulated and thereby adhere to a high level standards and practices would be set aside from unlicensed operators. Such interested platforms would first be placed in the SFC Regulatory Sandbox for observance by the SFC (which would include assessing whether the platform is indeed appropriate to the regulated by the SFC, and whether inherent risks can be appropriately dealt with).

Building on the key Terms and Conditions set out in Appendix 1 to the November 2018 Statement, on 4 October 2019 the SFC published more detailed proforma terms and conditions for VA portfolio managers (the “Proforma Terms and Conditions”). The Proforma Terms and Conditions will be imposed as licensing conditions on licensed corporations that manage a fund (or portion of a fund) that invests in VAs as defined in the Proforma Terms and Conditions and which meet the De Minimis Threshold. The Proforma Terms and Conditions define VAs as: “digital representations of value which may be in the form of digital tokens (such as digital currencies, utility tokens or security or asset backed tokens), any other virtual commodities, crypto assets or other assets of essentially the same nature, irrespective of whether they amount to “securities” or “futures contracts” as defined under the SFO”. The key areas covered by the Proforma Terms and Conditions include: (i) general principles (similar to those under the Code of Conduct for Persons Licensed by or Registered with the SFC (the “SFC Code”) but tailored for VAs); (ii) organisation and management structures (including detailed risk management control techniques and procedures at Appendix 2); (iii) VA fund management; (iv) custody of fund assets and client money; (v) operations; (vi) dealing with the fund and fund investors (including provision of adequate information to investors); (vii) marketing activities (including only allowing professional investors to invest in VA funds (other than other than CISs authorised by the SFC)); (viii) fees and expenses; and (ix) reporting to the SFC. Contravention of a licensing condition is likely to be considered misconduct under the SFO which will reflect adversely on the fitness and properness of a VA fund manager to remain licensed and may result in disciplinary action by the SFC. However, the SFC notes that it will adopt a pragmatic approach taking into account all relevant circumstances, including the size of the VA fund manager and any compensatory measures implemented by its senior management.

On 3 April 2020, Venture Smart Asia Limited (“VSAL”), which had held Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activity licences from the SFC since 2015, became the first asset manager to be approved by the SFC as a VA portfolio manager via the imposition of the Proforma Terms and Conditions. On 20 April 2020, Arrano Capital, the blockchain arm of VSAL, announced the launch of the first cryptocurrency fund in Hong Kong to have an advisor and distributor – i.e. VSAL – that is licensed and approved by the SFC. The fund comprises Digitrackers SPC and its first Segregated Portfolio, Digitrackers Bitcoin SP, a Cayman Islands exempted limited segregated portfolio company and segregated portfolio respectively. Arrano Capital acts as offshore adviser to the fund, whilst VSAL acts as onshore advisor and distributor.

Building on the conceptual framework set out in Appendix 2 to the November 2018 Statement, on 6 November 2019 the SFC published the 2019 SFC Paper setting out a new regulatory framework for VA trading platforms (the “opt-in regime”). Like the original conceptual framework, the opt-in regime effectively applies on a voluntary basis. This is achieved under the opt-in regime by platform operators who wish to be licensed ensuring that they offer trading on their platform of at least one “security token” – being VAs which fall within the definition of “securities” under the SFO. This means that the platform operator will fall within the regulatory jurisdiction of the SFC and require a licence for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities. The position paper emphasises that the SFC will only grant licences to platform operators which are capable of meeting robust regulatory standards, being standards comparable to those which apply to licensed securities brokers and automated trading venues but which also incorporate additional requirements to address specific risks associated with VAs. For example, the SFC will impose licensing conditions requiring that platform operators offer their services exclusively to professional investors, only service clients who have sufficient knowledge of VAs and maintain stringent criteria for the inclusion of VAs on their platforms. In addition, licensed platforms will be placed in the SFC Regulatory Sandbox for a period of close and intensive supervision. However, the position paper also makes it clear that, even if the SFC licenses and supervises a VA trading platform, the non-”security token” VAs traded on the platform are not subject to the authorisation or prospectus registration provisions that apply to traditional offerings of securities or CISs. Moreover, the SFC has no power to grant a licence to or supervise platforms which only trade VAs or tokens which are not “security tokens”.

As mentioned above, the November 2018 Circular has been replaced and superseded by the SFC-HKMA 2022. The SFC-HKMA 2022 Circular covers: (i) distribution of VA-related products; (ii) provision of VA dealing services; (iii) provision of VA advisory services; and (iv) implementation of the requirements, as follows:

• Distribution of VA-related products – the SFC-HKMA 2022 Circular highlights the risks associated with such distribution, including those services provided by trading platforms, which may be unregulated or only regulated only for AML and CTF. For the purpose of additional investor protection measures on the distribution of VA-related products, the SFC and the HKMA are of the view it would be necessary to impose: (i) selling restrictions, as (other than certain derivatives products) VA-related products are generally considered complex products and should only be offered to professional investors; and (ii) a VA-knowledge test, such that intermediaries should assess whether clients have knowledge of investing in VAs or VA-related products prior to effecting a transaction in VA-related products on their behalf, including non-exhaustive criteria for such assessment in the appendix to the SFC-HKMA 2022 Circular. The SFC and the HKMA also reminded intermediaries to observe the selling restrictions in Hong Kong and other jurisdictions which may be applicable to a particular VA-related product, in particular the provisions in Part IV of the SFO which prohibits the offering to the Hong Kong public of investments which have not been authorised by the SFC.
• Provision of VA dealing services – to provide adequate investor protection, intermediaries should partner only with SFC-licensed VA trading platforms for the provision of VA dealing services, whether by way of introducing clients to the platforms for direct trading or establishing an omnibus account with the platforms. Such services should only be provided to professional investors. Although VA dealing services may involve trading in non-security VAs which falls outside the SFC’s jurisdiction, such services may have an impact on an intermediary’s fitness and properness to conduct regulated activities. Trading activities involving VAs also form part of the dealing services provided by intermediaries. Accordingly, intermediaries are expected to comply with all the regulatory requirements imposed by the SFC and the HKMA when providing VA dealing services, irrespective of whether or not the VAs involved are securities. Furthermore, such services should only be provided to the intermediaries’ existing clients to which they provide services in Type 1 regulated activity. With respect to VA discretionary account management services, licensed corporations providing services which meet the De Minimis Threshold and are subject to additional requirements set out in the Proforma Terms and Conditions.
• Provision of VA advisory services – intermediaries are expected to comply with all the regulatory requirements imposed by the SFC and the HKMA when providing advisory services, irrespective of the nature of the VAs, and such services should only be provided to intermediaries’ existing clients to which they provide services in Type 1 or Type 4 regulated activities. The expected conduct requirements for VA-advisory services are set out in the prescribed terms and conditions in an appendix to the SFC-HKMA 2022 Circular. In particular, intermediaries providing VA-advisory services are expected to observe the suitability obligations. They should offer such services only to professional investors and conduct a VA-knowledge test before providing them.
• Implementation of the requirements – the SFC and the HKMA understand that intermediaries which already engage in VA-related activities may wish to revise their systems and controls to align with the updated requirements. Accordingly, there will be a six-month transition period for intermediaries when serving existing clients of its VA-related activities before the full implementation of the expected requirements in this circular. Intermediaries which do not currently engage in VA-related activities should ensure that they are able to comply with the requirements in the SFC-HKMA 2022 Circular before introducing such services.

Please also refer to question 2 above for the current regulatory approach in respect of risks associated with NFTs as set out in the 2022 SFC Reminder.

Anti-money laundering and counter-terrorist financing

On 3 November 2020, the FSTB published a consultation paper on legislative proposals to enhance AML and CTF regulation in Hong Kong through the introduction of, amongst other measures, a new licensing regime for VASPs. In May 2021, the FSTB published the consultation conclusions to the public consultation. Based on these consultation conclusions, on June 24, 2022, the Hong Kong Government gazetted the AML Amendment Bill which will introduces changes, including a new licensing regime for VASPs, to the AMLO. The AML Amendment Bill will come into effect on 1 March 2023.

Under the amendments, any person carrying on a business of providing a VA service, being operating a VA exchange in Hong Kong, or holding themselves out as doing so, will need be licensed as a VASP by the SFC.
Operating a VA exchange will be defined as providing services through means of electronic facilities: (i) whereby: (a) offers to sell or purchase VAs are regularly made or accepted in a way that forms or results in a binding transaction; or (b) persons are regularly introduced, or identified to others so that they can negotiate or conclude (or have a reasonable expectation of negotiating or concluding) sales or purchases of VAs; and (ii) where client money or client VAs comes into the direct or indirect possession of the person providing the service.

VAs will be broadly defined as a cryptographically secured digital representation of value that: (i) is expressed as a unit of account or a store of economic value; (ii) either: (a) is used, or intended to be used, as a medium of exchange accepted by the public for payment for goods or services, for the discharge of a debt and/or for investment; or (b) provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with, or to vote on any change of the terms of any arrangement applicable to, any cryptographically secured digital representation of value; (iii) can be transferred, stored or traded electronically; and (iv) satisfies other characteristics prescribed by the SFC. This definition expressly excludes a digital representation of value if it: (i) is (a) issued by a central bank or by an entity that performs the functions of a central bank or by an entity authorized by a central bank on its behalf; or (b) issued by a government of a jurisdiction, or by an entity authorized by the government of a jurisdiction and acting pursuant to an authority to issue currency in that jurisdiction; (ii) is a limited purpose digital token; (iii) constitutes securities or future contract; or (iv) constitutes any float or SVF deposit of a stored value facility.

An applicant for a VASP licence, its responsible officers, licensed representatives, directors and ultimate owners will be required to satisfy a fit and proper test. The factors which the SFC will take into consideration in determining whether a person is fit and proper are modelled on the fit and proper requirements under the SFO. The requirements include: (i) the person’s financial status or solvency; (ii) the person’s educational or other qualifications or experience; (iii) the person’s ability to provide the VA services competently, honestly and fairly; (iv) the person’s reputation, character, reliability and financial integrity; (v) whether the person has been convicted of certain offences; and (vi) whether the person has failed to comply with the requirements under the AMLO.

Licensed VASPs will be subject to the AML and CTF requirements of the AMLO, including the customer due diligence and record-keeping requirements set out in Schedule 2 of the AMLO. In the case of non-compliance by a VASP with the statutory AML and CTF obligations, both the VASP and its responsible officers will commit an offence carrying maximum penalties of a HK$1 million fine and two years’ imprisonment.

In the 2022 Hong Kong Money Laundering and Terrorist Financing Risk Assessment Report published by the Hong Kong Government, the Hong Kong Government has warned that as a new segment of the banking sector, virtual banks have been targeted to test vulnerabilities and launder crime proceeds derived from deception cases and illegal gambling activities. The Hong Kong Government has noted that virtual banks have responded swiftly to the emerging threats, as reflected by their Suspicious Transaction Report filing and contributions to platforms such as Fraud & Money Laundering Intelligence Taskforce.

Taxation

On 27 March 2020, the Hong Kong Inland Revenue Department (“IRD”) published a revised version of Departmental Interpretation and Practice Note No. 39, renamed ‘Profits tax – Digital Economy, Electronic Commerce and Digital Assets’, which includes a new section on digital assets. This provides that, broadly, the profits tax treatment of digital assets will depend on their nature and use. Some more specific illustrations of this general principle in the context of different types of digital assets / transactions are summarised below.

• ICOs: The IRD would review an ICO’s white paper or any other underlying documents of an ICO and examine what rights and benefits (e.g. equity interests or a right to access to a future service similar to a voucher) are attached to the digital tokens. From the perspective of the issuer, the tax treatment of the proceeds from an ICO generally follows from the attributes of the tokens that are issued. It is the nature of the rights and obligations of the tokens, not the form in which the tokens are issued, that determine the tax treatment.
• Digital assets held for investment: Profits arising from the sale of capital assets are excluded from the charge of profits tax. If digital assets are bought (e.g. through ICO or exchange platform) for long-term investment purposes, any profits from disposal would not be chargeable to profits tax. Whether the digital assets are capital assets or trading stock has to be considered on the basis of the facts and circumstances. Well-established tax principles like the “badges of trade” would continue to be applicable and the intention at the time of acquisition of the digital assets is always relevant to decide whether they are capital assets or trading stock.
• Cryptocurrency: Hong Kong sourced profits from cryptocurrency business activities are chargeable to profits tax. In deciding the source of profits, it is necessary to ascertain the nature of the profits in question, the person’s relevant operations that produced the profits in question and the place where those profit-generating operations were carried out; i.e., the usual principles will apply. The question whether the buying and selling of cryptocurrency, exchange of cryptocurrency or mining of cryptocurrency amounts to the carrying on of a trade or business is a matter of fact and degree to be determined upon a consideration of all the circumstances. Factors such as the degree and frequency of the activity, the level of system or organisation (i.e. whether the activity is undertaken in a business-like manner) and whether the activity is done for the purpose of making a profit are relevant considerations.

Although the use or trading of cryptocurrencies is not prohibited in Hong Kong, the Hong Kong Police Force, as well as a number of Hong Kong regulators including the HKMA, the SFC and the Customs and Excise Department, have published statements or circulars warning investors of the risks associated with investing in or trading in cryptocurrencies, as described in the response to question 9 above.

In addition, the SFC’s statements on ICOs published on 5 September 2017 and 9 February 2018 respectively warned market participants that, depending on the facts and circumstances of an ICO, digital tokens that are offered or sold may be “securities” as defined in the SFO, and therefore subject to the securities laws of Hong Kong. The latter statement also disclosed that the SFC had sent letters to seven cryptocurrency exchanges in Hong Kong or with connections to Hong Kong warning them that they should not trade cryptocurrencies which are “securities” as defined in the SFO without a licence. The statement also disclosed that the SFC had written to seven ICO issuers.

In March 2018, the SFC confirmed that ICO issuer Black Cell Technology Limited (“Black Cell”) had halted its ICO to the Hong Kong public and agreed to unwind ICO transactions for Hong Kong investors by returning them the relevant tokens, following regulatory action by the SFC over concerns that Black Cell had engaged in potential unauthorized promotional activities and unlicensed regulated activities. In addressing SFC’s regulatory concerns, Black Cell agreed not to devise, set up or market any scheme that constitutes a CIS unless in compliance with the relevant requirements under the SFO. This followed the SFC’s finding that Black Cell had promoted an ICO to sell digital tokens to investors through its website accessible by the Hong Kong public, with the pitch that the ICO proceeds would be used to fund the development of a mobile application and holders of the tokens would be eligible to redeem equity shares of Black Cell. The SFC considered that the arrangement may constitute a CIS.

As noted in the response to question 9 above, the AMLO will prohibit a person, whether in Hong Kong or elsewhere, from actively marketing to the Hong Kong public a regulated VA activity or associated services, unless that person is properly licensed and regulated by the SFC to carry out the regulated VA activity (see the response to question 9 above for further detail).

Hong Kong had emerged as a leading Asian ICO hub, likely due in part to the PBoC’s announcement in September 2017 of an outright ban on ICOs in China.

According to a joint report published in January 2020 by PricewaterhouseCoopers (“PwC”) and Crypto Valley, Hong Kong was one of the leading token offering jurisdictions worldwide throughout 2018 and 2019 (as at 31 October 2019) in terms of funding volume and number of completed offerings, along with the USA, Singapore and the UK. The report also ranked Hong Kong as the leading jurisdiction for token offerings globally in 2019 by total funds raised (as at 31 October 2019), with a total of USD1,009 million raised through 4 closed offerings. However, this was accounted for primarily by the USD1,000 million raised by cryptocurrency exchange Bitfinex in May 2019.

In addition to Bitfinex, other notable examples of successful Hong Kong ICOs include: (i) Gatcoin, which offers a solution for businesses to transform their traditional discount coupons, shopping vouchers and loyalty points into digital tokens, and which raised US$14.5 million in January 2018; (ii) AirSwap, which is developing a decentralized cryptocurrency marketplace and which raised US$36 million in October 2017; and (iii) the OAX Foundation, which is building a decentralized cryptocurrency exchange platform and which raised US$18 million in July 2017.

However, as mentioned in the response to questions 2 and 9 above, ICO activity has significantly declined since its peak 2018 as an active form of VA fundraising, consistent with the global decline in VA fundraising and the further regulatory scrutiny. Given such decline, as noted in the 2021 IMF Report, the SFC does not currently consider ICOs to be a significant source of risk to investors.

The SFC’s statement on ICOs published on 5 September 2017 (referred to in the response to question 9 above) explained that where the digital tokens involved in an ICO fall under the definition of “securities”, dealing in or advising on the digital tokens, or managing or marketing a fund investing in such digital tokens, this may constitute a “regulated activity”; and that parties engaging in a “regulated activity” are required to be licensed by or registered with the SFC irrespective of whether the parties involved are located in Hong Kong, so long as such business activities target the Hong Kong public.

In addition, where an ICO involves an offer to the Hong Kong public to acquire “securities” or participate in a CIS, registration requirements under the prospectus regime contained in Part II and Part XII of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32 of the Laws of Hong Kong) (in the case of an offer to the Hong Kong public to acquire “securities”) or authorisation requirements under Part IV of the SFO (in the case of an issue of offering documents of a CIS to the public of Hong Kong) may be triggered unless an exemption applies.

The statement also noted that parties engaging in the secondary trading of such tokens (e.g. on cryptocurrency exchanges) may also be subject to the SFC’s licensing and conduct requirements; and that certain requirements relating to automated trading services and recognised exchange companies may be applicable to the business activities of cryptocurrency exchanges.

Note also that any distributor which is regulated by the SFC is subject to fit and proper requirements, which extend beyond the scope of its regulated activities and so may cover an ICO product.

As described in the response to question 11 above, a joint report published in January 2020 by PwC and Crypto Valley ranked Hong Kong as one of the leading token offering jurisdictions worldwide throughout 2018 and 2019 (as at 31 October 2019) in terms of funding volume and number of completed offerings, along with the USA, Singapore and the UK.

According to a March 2019 report by CryptoCompare, a global digital currency data provider, Hong Kong ranked second globally for monthly cryptocurrency trading by volume in March 2019, based on legal jurisdiction of exchange, with US$53.1 billion worth of cryptocurrencies traded.

Local interest in cryptocurrencies saw a surge in the third quarter of 2019, with local peer-to-peer Bitcoin trading platform, LocalBitcoins, reportedly recording its highest ever weekly trading volume (in excess of HK$12 million) in the final week of September. The spike was reported by some sections of the media as being linked to the anti-government protests that started in June 2019 in response to a controversial China-sponsored extradition bill, and more specifically a perception that the Hong Kong Government had been tracking digital payment habits to follow the protestors, prompting people to switch to physical cash (demonstrated by reports of ATMs across the city running out of money) and cryptocurrencies. Since the spike in September 2019, weekly trading volumes have reduced, fluctuating between approximately HK$1 million and HK$4.3 million in the first three quarters of 2020.

The relative public appeal of cryptocurrencies can be contrasted with the generally cool reception to cryptocurrency trading amongst mainstream financial institutions in Hong Kong. This has been shaped in part by the attitude of the HKMA, as evidenced by the HKMA BCBS Circular published on 18 March 2018, in which the HKMA stated that authorized institutions planning to engage in activities relating to cryptoassets should discuss with the HKMA and demonstrate that they have put in place appropriate systems and controls to identify and manage any risks associated with such activities.

As noted in the 2021 IMF Report, in a 2019 ranking of cryptocurrency exchanges, Hong Kong was listed as the fourth-largest with 22 exchanges, after the European Union, United States and United Kingdom, and just ahead of Singapore (with 19 exchanges). Based on December 2018 data, the monthly trading volume was much larger in Hong Kong (US$32.5 billion) than in the other jurisdictions, with the exception of Malta. In 2019, Hong Kong ranked first with regards to crypto trading platform volumes, especially for crypto to crypto exchanges. In addition, there has been a notable increase in high-profile initial exchange offerings (“IEOs”), which typically involve the exclusive launch on a VA trading platform of an initial offering and sale of a token utilizing blockchain. Reportedly, the total number of funds raised by IEOs in the second quarter of 2019 exceeds US$1.4 billion.

On 26 July 2022, OSL announced that it was the first Type 1 SFC-licensed digital asset broker to distribute Security Tokens to professional investors in Hong Kong in a private STO. Each token represents a USD10,000 unit of a bitcoin-linked, coupon-rate USD bond. The tokens were developed using the Ethereum blockchain, have a three month tenor and carry a fixed and a bonus coupon linked to bitcoin performance. OSL acted as the bookrunner, placing agent, fiscal and paying agent, transfer agent, registrar, calculation agent, tokenization technology partner and trading venue for the STO transaction.

On 11 December 2017, the SFC published a circular on Bitcoin Futures and cryptocurrency-related investment products (referred to in the response to question 9 above), the primary purpose of which was to remind intermediaries of the legal and regulatory requirements for providing to Hong Kong investors any financial services in relation to Bitcoin Futures and other cryptocurrency-related investment products and the risks associated with these products. The circular was primarily in response to the launch of Bitcoin Futures on the Chicago Mercantile Exchange (“CME”), which is authorised by the SFC to provide automated trading services, meaning that Hong Kong investors may be able to trade in Bitcoin Futures through an intermediary which is a member of CME. The circular noted that Bitcoin Futures have the conventional features of a “futures contract” as defined in the SFO. Therefore, even though the underlying assets of Bitcoin Futures are not regulated under the SFO, Bitcoin Futures traded on and subject to the rules of those exchanges are regarded as “futures contracts” for the purposes of the SFO. Accordingly, parties carrying on a business in dealing in Bitcoin Futures, including those who relay or route Bitcoin Futures orders, are required to be licensed for Type 2 regulated activity (dealing in futures contracts) under the SFO unless an exemption applies. The SFC also expects that intermediaries should strictly observe the suitability requirement and the conduct requirements in relation to providing services in derivative products to clients under the SFC Code. In addition, marketing a fund investing in Bitcoin Futures will normally constitute Type 1 regulated activity (dealing in securities) and managing such a fund may constitute Type 9 regulated activity (asset management). The provision of advisory services in relation to Bitcoin Futures may also constitute Type 5 regulated activity (advising on futures contracts).

As described in the response to question 9 above, the SFC issued, on 6 November 2019, the SFC 2019 Paper warning investors about the risks associated with the purchase of VA (e.g. Bitcoin) futures contracts, focusing on the fact that they are largely unregulated, highly leveraged and subject to extreme price volatility. The statement also notes that there have been reports of market manipulative and abusive activities on platforms offering or trading VA futures contracts and that such platforms may not have clear and fair trading rules, with some platforms having been criticised by investors for changing their trading rules during the life of futures contracts, for example halting trades or rolling back transactions and causing significant losses to investors. The statement cautions that any trading platforms or persons which offer and/or provide trading services in VA futures contracts in Hong Kong without a proper licence or authorisation may be in contravention of the SFO (if the VA futures contracts are “futures contracts” as defined under the SFO) or the Gambling Ordinance (Cap. 148 of the Laws of Hong Kong) (if the VA futures contracts are “contracts for differences” as defined under the Gambling Ordinance).

On 28 March 2019, the SFC published a statement on STOs (also referred to in the response to question 9 above), again reminding investors to be wary of the risks associated with VAs, but this time focusing on Security Tokens. The circular explains that 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 or real estate) or economic rights (e.g. a share of profits or revenue) utilising blockchain technology. It goes on to explain that Security Tokens are normally offered to professional investors only and that in Hong Kong, they are likely to be “securities” as defined under the SFO and therefore subject to the securities laws of Hong Kong. Where Security Tokens are “securities” as defined under the SFO, then unless an applicable exemption applies, any person who markets and distributes Security Tokens (whether in Hong Kong or targeting Hong Kong investors) is required to be licensed or registered for Type 1 regulated activity (dealing in securities) under the SFO. Intermediaries which market and distribute Security Tokens are required to ensure compliance with all existing legal and regulatory requirements. In particular, they should comply with paragraph 5.2 of the SFC Code as supplemented by the Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons and the Frequently Asked Questions on Triggering of Suitability Obligations. Under the Guidelines on Online Distribution and Advisory Platforms and paragraph 5.5 of the SFC Code, Security Tokens would be regarded as “complex products” and therefore additional investor protection measures also apply. In addition, intermediaries are expected to observe requirements which are similar to those set out in the SFC-HKMA 2022 Circular.

The question of the extent to which legally effective transfers of title to, or granting of security over, legal tokens and VAs can be achieved will depend primarily on whether such tokens and VAs constitute “property” under Hong Kong law. To date, there has been very limited legal, regulatory or judicial consideration of this question, likely reflecting both the relative infancy of these asset types and the wide potential variance of characteristics between them.

Hong Kong is likely to follow the approach of other common law jurisdictions in this regard, which traditionally recognise property as either real property or personal property, with all personal property being either a chose in possession or a chose in action. These categorisations present difficulties when applied to tokens and VAs, which (in some cases at least) may exist solely in the form of information or data on a distributed ledger or blockchain, as opposed to being tangible (i.e. a chose in possession) or being legal rights capable of being enforced (i.e. a chose in action). Where the holders of tokens and VAs are given some form of right, then the Hong Kong courts should regard that right as a form of property.

Recent court decisions in other common law jurisdictions such as England and Singapore support the view that tokens and VAs may be recognised as property, notwithstanding that they may not sit easily within the traditional common law categories referred to above. See for example: (i) the 2012 case of Armstrong DLW GmbH v Winnington Network Ltd in the High Court of England and Wales, which recognised EU carbon trading allowances as property under English law; and (ii) the 2019 case of B2C2 Ltd v Quoine Pte Ltd in the Singapore International Commercial Court, which recognised virtual currencies as property under Singapore law.

In November 2019 the UK Jurisdiction Taskforce published a ‘Legal statement on cryptoassets and smart contracts’ which concluded that, in general, cryptoassets are to be treated in principle as property. We expect the statement to be persuasive when the Hong Kong courts consider the point.

Where tokens and VAs do constitute property under Hong Kong law, then it should be possible (subject to the terms of such assets) to transfer legal title to, and to grant security over, such assets in the same way as other intangible property.

The HKMA’s Second DLT Whitepaper, reflecting input from the Technology Committee of The Law Society of Hong Kong, provides that a smart contract may be considered as an arrangement whereby autonomous software running on a DLT platform automatically exchanges assets that are stored or represented on the DLT platform (e.g. the delivery vs payment arrangement). Whether a smart contract can be considered as a legal contract is still an open debate. However, the notion that smart contracts can be used to completely replace legal contracts or govern the relationships between participants in a DLT platform is misguided. Using a smart contract without explicit contractual terms could cause uncertainty for participants in the event of unforeseen consequences or disputes.

The Second DLT Whitepaper points to the 2016 Decentralised Autonomous Organisation (“DAO”) Ethereum hack as a wake-up call and a reminder that programming/modelling errors and complex contract interdependencies can give rise to the risk of smart contracts failing to reflect the intention of the creator. Steps must therefore be taken to ensure that, if an undesirable consequence should occur, there is already a pre-agreed governance structure and contractual framework in place to handle the situation. Furthermore, the smart contract should contain an “escape hatch” or clean path for modifying and undoing the smart contract in light of unforeseen eventualities, which would allow human intervention under strict conditions (e.g. all party approval) without realistically threatening the immutability of the smart contract.

The Annex to the Second DLT Whitepaper drafted by the Technology Committee of The Law Society of Hong Kong provides further elaboration on the concepts described above. Its starting point is that, whilst smart contracts may have the effect of a contract, they take on many forms and should not be understood simply as contractual documents in digital form. Whilst a smart contract usually contains the mechanics for execution, performance and enforcement, it may not contain the entirety of terms forming the contract at law. The relevant question is therefore what sort of legal remedies are sought and under what claims. If a party desires to seek contractual remedies and enforce the smart contract as a contract at law, then the common law contract requirements would need to be proven to have existed contemporaneously during the purported contractual relationship between the relevant parties. There may, however, be other ways to characterise the smart contract and its relationships with the relevant stakeholders, which could give rise to legal recourse. This might be founded on a legal binding contract, such as securities trading on exchange or DAOs, or some other grounds, such as negligence, restitution and fiduciary duty. The remedy of unjust enrichment – often associated with mistakes of fact or law, total failure of consideration, duress and undue influence – might be available in the case of the restitution of unjust gains resulting from a breach of a smart contract. The bottom line, however, is that given the underlying risks of modelling errors and complex contract interdependencies, the performance of each smart contract carries the risk of failing to reflect the intentions of its creators. The Law Society therefore recommends that smart contracts should be adopted only if their design follows the latest best practices and international standards, such as the “escape hatches” referred to above.

The HKMA noted in the Second DLT Whitepaper that smart contracts “have been singled out as requiring additional attention due to their huge potential for automating transactions in DLT”.

Smart contracts played a prominent role in one of the three use cases selected by the HKMA for PoC development in the First DLT Whitepaper, the results of which were reported on in the Second DLT Whitepaper – namely the trade finance PoC use case. The Second DLT Whitepaper reported that smart contracts had been used in a number of areas, namely: (i) to store the status of a transaction with a stated data structure so that enquiries can be made quickly; (ii) to distribute event-triggered logic among nodes so that finance can be provided to customers more promptly based on “triggering events” built into the smart contract; and (iii) to reconcile purchase orders and invoices automatically in the DLT network.

On 31 October 2018, the HKMA officially launched eTradeConnect, a blockchain-based trade finance platform developed by a consortium of twelve major Hong Kong banks. According to the HKMA, eTrade Connect aims to “improve trade efficiency, build better trust among trade participants, reduce risks and facilitate trade counterparties to obtain financing by digitising trade documents, automating trade finance processes and leveraging the features of blockchain technology”. eTradeConnect was subsequently connected to a similar trade finance platform built by the PBoC to facilitate cross-boundary trade finance processes. On 22 January 2020, the HKMA and the Bank of Thailand (“BOT”) published a report on Project Inthanon-LionRock, which is a joint CBDC research project studying the application of CBDC to cross-border payments. Project Inthanon-LionRock involved the development of a THB-HKD cross-border corridor network prototype, with the goal of facilitating the transfer of funds and foreign exchange transactions between participating banks in Hong Kong and Thailand on a peer-to-peer basis, ultimately simplifying the settlement process by leveraging on smart contracts. Project Inthanon-LionRock was completed in December 2019 and ten participating banks from the two jurisdictions successfully developed a DLT based PoC prototype. The 22 January 2020 report covers topics including token conversion, real-time interbank funds transfer, foreign exchange execution, liquidity management and regulatory compliance. The HKMA and the BOT also agreed to proceed with further joint research work in relevant areas, including exploring business cases and connections to other platforms, involving participation of banks and other relevant parties in cross-border funds transfer trials.

Project Inthanon-LionRock entered the second phase in 2020 and was subsequently renamed to the “Multiple Central Bank Digital Currency Bridge (“mBridge”) in February 2021. mBridge involved collaborating with the Central Bank of the United Arab Emirates and the Digital Currency Institute of the PBoC. Supported by the BIS Innovation Hub Centre in Hong Kong, mBridge further explores the potential for DLT to facilitate real-time cross-border foreign exchange payment-versus-payment transactions on a 24/7 basis in a multi-jurisdictional context.

In April 2022, the FSTB noted that the HKMA is exploring the feasibility of using mBridge for international trade settlement, and connecting it to different trade platforms to enhance efficiency of cross-border trade transactions and achieve synergy.

Building on the knowledge and experience in wholesale CBDC, in June 2021, the HKMA commenced Project e-HKD, which is a retail or general-purpose CBDC project that aims to study the feasibility of e-HKD and subsequently, on 27 April 2022, the HKMA released a discussion paper titled “e-HKD: A policy and design perspective” which focused on the policy and design aspects of introducing the e-HKD (see the response to question 6 above for further detail). In addition, Project Genesis also combine smart contracts, blockchain, internet-of-things, and digital assets as further detailed in the response to question 3 above.

As described in the response to question 10 above, the SFC’s statement published on 9 February 2018 noted that the SFC had sent letters to seven cryptocurrency exchanges in Hong Kong or with connections to Hong Kong warning them that they should not trade cryptocurrencies which are “securities” as defined in the SFO without a licence. The statement also noted that the SFC had written to seven ICO issuers.

In addition, in March 2018, the SFC confirmed that ICO issuer Black Cell had halted its ICO to the Hong Kong public and agreed to unwind ICO transactions for Hong Kong investors by returning them the relevant tokens, following regulatory action by SFC over concerns that Black Cell had engaged in potential unauthorized promotional activities and unlicensed regulated activities (also discussed in the response to question 10 above).

In February 2019, the Hong Kong Police Force arrested 25-year-old Wong Ching-kit, better known as “Coin Young Master”, and his 20-year-old colleague for conspiracy to defraud investors in so-called cryptocurrency ‘mining machines’ sold by the pair relating to the cryptocurrency ‘Filecoin’.

In July 2021, the SFC issued a warning statement that it is aware that Binance has offered trading services in stock tokens in a number of jurisdictions and is concerned that these services may also be offered to Hong Kong investors. The SFC specified that it wishes to make it clear that no entity in the Binance group is licensed or registered to conduct a regulated activity in Hong Kong and that it “does not tolerate any violations of the securities laws and will not hesitate to take enforcement action against unlicensed platform operators where appropriate”.

In the 2022 Hong Kong Money Laundering and Terrorist Financing Risk Assessment Report, it was recorded that, echoing the increasing scale and popularity of VA activities in Hong Kong, the number of VA-related crimes has increased from 324 in 2018 to 494 in 2020. Additionally, in the first eight months of 2021, losses from VA-related crimes have increased to HK$324 million, reflecting an increase of 372% over the same period the year prior. Fraud and theft constitute the major money-laundering threats in the VA sector so far. Majority of deception and investment fraud cases involving VAs involve victims who met fraudsters via different social media platforms, and were lured to invest into non-existing lucrative crypto investment plan. There are also reported cases in which people were robbed or conned out of millions of Hong Kong dollars in face-to-face VA transactions. The report specifies that the Hong Kong Police Force is committed to combating the increasing VA-related crime, and that a taskforce has been formed up to study and monitor the latest industry development and crime trend. Local and overseas training are provided to officers to enhance their professional investigation capabilities, and proactive engagement is also carried out with stakeholders.

There has been very limited judicial consideration of blockchain concepts or smart contracting in Hong Kong to date.

However, given, among others, local interest in cryptocurrency trading (discussed in the responses to questions 11 and 13 above), combined with well-publicised governmental and regulatory scrutiny of cryptocurrency trading and ICO / STO issuances (discussed in the responses to questions 9 and 14 above), future judicial consideration in this area seems likely.

As described in the response question 4 above, the HKMA’s Second DLT Whitepaper, published on 25 October 2017, identified 7 broad legal issues arising from the use of DLT, namely: (i) legal basis (validity and enforceability); (ii) data protection and privacy (accessibility, immutability and cross-border considerations); (iii) cross-border and localisation issues (cross-border data flow, legal enforceability and localisation law); (iv) smart contracts (legal basis and effects); (v) liability (governance model and liability of participants); (vi) competition / anti-trust laws (fair competition and anti-trust practice); and (vii) legal issues in specific applications (asset management, mortgages / e-conveyancing, trade finance and digital ID management).

On privacy and data protection, the Second DLT Whitepaper explains that the three key characteristics of DLT that need addressing under the Personal Data (Privacy) Ordinance (Cap. 486 of the Laws of Hong Kong) are: (i) first, the accessibility of some DLT platforms, in which all nodes have equal access to all stored personal data regardless of whether they need to see it; (ii) second, the immutability of stored data, whereby data cannot be amended or erased; and (iii) third, the often cross-border nature of DLT, meaning that personal data may be stored outside Hong Kong. The Second DLT Whitepaper concludes that the simplest way to address privacy concerns would seem to be to avoid storing personal data in the ledger, but rather only keep the hashes of personal data in it. Storing personal data off the ledger in more conventional databases while keeping hashes in the ledger could continue to ensure data integrity while controlling and limiting access to personal data.

In addition to the legal issues referred to in the Second DLT Whitepaper, the use of blockchain technology, in particular cryptocurrencies and other VAs, raises obvious AML and CTF concerns given the unregulated nature of many parts of this industry. As noted by the HKMA’s then-Chief Executive, Norman T.L. Chan, in the HKMA Cryptoasset Keynote Speech on 21 September 2018, because many cryptoassets are so designed that anonymous email accounts can be used for trading and transfers without a central clearing agent, they effectively bypass the existing regime in combatting money laundering, terrorist financing and other illicit activities. The ease with which cryptoassets can be transferred across national borders had made it even more attractive to criminals in laundering their proceeds and income, Mr Chan remarked, with the result that for the banks and other regulated financial institutions, it was proving difficult, if not impossible, for them to comply with the statutory or supervisory requirements in respect of know-your-customer (KYC) or ascertaining the source of funds.

Cryptocurrencies and other VAs also present potential problems in the context of insolvency law, in particular with respect to asset tracing.

As explained in the BCBS Statement published on 13 March 2019 and referred to in the HKMA Cryptoasset Keynote Speech (discussed in the response to question 9 above), the BCBS is of the view that the continued growth of cryptoasset trading platforms and new financial products related to cryptoassets has the potential to raise financial stability concerns and increase risks faced by banks, to the extent that the BCBS felt it necessary to set out its prudential expectations regarding banks’ exposures to cryptoassets and related services in jurisdictions where banks are involved in such business activities – including Hong Kong.

In September 2021, the PBoC published a notice that cryptocurrency-related transactions in the PRC are illegal. While this may have caused ripples in the cryptocurrency business in Hong Kong, the city operates under a separate financial and regulatory regime to the PRC system. As detailed in the response to question 9, a new licensing regime for VASPs will come into effect on 1 March 2023 under the AML Amendment Bill.