The Financial Technology Law Review: Hong Kong
The Hong Kong regulatory frameworks for fintech are currently provided under a medley of different pieces of legislation, which include the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong) (SFO), the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615) (AMLO) and the Payment Systems and Stored Value Facilities Ordinance (Cap 584) (PSSVFO), as well as various guidelines and codes of conduct issued and updated periodically by regulatory authorities including the Securities and Futures Commission (SFC), the Hong Kong Monetary Authority (HKMA) and the Customs and Excise Department (CED).
To foster innovation, the Hong Kong government has established the Enhanced Tax Deduction scheme offering tax deductions of up to 300 per cent for expenditure on research and development (R&D) in science and technology,2 as well as the Research and Development Cash Rebate Scheme offering rebates of up to 40 per cent of expenditure on science and technology R&D projects.3 Several funding schemes for R&D in the fintech area,4 as well as fundraising programmes,5 are available for fintech companies and start-ups in Hong Kong.
Given that the fintech industry is still relatively new and evolving quickly, the regulatory authorities in Hong Kong rely on existing regulatory frameworks with specific amendments to cover the risks and complexities that fintech may bring to the financial and monetary systems. No single bureau is designated to specifically oversee the regulation and development of fintech in Hong Kong. Regulatory supervision is spread across various bureaus, depending on the nature of activities. In formulating any new regulatory regimes, the principle of 'same business, same risks and same rules' is adopted.6 Regulators in Hong Kong aim to provide legal clarity to the market, so that there is a clear regulatory environment that fosters innovation, market development and investor protection.
i Licensing and marketing
There are several licences that are applicable to the fintech industry, depending on the business being conducted by a corporation, but there is no one specific licence for fintech, in light of the broad spectrum of services available in the field of fintech. These include:
- the virtual bank licence, issued by the HKMA, which allows a licence holder to deliver retail banking services through the internet without a physical branch;
- the payment system and stored value facility licence, also issued by the HKMA, which governs the operation of retail payment systems and stored value facilities;
- various securities licences, issued by the SFC, which allow a licence holder to carry out specified regulated activities (most likely covering services that involve securities and futures), including licences for Type 1 (dealing in securities) and Type 7 (providing automated trading services) activities, issued by the SFC under the voluntary opt-in licensing regime for virtual asset trading platform (VATP) operators;
- the money service operator licence (MSO licence), issued by the CED, which allows a licence holder to provide money services; and
- the money lender licence, issued by a Hong Kong licensing court and monitored by the Hong Kong Police.
With the increasing popularity of insurance technology (which falls under the big umbrella of fintech), the Insurance Authority has also granted several virtual insurance licences under Fast Track, which was launched in September 2017.
Depending on the exact nature and scope of regulated activities to be carried out by the corporation, the provision of automated digital advisory service may require a licence from the SFC to carry out Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities.7 A corporation providing asset management services would typically require a licence by SFC to carry out Type 4 (advising on securities) and Type 9 (asset management) regulated activities.8
Credit information services are generally governed by Type 10 regulated activities (providing credit ratings services) under the SFO, pursuant to which 'credit ratings' means opinions, expressed using a defined ranking system, primarily regarding the creditworthiness of a person other than an individual, debt securities, preferred securities or an agreement to provide credit. The corporation carrying out these regulated activities will also be required to comply with the Code of Conduct for Persons Providing Credit Rating Services, as issued by the SFC in June 2011.
Under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (C(WUMP)O), it is unlawful to issue any form of application for shares in, or debentures of, a company to the Hong Kong public unless the form is issued with a prospectus that complies with the requirements of the C(WUMP)O and is registered with the Registrar of Companies in Hong Kong (the Prospectus Requirements). In addition, Section 103 of the SFO prohibits a person from issuing an advertisement, invitation or document that to his or her knowledge is, or contains, an invitation to the public to deal in any 'securities' (which is widely defined under Schedule 1 of the SFO) unless the issue has been authorised by the SFC (the SFC Authorisation), which would in turn require the offering document to comply with the Prospectus Requirements. There are certain exemptions to the Prospectus Requirements and the SFC Authorisation requirement, the most common of which are:
- professional investors exemption: offers made to professional investors only (as defined under the SFO);
- private placement exemption: offers made to a maximum of 50 persons in Hong Kong provided that the offering document contains a warning statement as specified under Part 3 of the Eighteenth Schedule of the C(WUMP)O;
- sophisticated investor exemption: offers where the minimum principal amount to be subscribed by any person is not less than HK$500,000 (or its foreign currency equivalent), with the appropriate specified warning statement in a prominent position of the offering document;
- de minimis offering exemption: offers in respect of which the total considerable payable amount for the offering does not exceed HK$5 million (or its foreign currency equivalent); and
- outside Hong Kong investors exemption: offers to persons outside Hong Kong.
In addition, pursuant to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the SFC Code of Conduct), licensed intermediaries are required to act honestly and fairly towards customers, and under Paragraph 2.3 of the SFC Code of Conduct licensed intermediaries should ensure that invitations and advertisements do not contain information that is false, disparaging, misleading or deceptive. The SFC has also issued various guidelines that apply to all forms of product advertising (e.g., distribution materials, display-only materials, broadcasts and interactive systems), including:
- the Advertising Guidelines Applicable to Collective Investment Schemes Authorized under the Product Codes;
- the Guidelines on use of offer awareness and summary disclosure materials in offerings of shares and debentures under the Companies Ordinance; and
- the Guidelines on marketing materials for listed structured products.
If the corporation operates an automated digital advisory or asset management company relating to financial products or services, it may also be bound by the SFC Guidelines on Online Distribution and Advisory Platforms, issued in July 2019 (the SFC Online Guidelines).
Among other principles, the platform operator should comply with the six core principles identified by the SFC:
- proper design;
- information for clients;
- risk management;
- governance, capabilities and resources;
- review and monitoring; and
- record keeping.
If the corporation is to provide robo-advice directly to clients online through technology tools, Chapter 4 of the SFC Online Guidelines would apply, according to which the robo-adviser should comply with various rules regarding the provision of sufficient information to clients, client profiling, system design and development, supervision and testing of algorithms, adequate resources and rebalancing.
ii Cross-border issues
As a general rule, if a corporation deals with the general public in Hong Kong, its activities are subject to Hong Kong law. If the services or products provided by these corporations are securities-related, these will be governed by the SFO. The SFO is silent on whether the regulated activities are subject to any geographical requirements but it is generally accepted that the SFO will apply to activities conducted in Hong Kong. However, even if the regulated activities are not conducted in Hong Kong, the corporation may still be subject to Section 103 of the SFO if it has marketing activities in Hong Kong. Whether there are any marketing activities in Hong Kong would be determined by the specific circumstances of the matter, as the term 'actively market' is not defined under the SFO, but the starting point would be whether there is any active marketing to the Hong Kong public (for example, whether the corporations had called a Hong Kong investor or organised marketing campaigns targeting Hong Kong investors, whether the products are denominated in Hong Kong dollars). If it is determined that the corporation is marketing into Hong Kong, then it may need to be licensed or registered with the SFC, and may even be subject to the Prospectus Requirements and the SFC Authorisation requirement under the C(WUMP)O and the SFO unless one of the exemptions discussed above applies.
Regarding fund distribution from jurisdictions outside Hong Kong, following the memoranda of understanding (MOU) signed between Hong Kong and other jurisdictions, including China, Switzerland, France, Luxembourg, the United Kingdom and Thailand (with China being the first country to sign the MOU with Hong Kong), a system of mutual recognition of funds is put in place between Hong Kong and the signing countries to allow eligible funds to be passported into Hong Kong, and vice versa. Each MOU differs slightly on the type of funds that would be eligible for mutual recognition and the structure of the funds. For example, the MOU with France requires the fund to retain a minimum of 20 per cent of the net asset value to be attributable to Hong Kong investors; the MOU with the United Kingdom prohibits leverage over 100 per cent of the net asset value; and the MOU with Luxembourg requires the fund to be managed by a fund manager that has a minimum of HK$10 million in capital. Having said that, all foreign funds to be offered into Hong Kong will be required to appoint a firm in Hong Kong as representative and engage a licensed intermediary to carry out any marketing activities of the fund in Hong Kong.
Similarly, under Section 114 of the SFO, the restriction on carrying out regulated activities does not make any distinction between foreign or local corporations. Therefore, corporations should obtain licences from the SFC if they provide cross-border regulated services and products targeting the Hong Kong public.
Nevertheless, a temporary licence under Section 117 of the SFO could be available to foreign corporations if they are already licensed or regulated in another jurisdiction. This temporary licence is valid for up to three months or up to six months within any two-year period. The SFC will consider whether the foreign corporation is subject to similar regulatory requirements as imposed, monitored or enforced by the foreign corporation's local regulator and whether that local regulator would be able to take disciplinary action against the foreign corporation for its actions in Hong Kong as part of the consideration in granting the temporary licence. There are also other restrictions to the temporary licence (including that not all types of regulated activities would be allowed), and the licensee cannot hold client assets.
Furthermore, the Cross-boundary Wealth Management Connect Scheme in the Guangdong–Hong Kong–Macao Greater Bay Area (the Cross-boundary WMC) was launched in September 2021, allowing eligible mainland China, Hong Kong and Macao residents in the Guangdong–Hong Kong–Macao Greater Bay Area (GBA) to invest in wealth management products distributed by banks in each other's market through a closed-loop funds flow channel established between their respective banking systems. It gives flexibility to individual retail investors to open and operate cross-boundary investment accounts directly, through a formal and convenient channel, and to choose their preferred products.
The Cross-boundary WMC consists of the Southbound Scheme and the Northbound Scheme. The Southbound Scheme refers to eligible residents in the GBA cities investing in wealth management products distributed by banks in Hong Kong and Macao via designated channels. The Northbound Scheme refers to eligible residents in Hong Kong and Macao investing in wealth management products distributed by mainland China banks via designated channels. Only relatively simple wealth management products of low-to-medium risk are currently available under the Cross-boundary WMC. One bank account with a cross-boundary remittance function and another bank account with an investment function are required to be opened with banks in investors' place of residence and the other market, respectively, and the two accounts must be paired with each other. Cross-boundary renminbi fund flows are subject to closed-loop and quota management.
The restrictions relating to offering or inviting investors under Section 103 of the SFO are only relevant to invitations to invest made in Hong Kong, but there are no specific restrictions under the SFO if there is a genuine enquiry made by a Hong Kong investor to the foreign corporation. Provided that the response to the enquiry made by the Hong Kong investor is bespoke and tailored to the enquiry, the foreign corporation may not be subject to the restriction under Section 103. This is a process that is commonly referred to as 'reverse enquiry'.
There are no currency exchange controls in Hong Kong, but the flow of funds in and out of Hong Kong may be prohibited or restricted by laws such as the United Nations (Anti-Terrorism Measures) Ordinance (Cap 575) (UNATMO) and the United Nations Sanctions Ordinance (Cap 537), as well as other relevant laws and regulations. There is no limitation on ownership of companies by foreigners in place in Hong Kong.
Digital identity and onboarding
There are no laws or regulations in Hong Kong relating to establishing digital identity, although similar arrangements were introduced by the Electronic Transaction Ordinance (Cap 553) (ETO), which allow digital certificates to be created to serve as a guarantee of identity during electronic transactions. Digital certificates can only be issued by recognised certification authorities, which, to date, only includes the Hongkong Post Certification Authority and Digi-Sign Certification Services Limited. Nevertheless, any person may apply to the government chief information officer to become a recognised certification authority pursuant to Section 20 of the ETO. Once issued, digital certificates can be used to identify a person in a process known as electronic authentication to verify transactions. At present, personal digital certificates can only be applied by individuals who possess a Hong Kong identity card (the applications do not accept other forms of identification documents, such as passports). On the other hand, corporations can also apply for digital certificates and there is no restriction on the jurisdiction of the corporations as long as the corporation has obtained a business registration certificate issued by the Hong Kong government.
The ETO covers the circumstances in which electronic signature or services can be conducted, including transactions between private individuals or with government entities. Digital certificates are more commonly used for applications or transactions with government entities; for example, voter registration and vehicle licence renewal application. The ETO also recognises private transactions conducted by electronic means, provided the parties to the transaction consent to it.
Pursuant to the amended Paragraph 5.1 of the SFC Code of Conduct, acceptable account opening methods are now set out on the SFC's website instead of in the SFC Code of Conduct. The SFC also issued the Circular to Intermediaries: Remote onboarding of Overseas Individual Clients on 28 June 2019, along with an FAQ that addresses various issues of digital onboarding. In addition to the face-to-face approach, the SFC now permits licensed intermediaries to adopt other account opening procedures, provided the procedures can satisfactorily ensure the identity of the client. There are several methods that are acceptable to the SFC, including:
- certification by qualified person: the client agreement and the identity documents of the customer are certified by another licensed person, an affiliate, a justice of the peace or a professional person;
- using the certification services: the licensed intermediary accepts electronic signature certificates to replace actual identity documents;
- mail approach: the customer posts a copy of the identity document and the client agreement to the intermediary together with a physical cheque bearing the same signature as the one on the client agreement;
- online onboarding with Hong Kong-designated bank account: the customer electronically signs the client agreement and provides a copy of the identity document, and all future deposits and withdrawals from the client's trading account must be with a bank account in Hong Kong in the customer's name; and
- remote onboarding of overseas individual clients: technology adhering to international standards and best practice, such as ISO/IEC 19795 (biometric performance testing and reporting) and ISO/IEC 30107 (biometric presentation attack detection) would be adopted in the process of client identification together with the requirement that all deposits into and withdrawals from the client's trading account are made with a bank account in the customer's name opened with a designated bank from an eligible jurisdiction.
For point (e), there are currently 16 eligible jurisdictions, namely Australia, Austria, Belgium, Canada, Ireland, Israel, Italy, Malaysia, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States.
Digital markets, payment services and funding
A voluntary, opt-in licensing regime for VATPs (the Voluntary Licensing Regime) has been introduced by the SFC pursuant to its Position Paper: Regulation of Virtual Asset Trading Platform (the Position Paper), issued on 6 November 2019. The SFC has reiterated in the Position Paper that VATP operators that trade only non-security virtual assets are not regarded as carrying out 'regulated activities' for the purpose of the SFO, and that these platform operators would not be eligible to apply for an SFC licence under the Voluntary Licensing Regime. Nevertheless, if a platform operator decides to 'opt-in' to the SFC's regulatory remit by offering at least one security token on its platform, the SFC would be empowered to grant licences for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities. The SFC will take a holistic approach with the 'infrastructure, core fitness, properness and conduct' of all virtual asset trading activities (whether the virtual assets are traded as securities or not) being viewed as a whole and subject to the SFC's supervision.
If the SFC decides to grant the licences (Types 1 and 7) to a VATP operator (the licensed VATP operator), it will impose certain licensing conditions, which are outlined in the terms and conditions attached to the Position Paper. The licensed VATP operator is also required to comply with all other regulatory requirements as set out in the SFC Code of Conduct and guidelines, circulars and FAQs published periodically by the SFC.
However, this voluntary opt-in licensing regime under the Position Paper may potentially be supplemented by the mandatory licensing regime set out in the Consultation Conclusions published by the Financial Services and Treasury Bureau (FSTB) in May 2021. These were published following a public consultation conducted between 3 November 2020 and 31 January 2021 on various legislative proposals to enhance the anti-money laundering and counter-terrorist financing regulation in Hong Kong, including a proposal to introduce a new licensing regime for virtual asset services providers (VASPs) under the AMLO. Under this new licensing regime for VASPs (the VASP Licensing Regime), a person who operates a 'virtual asset exchange', namely a VATP, that comes into custody, control, power or possession of any money or virtual assets will be required to apply for a licence from the SFC (VASP licence). Peer-to-peer trading platforms, to the extent that the actual transactions are conducted outside the platform and the platform is not involved in the underlying transactions by coming into possession of any money or any virtual asset at any point in time, would not be regarded as virtual asset exchanges under this definition. Similarly, over-the-counter trades would not be covered by the VASP Licensing Regime, at least in the initial stage.
On 28 January 2022, the SFC and the HKMA published the Joint Circular on intermediaries' virtual asset-related activities (the Joint Circular), which sets out their updated regulatory framework on the distribution of virtual asset-related products, the provision of virtual asset dealing services and the provision of virtual asset advisory services. Only intermediaries licensed or registered for Type 1 regulated activities (dealing in securities) may provide virtual asset dealing services if partnered with VATPs licensed by the SFC. Further, intermediaries may only offer these virtual asset dealing services to existing clients who are professional investors.
Section 103 of the SFO prohibits the advertisement of offers and invitations to participate in a collective investment schemes (CIS) unless one of the exemptions applicable to the Prospectus Requirement and SFC Authorisation, as referred to in Section II, applies. CIS is defined in Paragraph (d) of the definition of 'securities' of Schedule 1 of the SFO, which includes interests in CISs. A CIS is an investment product that is collective in nature, the definition of which embraces and modernises the concepts of unit trust, mutual fund corporation and investment arrangements. The definition under Schedule 1 can be narrowed down to a more concise four-part test of what a CIS generally requires:
- an arrangement in respect of property;
- participants in the scheme do not have day-to-day control over the management of the property;
- the property is managed as a whole by or on behalf of the person operating the arrangements, or the contribution of the participants and the profits or income from which payments are made are pooled; and
- the purpose of the arrangement is for participants to participate in or receive profits, income or other returns from the acquisition and management of property.
Therefore, if a product constitutes an interest in a CIS, it will also fall within the definition of 'securities' and be subject to all the licensing requirements for securities-related regulated activities under the SFO.
Hong Kong does not have any specific laws or regulations in relation to crowdfunding. Crowdfunding activities such as peer-to-peer lending and equity crowdfunding may be considered as a CIS and, if offered to the public in Hong Kong, may be subject to a number of Hong Kong regulatory provisions (e.g., the Prospectus Requirement and the SFC Authorisation requirement) unless an exemption applies (see Section II).
Operators of crowdfunding platforms would also be subject to Section 103 of the SFO as outlined above. If the operator of a crowdfunding platform carries on a regulated activity, it is required to obtain appropriate SFC licences9 and would also be required to comply with the SFC Code of Conduct, which contains provisions requiring licensed intermediaries to establish clients' financial situation and investment experience and ensure that recommended investment products are suitable for each particular client.
Peer-to-peer lending is subject to the same regulatory provisions that may be applicable to crowdfunding, as outlined above.
In addition, peer-to-peer lending by individuals or businesses might constitute the carrying on of business as a money lender, which requires the person or business to be a licensed money lender under the Money Lenders Ordinance (Cap 163) (MLO).
The MLO requires that anyone wishing to carry on business as a money lender must apply to a licensing court for a licence, processed by the Companies Registry and enforced by the Commissioner of Police. The term 'money lender' is defined in Section 2 of the MLO as 'every person whose business (whether or not he carries on any other business) is that of making loans or who advertises or announces himself or holds himself out in any way as carrying on that business'. Certain persons and loans under Schedule 1 of the MLO are excluded from the definition.
Peer-to-peer lenders may be able to rely on an exemption in the case of a loan made by a corporation, firm or individual whose ordinary business does not primarily or mainly involve the lending of money. It would, however, be difficult in the case of any individual lender to determine at what point the lender is 'carrying on a business of lending money'.
Subject to whether the loans or financings would constitute securities (which is inclusive of an interest in a CIS), the trading of loans or financings may fall under the regulation of the SFO, which means only licensed corporations can conduct any secondary trading. Otherwise, transfers of loans and financings may be conducted by way of legal or equitable assignment:
- legal assignment: an assignment that meets the criteria set out in the Law Amendment and Reform (Consolidation) Ordinance (Cap 23):
- an absolute assignment by way of sale of the assignor's entire legal interest in the receivables (e.g., loan);
- the assignment is in writing and signed by the assignor; and
- express written notice of the assignment (in particular, the date of assignment and the identity of the assignee) is given to the obligor; and
- equitable assignment: an assignment that has not met all the above requirements to create a legal assignment (typically, not being able to give notice to the obligor).
In Hong Kong, there are no laws specifically for securitisation other than in respect of capital treatment and disclosure requirements for 'authorised institutions' as defined in the Banking Ordinance (Cap 155) (e.g., banks).
Any person or entity operating a money service should apply for an MSO licence from the Commissioner of Customs and Excise pursuant to the AMLO. The term 'money service' includes money changing services and remittance services.
If the person or entity operating a payment service will issue a facility that can store the value of an amount of money and will be giving an undertaking that the facility may be used for the payment of goods or services of either the issuer or another person, the person or entity may be required to obtain a stored-value facility (SVF) licence pursuant to the PSSVFO. The 'undertaking' referred to above means an undertaking that the issuer will accept the payment up to the amount of the stored value that is available for use under the rules of the facility or that the issuer will make payment to the recipient of that amount. It is noteworthy that the SVF licence also applies to 'facilitators', which are defined as anyone who is not the issuer and provides 'the issuer with valuable consideration the value of which determines . . . the extent to which the issuer may give an undertaking' (for example, by providing some of the reserve in stablecoins).
The HKMA published a discussion paper on the regulation of payment-related stablecoins on 12 January 2022 (the Discussion Paper), in which it proposes to either expand the scope of the PSSVFO to cover payment-related stablecoin arrangements that do not currently fall under the definition of SVF or introduce a new legislation to regulate various stablecoin-related activities, including:
- issuing, creating or destroying stablecoins;
- managing reserve assets to ensure stabilisation of stablecoin value;
- validating transactions and records;
- storing private keys used to provide access to stablecoins;
- facilitating the redemption of stablecoins;
- transmission of funds to settle transactions; and
- executing transactions in stablecoins on behalf of others.
According to the preliminary views of the HKMA set out in the Discussion Paper, it appears that any new legislation for the regulation of stablecoin-related activities would very likely be modelled on the existing PSSVFO. It is expected that further details of the proposed regulatory framework for stablecoins will be released by the HKMA in 2022/23 and that the new regime will take effect by 2023/24.
Cryptocurrencies, initial coin offerings (ICO) and security tokens
There is no specific regulatory framework for blockchain technology in Hong Kong. This technology and related businesses are subject to the existing body of Hong Kong financial laws and regulations. However, the HKMA and the SFC have issued a number of statements clarifying their regulatory stance.
In February 2015, the HKMA stated in a press release that Bitcoin is not a legal tender but a 'virtual commodity'. Given that Bitcoin does not have any backing, either in physical form or from the issuer, it cannot be qualified as a means of payment or electronic money. The HKMA expressly stated that Bitcoin and other similar virtual commodities are not regulated by the HKMA.
The SFC published a circular in December 2017 in relation to Bitcoin futures contracts and other cryptocurrency-related investment products, in which it warned that Bitcoin futures contracts traded on a futures exchange are regarded as futures contracts for the purposes of the SFO, even though the underlying assets of the futures contracts may not be regulated under the SFO. It was noted that other cryptocurrency-related investment products may, depending on their terms and features, be regarded as securities as defined under the SFO.
Under the Consultation Conclusion published by the FSTB in May 2021, 'virtual asset' is defined as a digital representation of value that:
- is expressed as a unit of account or a store of economic value;
- functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; and
- can be transferred, stored or traded electronically.
It does not, however, cover digital representations of fiat currencies (including digital currencies issued by central banks), financial assets already regulated under the SFO or certain closed-loop, limited purpose items.
In its statement dated 5 September 2017, the SFC outlined three types of terms and features of digital tokens in ICOs (another term for a token sale) that might constitute securities:
- tokens may be regarded as 'shares' if they represent equity or ownership interests in a corporation; for example, where the token holders are given shareholders' rights, including the right to receive dividends and the right to participate in the distribution of the corporation's surplus assets upon winding up;
- tokens may be regarded as 'debentures' where the digital tokens are used to create or to acknowledge a debt or liability owed by the issuer; 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; and
- tokens may be regarded as an interest in a CIS if the 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 projects.
The SFC issued a statement on 28 March 2019 that further confirms its approach to virtual assets that fall within the definition of 'securities' under the SFO (security tokens), and confirmed that the marketing and distribution of security tokens must be conducted by a person licensed or registered for Type 1 regulated activity (dealing in securities) (Type 1 intermediaries). The SFC places substantial reliance on Type 1 intermediaries in complying with its existing codes of conduct and its new guidance, as well as other laws and regulations to ensure that purchasers of security tokens are fully protected, including: restricting the offering of security tokens to professional investors only; conducting thorough due diligence against the security tokens, its team, the asset backing the security tokens and all other materials relevant to the security tokens; and providing all information to the purchaser in a clear and easily comprehensible manner. The SFC has emphasised the need for compliance with the suitability requirements in Paragraph 5.2 of the SFC Code of Conduct, as well as the requirements for 'complex products' in Paragraph 5.5 of the SFC Code of Conduct, which came into effect on 6 July 2019 (the Complex Products Regime).
The SFC has also highlighted key requirements of its Circular to Intermediaries on the Distribution of Virtual Asset Funds, dated 1 November 2018 (that would apply equally to the distribution of security tokens):
- security tokens should only be offered to persons who qualify as 'professional investors' under the SFO and the Securities and Futures (Professional Investor) Rules;
- intermediaries distributing security tokens need to understand the security token offerings (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; and
- 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.
The SFC and HKMA's Joint Circular of 28 January 2022, which sets out an updated regulatory framework on matters including the distribution of virtual asset-related products and the provision of virtual asset dealing services, also applies to security tokens. In it, the SFC and HKMA have reiterated their view that virtual asset-related products (including security tokens) are very likely to be considered complex products so that their distribution would be subject to requirements of the Complex Products Regime. With limited exceptions, intermediaries may only offer these complex virtual asset-related products to professional investors and are required to conduct a virtual asset knowledge test on clients beforehand. Further, only Type 1 intermediaries are allowed to offer virtual asset dealing services by introducing clients to an SFC-licensed VATP or setting up an omnibus account for the SFC-licensed VATP. At the time of writing, only one VATP, namely OSL, has been licensed by the SFC and is therefore currently the only option for Type 1 intermediaries that wish to offer virtual asset dealing services.
Separately, the HKMA also issued its own circular (the HKMA Circular) on 28 January 2022, in which it has made it clear that authorised institutions would not be prohibited from investing in, lending against or allowing their customers to use credit cards or other payment services to acquire virtual assets (including security tokens) provided adequate risk-management controls are in place.
Tokens can be linked to the underlying assets through recording the assets digitally and providing a graphically secured representation of value that can be stored and transferred within a distributed ledger.
The current system in Hong Kong requires the issuance of paper certificates and the use of paper instruments of transfer for certain securities. Under Section 144 of the Companies Ordinance (Cap 622), a company must complete and issue share certificates after an allotment of shares has been completed. Nevertheless, there have been movements towards a paperless securities regime in Hong Kong over the past two decades; the Securities and Futures and Companies Legislation (Amendment) Ordinance 2021 (gazetted by the Hong Kong government on 11 June 2021) includes provisions introducing an uncertificated (therefore paperless) securities market (USM) regime, where investors will have the option of holding securities in their own names and without paper documents. The USM regime is expected to be introduced in phases commencing in late 2022.
There are no current laws or regulations that specifically deal with the laundering of cryptocurrencies and tokens. The AMLO principally applies to financial institutions (including HKMA-authorised institutions (i.e., banks, SFC-licensed corporations, licensed insurance companies, SVF issuers and money service operators)) and 'designated non-financial business and professions' (DNFBPs) (e.g., law firms). If a corporation deals with cryptocurrencies and tokens, it is not directly subject to the provisions of the AMLO, unless it falls within the definition of financial institution or DNFBP.
In addition to the AMLO, corporations would be subject to the Drug Trafficking (Recovery of Proceeds) Ordinance (Cap 405) (DTPRO) and the Organized and Serious Crime Ordinance (Cap 455) (ORSCO), which make it a criminal offence for a person who knows, or has reasonable grounds to believe, that any 'property' (the definition of which likely encompasses Bitcoins, Ethereum and other forms of virtual commodities or virtual assets), whether in whole or in part, represents any person's proceeds of drug trafficking or crime, deals with that property. Corporations must also comply with the UNATMO in relation to terrorism financing. In general, the DTPRO, ORSCO and UNATMO require any suspected transactions involving money laundering, terrorist financing or receipts of crime to be reported to the Joint Financial Intelligence Unit by submitting a suspicious transaction report (STR). Failure to file an STR is a criminal offence.
In general, there is no capital gains tax, withholding tax or value added tax payable in Hong Kong.
That being said, any Hong Kong-sourced income from frequent cryptocurrency trading (e.g., Bitcoins and Ethereum, which are generally considered as 'virtual commodities' in Hong Kong) in the ordinary course of business may be treated as income in the case of individual clients and profits in the case of a corporation, and subject to income tax and profits tax, respectively, regardless of whether the trading is made in exclusive cryptocurrency or fiat-to-cryptocurrency exchanges. Pursuant to a press release dated 3 April 2019, the Inland Revenue Department (IRD) of Hong Kong does not maintain statistics specifically on tax payable by persons carrying on virtual asset-related activities and each case should be assessed on the basis of its own individual facts and circumstances. The IRD would also, if necessary, seek relevant information from other tax authorities through the exchange of information mechanism under tax treaties to assess the situation.
On 27 March 2020, the IRD issued its revised Departmental Interpretation and Practice Notes (DIPN) No. 39, laying out its treatment of different digital assets. The IRD treats tokens differently based on the function of the tokens rather than how they are labelled. It divides digital assets into three types: payment tokens, security tokens and utility tokens. While the DIPN has provided certain guidelines on the treatment of digital assets, a number of issues remain unclear, which require further clarification by the IRD (e.g., whether a transfer of security tokens gives rise to stamp duty obligation).
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. Only marketing to professional investors is currently allowed.
Other new business models
There is no law that regulates self-executed contracts. As long as the execution can comply with the applicable regulatory regime, it would be acknowledged. For instance, as long as the contract is validly entered into, any automatic transfer of funds or digital assets would be deemed validly made. However, any specific assets that require registration with local authorities (e.g., transfer of property or shares in a Hong Kong company) would not be recognised unless the necessary transfer procedure is followed and all necessary filings are made with the government authorities.
Mediation and arbitration are recognised and acceptable methods of alternative dispute resolution. Under Hong Kong law, parties to a private transaction are at liberty to require any disputes to be resolved through mediation or arbitration, or both, instead of court proceedings, provided that the parties clearly record this arrangement in the agreement entered into by them.
It is currently unclear whether fully automated investment processes (i.e., dealing in securities without any human intervention) would be permitted. In light of the SFC Online Guidelines, robo-advice refers to the provision of financial advice in an online environment using algorithms and other technology tools (which the SFC notes in the SFC Online Guidelines as including fully automated investment advice via an online platform with no human intervention) but this does not seem to cover situations in which investment processes are automated.
The increasing interest in blockchain technology in Hong Kong has sparked the creation of different business models and has even introduced a new industry. One notable new business model is the creation and issuance of non-fungible tokens (NFTs) and other creative uses of NFTs, such as NFT domain names and NFT cloud services. Currently, there are no specific laws in Hong Kong for the regulation of NFT-related activities. Due to the non-fungible nature of NFTs, they are also less likely to be regarded as shares (or other types of securities) under the SFO, provided that the NFTs are not fragments of a single asset. However, as the regulators in Hong Kong continue to develop a more comprehensive regulatory framework for virtual assets, clearer guidelines are likely to be issued by the SFC, the HKMA and other Hong Kong regulators in relation to NFTs in the future.
Another notable business model is the issuance of stablecoin that is linked to the value of Hong Kong dollars. While there are currently no specific laws in Hong Kong that deal with, prohibit or even regulate stablecoins, the PSSVFO is most relevant to the operation and issuance of stablecoins. The PSSVFO regulates SVFs that are used for payment of goods and services, which function similarly to stablecoins by having monetary value stored, and a facility is issued for assisted payment using the stored monetary value. Any corporation that wishes to issue an SVF must apply for an SVF licence from the HKMA.
However, there will likely be direct regulation of stablecoins in the near future. As mentioned in Section IV, in its Discussion Paper dated 12 January 2022, the HKMA has proposed to introduce regulation of payment-related stablecoin arrangements in Hong Kong by either expanding the scope of the PSSVFO or passing a whole new legislation. It is expected that the regulatory regime for payment-related stablecoin arrangements would be very similar to that for SVFs, although different entities involved in this type of stablecoin arrangement would likely be required to obtain a separate licence from the HKMA. The current target of the HKMA is to introduce this new licensing regime no later than 2023/24.
Intellectual property and data protection
Codes, programs, source codes and related software are generally protected under the Copyright Ordinance (Cap 528) by way of copyright. Copyright arises automatically as long as the work is original and recorded in a material form. Software is usually covered under the category of 'literary works' under the Copyright Ordinance. However, mere ideas are not protected and therefore business models may not be protected. There is no regime of registration for copyright in Hong Kong but the Copyright Ordinance grants copyright owners exclusive rights to carry out certain acts in relation to the works, including (but not limited to) distributing the work to the public and copying the work.
Any infringement of an owner's copyright would give rise to civil liability that the owner can take action on. Depending on the action taken by the infringing party, there may also be criminal liability (e.g., if the infringing party makes the copyright work for sale or hire).
In addition to copyright, any invention that is new and involves an inventive step can be patented in Hong Kong by registration as long as it is susceptible to industrial application and does not belong to the excluded classes of inventions through the Patents Ordinance (Cap 514) and the Patents (General) Rules (Cap 514C). Patents are generally separated into two types: standard and short-term. Standard patents can cover up to 20 years, while short-term patents can cover up to eight years. However, standard patents are registered based on the registration of a patent granted by one of the designated patent offices: the State Intellectual Property Office in China, the European Patent Office or the United Kingdom Intellectual Property Office. Whether a software-related invention used in a fintech business model is capable of being patented will depend on whether the invention is new, involves an inventive step and solves a technical problem, which would be determined on a case-by-case basis. For blockchain corporations, this may be difficult unless they can prove that the software-related invention that relies on blockchain satisfies the patent office's requirements.
It is standard for employees or contractors to agree in their employment contracts that all works created by them for the purpose of the employer or client's business would be considered as works created by the employer or client. It is also standard for parties to agree for the employee or contractor to sign any documents or perform any acts to give effect to the transfer of the intellectual property of the works created during their engagement.
Businesses in Hong Kong are subject to the Personal Data (Privacy) Ordinance (Cap 486) (PDPO), which regulates the collection, use and handling of personal data received by corporations or persons (data users). The PDPO places restrictions on the use and disclosure of personal data under Data Protection Principle 3 outlined in the PDPO and thus data users should not make client data accessible to third parties without the consent of the data subject under normal circumstances. The principles that data users must observe mainly relate to notification requirements at the time of collection of personal data, security and access to personal data and accuracy and duration of retention of personal data. There are also particular restrictions regarding the use of client lists to market products.
The PDPO also contains exemptions to the restrictions on use and disclosure of client data under Data Protection Principle 3. Exemptions apply for any use or disclosure of client data that is: (1) required or authorised by any Hong Kong law or court order; (2) required in connection with legal proceedings in Hong Kong or exercising or defending legal rights in Hong Kong; (3) for the purpose of a due diligence exercise in connection with a proposed sale or merger; or (4) for the purpose of preparing statistics or carrying out research (provided that no identifying information of any client is published). Under the PDPO, clients do not have a general right to object to data processing (including digital profiling) but they may opt out of direct marketing activities.
In relation to product data, companies would need to disclose their product data if requested by a regulator in Hong Kong to provide this information in accordance with the provisions of a specific law in Hong Kong. There are various laws in Hong Kong that grant wide investigative powers to authorities to conduct investigations, including the SFC, the HKMA, the Insurance Authority and the Hong Kong Independent Commission against Corruption.
Year in review
i VASP Licensing Regime
As mentioned above, the Consultation Conclusion released by the FSTB in May 2021 sets out a licensing regime for VASPs, which mainly covers the licensing of virtual asset exchanges. The amendment bill is expected to be presented to the Legislative Council within the 2021/22 legislative session.
ii Guidelines for financial services advisory
The SFC and the HKMA published the Joint Circular in January 2022, which sets out their updated regulatory framework on the distribution of virtual asset-related products and the provision of virtual asset dealing and advisory services. The Joint Circular provides much-needed clarity on Hong Kong's regulatory framework on virtual asset-related activities. Importantly, the Joint Circular makes it clear that certain limited virtual asset-related derivative products traded on regulated exchanges may be offered to retail investors. The HKMA issued a circular in January 2022 making it clear that it does not intend to prohibit authorised institutions from investing in, lending against or allowing their customers to use credit cards or other payment services to acquire virtual assets, provided that adequate risk-management controls are adopted. Together, the Joint Circular and the HKMA circular may prove to be a first step in opening a small door for virtual asset-related products to enter the mainstream economy and become part of people's daily lives in Hong Kong.
iii Regulation on stablecoins
The HKMA issued the Discussion Paper in January 2022 to seek market feedback on the HKMA's thoughts on expanding the regulatory framework in relation to stablecoins, especially those activities related to payment-related stablecoins. It is expected that further details on specific aspects of this regulatory framework will be issued by the HKMA in 2022/23, so that the new regime may commence no later than 2023/24.
Outlook and conclusions
The past year has seen a number of important developments in Hong Kong's regulatory landscape for virtual assets, as the city's regulators (in particular, the SFC and the HKMA) seek to expand their scope of supervision and streamline the existing regulatory regimes for various types of virtual asset-related activities. Initiatives from the SFC and the HKMA on regulating activities relating to virtual assets demonstrate their recognition of the developments in the fintech market. However, it is anticipated that regulators in Hong Kong will remain cautious towards virtual assets and will continue to adopt a prudent approach by limiting the offerings and distribution of most virtual asset-related products to professional investors only.
Meanwhile, further guidelines and amendments in the regulation with respect to the licensing of VATPs and stablecoin issuance activities have yet to be unveiled. This has created many new regulatory uncertainties as the fintech industry evolves.
Undoubtedly, the proposed amendments in the legislation will enable the SFC and the HKMA to closely supervise virtual asset-related activities. However, to bring virtual assets into the mainstream financial systems of Hong Kong without undermining its stability and development, further clarifications and clear guidelines on regulation from the HKMA and the SFC are needed, so that Hong Kong can continue to provide a well-defined regulatory environment and thereby maintain its competitiveness as a leading international financial centre.
1 Yu Pui Hang is a partner and Chan Wa is an associate at Henry Yu & Associates, in association with L & Y Law Office.
2 The Enhanced Tax Deduction scheme, established under the Inland Revenue (Amendment) (No. 7) Ordinance 2018, provides for tax deductions of 300 per cent for the first HK$2 million of the aggregate amount of payments made to certain designated local research institutions for qualifying research and development activities, and 200 per cent for the remaining amount. There is no cap on the amount of enhanced tax deductions available.
4 Such as the Enterprise Support Scheme and the Partnership Research Programme.
5 Such as the Innovation and Technology Venture Fund, the SME Financing Guarantee Scheme and the Dedicated Fund on Branding, Upgrading and Domestic Sales.
6 This generally means focusing on the functions performed and risks posed by an activity, and applying the appropriate regulatory framework to that activity in the same manner as it would be applied to entities performing the same functions or activities and posing the same risks. See Julia Leung, deputy chief executive officer and executive director of the Securities and Futures Commission (SFC), 'Fintech: Metamorphosis of the financial industry: Keynote address at Hong Kong FinTech Week 2021', 3 November 2021; and Eddie Yue, chief executive of the Hong Kong Monetary Authority, 'Crypto-assets and stablecoins' press release, 12 January 2022.
7 For example, 8 Securities Limited's robo-adviser, Chloe, and Magnum Research Limited's Aqumon platform, both of which obtained Type 1 (dealing in securities) and Type 4 (advising on securities) licences.
8 For example, Kristal Advisors (HK) Limited's robo-adviser, Kristal.AI, which obtained Type 4 (advising on securities) and Type 9 (assessment management) licences.