The Issuer is a state-owned enterprise 67% owned by Jiangyou Hongyuan Hechuang Industrial Development Group Co., Ltd. and 33% owned by Mianyang Miantai Industrial Co., Ltd. The Issuer is an asset operating entity in Jiangyou City and engages in the businesses of gas supply, water supply and public transportation. It also participates in the investment and construction of municipal infrastructure, road pipeline networks, resettlement housing and other projects.

Our team was led by Partner Rodney Teoh, supported by Associates Angela Lau and Audrey Ng, Trainee Solicitor Austin Kot, and Paralegal Jay Lee.

Please contact our Partner Rodney Teoh for any enquiries or further information.

The proposed reforms aim to introduce a licensing regime for providers of VA OTC services under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”). The proposal can be divided into four main parts: (1) the scope and coverage of the regime; (2) the proposed regulations to be imposed on licensees; (3) the licence period and transitional arrangements; and (4) the powers of the licensing authority in regulating the regime.

Legislative Proposals

Scope and coverage of the regime

The FSTB notes that regulating the VA OTC industry requires regulating any person involved in the marketing and operation of said business in Hong Kong. They propose that such involved persons must obtain a licence issued by the Commissioner of Customs and Excise (the “CCE”) under their proposed licensing regime. They propose that a VA OTC business shall be defined as:

(a)   by way of business, provision of service of spot trade of any VA;

(b)   irrespective of whether the service is provided through a physical outlet (i.e. including ATMs) or other (e.g. digital) platforms; and

(c)   explicitly excluding the operation of a virtual asset trading platform (“VATP”) as already covered under the VATP licensing regime.

The FSTB also notes that operators of VA trading services may also provide temporary custody/escrow service for their client’s VA as part of the transaction process. The FSTB welcomes public feedback on whether temporary custody/escrow service as part of the transaction process should be covered by the proposed regulatory regime, and whether there should be dedicated regulatory requirements for such temporary custody/escrow service.

With the intention for effective supervision and monitoring, the FSTB proposes that license applicants will be restricted to locally incorporated companies with a permanent place of business in Hong Kong, or companies incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622). The CCE will also consider all relevant matters in deciding whether an applicant is fit and proper.

Noting the regulations already in place for licensed corporations, authorised institutions and licensed stablecoin issuers, the FSTB believes it appropriate for these entities to be exempt from the licensing regime should they provide VA OTC services.

Proposed regulations imposed on licensees under the regime

Under the regime, licensees are allowed to perform spot trade of VA for any money or vice versa in their course of business, but will only be allowed to perform remittance of exchange proceeds on specified conditions. To mitigate money laundering/terrorist financing (“ML/TF”) risks, licensees will only be allowed to transfer VA relevant to a transaction from their registered wallets to a client wallet owned or controlled by the client. Furthermore, VA-to-VA trading services are prohibited unless with a VATP licence. Licensees will also be required to observe the anti-money laundering/counter-terrorist financing (“AML/CTF”) requirements as set out in the AMLO when it comes to customer due diligence and record-keeping.

FSTB notes that the licensing regime will be limited to trading purposes only and other services, including any form of advisory, referral, or offering of VA derivates or other financial products will not be permitted under the licensing regime.

With the intention of having a more stringent standard of supervision to offer adequate investor protection, VA OTC licensees will not be permitted to offer services in respect of tokens that not accessible by retail investors on at least one SFC-licensed VATP or stablecoins not issued by issuers licensed by the Hong Kong Monetary Authority (“HKMA”).

FSTB also proposes that further safeguards be put in place due to the tech-savvy and highly speculative nature of VA. In particular, FSTB considers it appropriate for VA OTC licensees to be subject to a set of robust regulatory requirements to ensure that they have the capacity and know-how to operate the VA OTC business properly.

Further regulatory requirements also reference those enlisted in the VATP and money service operators (“MSOs”) regime. For further details relating to the scope of such requirements, please refer to paragraph 2.18 of the Consultation Paper.

As part of the CCE’s duty to regulate, licence will only be granted when all specified requirements are met. It would subsequently be prohibited for any person to actively market a regulated VA OTC service unless licensed by CCE to conduct such service. In case of non-compliance, VA OTC licensees will be subject to disciplinary and investigative proceedings and subsequent enforcement actions, as elaborated below.

Licence period and transitional arrangements regarding the regime

The FSTB proposes that under the licensing regime, a successful applicant will be granted a licence of two years, renewable for two years upon application and to the satisfaction of CCE. The FSTB also suggests a transition period of six months immediately before the commencement of the regime to facilitate transition of the existing VA OTC operators. Pre-existing VA OTC service providers will be allowed to continue their operations until the end of the six-month transition period, on condition that they submit within the first three months a licence application to CCE and subject to the proposed arrangements by the FSTB:

Option 1: Pre-existing VA OTC service providers that do not submit a licence application to CCE within the first three months of the commencement of the transition period must close down their business by the end of the fourth month of the commencement of the transition period; or

Option 2: Applicants that meet the requirements by the CCE will receive an interim “deemed licence” granted in the interim permitting them to continue their operations beyond the transitional period and until a final determination of the licence applications is made by the CCE.

Powers of the licensing authority, enforcement and sanctions

The FTSB suggests that the CCE will be provided the power to supervise AML/CTF conduct of VA OTC licensees, enforce statutory and regulatory requirements, and commence enforcement action where necessary. They will also be empowered to impose and/or add to, vary or modify existing licensing conditions. The FSTB also proposes that consideration be given to provide the CCE with additional powers to prevent access to websites or digital platforms of VA OTC operators involved in unlicensed or fraudulent activities.

The FSTB further suggests imposing strict penalties and sanctions for unlicensed VA OTC services to deter ML/TF activities, such as making it an offence to carry out a regulated VA OTC service without a licence or issuing an advertisement of such. Furthermore, non-compliance with AML/CTF requirements could result in a fine of $1 million, imprisonment for two years, and administrative sanctions. Licensees committing any offences in respect of fraudulent and misleading activities of VA OTC will bear the consequences as currently listed in the provisions under the AMLO.

To incorporate the licensing regime into the current AML/CTF regulatory system, the FSTB further proposes that Part 6 of AMLO be expanded to cover appeals against future decisions to be made by CCE in implementing the VA OTC licensing regime.

Analysis and takeaways

Earlier last year, a number of fraud cases associated with alleged VATPs have highlighted the urgency and demand in bringing VA OTC services within the statutory regulatory remit to ensure that sufficient investor protection is provided for.

In this long-awaited legislative proposal, the FSTB proposes to introduce a new licensing regime for providers of VA OTC services. It follows the already established VATP licensing regime and regulatory system for MSOs and aims to prevent further fraudulent or ML/TF activities from happening in the VA OTC service industry. It remains to be seen whether the proposed legislation would be perceived as conducive to tackling the rising VA fraud cases in Hong Kong.

“Please contact our Partner Mr. Rodney Teoh for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.”

Background 

Tokenisation of investment products is a process that leverages blockchain technology to represent ownership in traditional investment assets, such as real estate, stocks, bonds, or funds, through digital tokens.  Please also see our news update in relation to the Guide to Digital Assets and Tokens in Hong Kong.  These tokens are created on a blockchain network and serve as digital representations of the underlying assets, made available directly to individual investors, distributed by the intermediaries who are licensed by the SFC, or traded among the blockchain participants, in accordance with applicable regulations.

In Hong Kong, certain stakeholders have already initiated or are actively exploring the tokenisation of securities and other investment products in which the tokenisation is expected to be capable of enhancing product efficiency, lowering operational expenses by decreasing dependence on intermediaries, and accessing the end-investors through new channels.

To meet market demand and support the growth of the market, the SFC has been evaluating different suggestions related to the tokenisation of investment products.  These proposals encompass a range of activities, including primary transactions involving tokenised products such as subscriptions and redemptions, as well as secondary trading of tokenised products on virtual asset trading platforms licensed by the SFC.  The SFC believes that employing a see-through approach is suitable to permit primary dealing of tokenised SFC-authorised investment products.  Nevertheless, this is contingent upon the underlying product meeting all the relevant requirements for product authorisation and the implementation of additional safeguards to address the potential risks associated with the tokenisation arrangement.

Conversely, the secondary trading of SFC-authorised investment products that have been tokenised requires greater caution and meticulous evaluation to ensure that investors receive a level of protection that is substantially equivalent to that provided for non-tokenised products.  Several factors need to be considered, including maintaining accurate and immediate records of token ownership, the preparedness of trading infrastructure and market participants to facilitate liquidity, and the equitable pricing of tokenised products, among other considerations.

Guidelines pertaining to the primary dealing of tokenised SFC-authorised investment products 

Product providers of tokenised SFC-authorised investment products must ensure that the underlying products comply with the applicable requirements outlined in relevant rules, regulations and product codes.  These requirements encompass various aspects, including the eligibility of product providers, product structure, investment and operational criteria, disclosure obligations, and ongoing compliance responsibilities.  In addition, requirements in the Circular on intermediaries engaging in tokenised securities-related activities released by the SFC on 2 November 2023 (the “Tokenised Securities Circular”) should also be satisfied (please see our news update on the Tokenised Securities Circular). 

1.      Tokenisation arrangement

Considering that tokenised products are publicly offered in Hong Kong and the significance of accurately reflecting investors’ ownership through proper records, product providers have a ultimate responsibility for the management and operational soundness of the tokenisation arrangement adopted, as well as the accurate record-keeping of ownership, regardless of any outsourcing arrangements.  They should ensure the proper maintenance of records regarding token holders’ ownership interests in the product, while ensuring operational compatibility with the involved service providers.  Further, they must also implement suitable measures to identify, manage, and mitigate cybersecurity risks, ensure data privacy, address system outages and recovery, and maintain a comprehensive and robust business continuity plan.

When utilising blockchain networks, product providers should avoid using public-permissionless networks without adequate controls. Instead, they should impose additional control by employing a permissioned token.  Product Providers are required to, confirm and, when requested by the SFC, demonstrate to the satisfaction of the SFC the management and operational soundness of the tokenisation arrangement, record-keeping of ownership, and the integrity of smart contracts.

Upon request from the SFC, product providers should obtain third-party audits or verifications to assess the management and operational soundness of the tokenisation arrangement, record-keeping of ownership, and integrity of smart contracts.  Furthermore, product providers should obtain satisfactory legal opinions to support their applications upon SFC’s request.

2.      Disclosure

The offering documents for a tokenised SFC-authorised investment product should provide clear information on the following:

(i)               the tokenisation arrangement, including explicit disclosure regarding whether off-chain or on-chain settlement is considered final;

(ii)              the ownership representation of the tokens, such as details about legal and beneficial title, as well as ownership of or interests in the product; and

(iii)             the risks associated with the tokenisation arrangement, for instance, cybersecurity vulnerabilities, system outages, the potential existence of undiscovered technical flaws, the evolving regulatory landscape, and potential challenges related to the application of existing laws.

For more disclosure requirements, please also refer to paragraphs 19 to 20 of the Tokenised Securities Circular.

3.      Intermediaries and staff competence

Distributors of tokenised SFC-authorised investment products as well as product providers who distribute their own products must be regulated intermediaries such as SFC-licensed corporations or registered institutions.  They are required to adhere to the relevant requirements outlined in existing rules, codes, and guidelines.  This includes meeting obligations related to client onboarding requirements and conducting suitability assessments on their investors.  Product providers are also required to provide confirmation to the SFC that they have at least one competent staff member with relevant experience and expertise to operate and/or supervise the tokenisation arrangement and to manage the new risks associated with ownership and technology in an appropriate manner.

Prior consultation and approval

For investment products with tokenisation features that intend to seek authorisation from the SFC, prior consultation with the SFC is necessary. The same applies to the tokenisation of existing SFC-authorised investment products, which may require prior approval, for instance, approval should be obtained before adding the disclosure of new tokenised unit/share class of an SFC-authorised fund in the Hong Kong offering documents and offering it to the public in Hong Kong.

Considering the dynamic nature of this field, the SFC reserves the right to provide additional guidance or impose further requirements specific to tokenised SFC-authorised investment products as deemed appropriate.

Analysis and takeaway

The Circular sets out the requirements under which the SFC would consider allowing tokenisation of SFC-authorised investment products for offering to the public in Hong Kong.  The SFC’s evaluation of proposals and support for the tokenisation of investment products indicates the recognition of the market potential in Hong Kong.  Tokenisation can provide opportunities for increased market efficiency, reduced costs, and expanded access to investment products for investors.  Also, it may facilitate streamlining of processes and reduce reliance on intermediaries.

While the SFC recognises the potential benefits of tokenisation, it also places emphasis on investor protection and regulatory oversight.  The SFC aims to strike a balance between accelerating the growth of tokenised investment products and ensuring that market participants adhere to the necessary requirements and safeguards.  Ongoing communication among market participants, investors and the regulatory, and vigilance in mitigating risks, would be crucial in this evolving landscape.

Please contact our Partner Mr. Rodney Teoh for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

The Circular first distinguished between “Digital Securities” and “Tokenised Securities”.  “Digital Securities” are defined as “securities” under section 1 of Part 1 of Schedule 1 to the Securities and Futures Ordinance (Cap. 571) (the “SFO”) which adopt distributed ledger technology (“DLT”) or similar technology in their lifecycle; while the SFC classifies “Tokenised Securities” as a subset of “Digital Securities”, encompassing traditional financial instruments (like bonds or funds) which are also “securities” that utilise DLT or similar technology in their lifecycle.  Examples of “Digital Securities” which are not “Tokenised Securities” include tokenisation of fractionalised interests in real world or digital assets such that the arrangement would amount to collective investments schemes (“CIS”).

Key points from the Circular

Analysis and takeaways

As reflected in the Circular, the SFC acknowledges the growing interest and potential benefits of tokenisation in the financial market.  With more intermediaries exploring the tokenisation of securities and the distribution of tokenised assets, there is a need for guidance and regulatory certainty to manage the associated risks.  By providing guidance on addressing new risks and ensuring investor protection, the SFC aims to foster a healthy tokenisation marketplace.

Please contact our Partner Mr. Rodney Teoh for any enquiries or further information.

This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.

Rodney delivered an engaging and insightful keynote address “Raising capital in the web3 era”. He provided a comprehensive overview of recent deals in Hong Kong and highlighted key developments in RWA tokenization around the globe. He also shared valuable insights into transaction structures, requirements, and challenges associated with Security Token Offerings (STOs).

Following his keynote speech, Rodney participated in a panel discussion with the other speakers, including Mr. Samson Lee, Founder and CEO at Coinstreet, Mr. Robert Lui, Hong Kong Digital Asset Leader at Deloitte, Mr. Michael Wong, President of Society of Registered Financial Planners, and Mr. Kevin Ho, COO of Fusang to engage in further discussion on the topic of Security Token and RWA Tokenization.

The seminar received an overwhelmingly positive response from the audience, attracting over 80 participants from various sectors and industries.

About Digital Asset Series (DAS)

DAS is a series of educational seminars delivered by industry leaders and practitioners, legal and consulting professionals, regulators, and academic scholars from the fintech ecosystem in Hong Kong. The objective of DAS is to educate the general public about the ever-growing landscape of digital assets and facilitate mass adoption by covering key topics across the digital asset space including Investment Strategies, Asset Management, Security Tokens, Web3, Metaverse, NFT, Regulatory, Stablecoin, CBDC, DeFi, Cryptocurrencies, ESG, Impact and Social Good.

For more information, please contact our Partner Rodney Teoh.