Author: Lawyer Wu Wenqian
Editor: Techub News-Junge
Since the Hong Kong government began to implement the Web 3 policy last year, many NFT projects want to develop in Hong Kong, but many people say that Hong Kong currently has no regulations on NFT, so they think that the risks of legal compliance and licenses are relatively large. On the one hand, Hong Kong Financial Secretary Paul Hui said in an interview that if NFT has the nature of collective investment or securities, it needs to be approved by the SFC before it can be sold publicly. On the other hand, King Leung, head of fintech at Invest Hong Kong, also said that if NFT is not a security in Hong Kong, the SFC will not manage it, and NFT is completely legal in Hong Kong. This article aims to explore how to define whether NFT is compliant in Hong Kong and whether a license is required in Hong Kong.
The following content is for reference only and does not constitute legal advice.
Are NFTs securities?
According to the Hong Kong Securities and Futures Ordinance, the definition of securities can be roughly divided into the following categories:
(a) shares, stocks, debentures, loan stocks, funds, bonds or notes;
(b) rights, options and interests in shares, stocks, debentures, loan stocks, funds, bonds or notes;
(c) any certificate of interest, participation, interim certificate, receipt or warrant in respect of any share, stock, debenture, loan stock, fund, bond or note;
(d) interests in collective investment schemes;
(e) interests, rights or property commonly referred to as securities;
(f) Structured Products.
The above conditions apply equally to determining whether a general token is a security.
The above categories (a), (b), (c), and (e) are relatively easy to distinguish. Simply put, if an NFT (or token) is linked to a company/corporation/business/institution, or has a creditor relationship with the issuer, it will be considered a security.
As early as September 5, 2017, the China Securities Regulatory Commission has provided a simple guide on how to determine security coins, mainly divided into three situations:
(i) If a token represents equity or ownership interest in a company, e.g. token holders are given shareholder rights, including the right to receive dividends and the right to participate in the distribution of the company’s remaining assets upon liquidation, then the token may be considered a security;
(ii) If the tokens are used to create or acknowledge a debt or liability owed by the issuer, they may be considered "bonds". For example, the issuer may repay the token holder's investment principal at a fixed date or upon redemption and pay interest to the token holder;
(iii) Tokens may be considered interests in a “collective investment scheme” if the tokens are collectively managed by the scheme operator and used to invest in projects with the aim of allowing token holders to participate in sharing the benefits of the projects.
Generally, if NFT only represents the ownership of artworks or collectibles, or represents an avatar/character in a game, it is very likely not a category of shares, stocks, bonds, etc.
As for whether it is a collective investment plan, it mainly depends on whether the NFT holder purchases some assets through the NFT issuer, or whether the issuer uses the funds from selling NFTs to purchase assets and then gives them back to the NFT holders. There are several major principles:
(i) NFT holders have no day-to-day control over the management of their property;
(ii) the property is managed by the Issuer/Operator as a whole;
(iii) The purpose of the entire arrangement is to allow NFT holders to receive returns by acquiring assets.
It should be noted that some project parties hope to raise funds by selling NFTs first. NFTs do have a floor price, but NFT holders will receive tokens issued by the project through airdrops in the future. In these cases, we need to pay attention to whether they fall into the definition of collective investment plans.
In addition, airdrops are a topic that requires more caution. If the airdrops are based on the project's profits and revenues, they may be the right to receive dividends or a collective investment plan. There is no case in Hong Kong, but under US regulations, the Bored Ape project once airdropped Ape Coin to NFT holders and the SFC investigated whether Bored Ape NFT was a security coin.
As for the definition of structured products, they usually refer to products that are linked to the prices of securities, commodities, indexes, properties, interest rates, currency exchange rates or futures contracts. NFTs are generally not included in these definitions, so we will not discuss them here.
Finally, if an NFT is defined as a security, the issuer will be subject to regulation by the Securities and Futures Commission.
Is NFT a virtual asset?
After that, we need to discuss whether NFT is a virtual asset and whether a license is required.
According to the Anti-Money Laundering and Counter-Terrorist Financing Act, virtual assets are generally defined as digital value, that is,
1) expressed as a unit of account or store of economic value;
2) It is a medium of exchange accepted by the public and meets one of the following conditions:
a) a medium of exchange used for payment, settlement of debts, investment; or
b) voting rights for management, operations or governance; and
3) Can be transferred, stored or traded electronically
The following are not considered virtual assets:
1) CBDC
2) Securities or futures
3) Reward points or game assets
Whether NFT is a virtual asset actually depends on what the individual NFT represents.
For most NFTs on the market, the most relevant condition is whether the NFT is "a medium of exchange accepted by the public" or "a reward point or game asset." For example, if it is land in the Sandbox, it may be a "game asset." As for whether NFTs with low traffic are a medium of exchange accepted by the public, this line is very vague.
If NFT is a virtual asset and not a security, then the issuer does not need a license from the CSRC. However, if it is an exchange, a license may be required. Currently, the CSRC's VASP license is for centralized exchanges. In theory, if the project party is a centralized exchange and includes NFTs that are virtual assets, a VASP license is required.
But please note that by definition a centralized exchange must have an Order Book and a Matching Engine. In fact (or technically), each NFT is unique, so most NFT artworks and collectibles can only handle transactions through auctions and bidding, or match buyers and sellers in P2P form. Auctions and bidding may not be considered exchanges. As for P2P, the China Securities Regulatory Commission's consultation document as early as February has mentioned that it is currently not inclined to regulate P2P forms, such as decentralized exchanges and other business models. Therefore, as long as it is not a centralized exchange, a VASP license is not required. But we must also take a closer look at the business service content and operating model, and pay attention to all the latest policies of the China Securities Regulatory Commission.
For example, all transactions on Opensea are conducted on the chain, and buyers and sellers are matched by auction, so this type of platform does not fall within the definition of a centralized exchange.
