Jun 2022

SFC warns NFTs may require licensing

The Securities and Futures Commission (SFC) issued a statement on 6 June 2022 warning investors of the risks associated with investing in non-fungible tokens (NFTs).[1]

The SFC warned investors NFTs, like other digital assets, face heightened risks including illiquid secondary markets, volatility, opaque pricing, hacking and fraud.

The regulatory body also pointed out that while NFTs are intended to represent a unique copy of an underlying asset like a digital image, artwork, music or video, and investments in digital representations of a collectible would not fall within the scope of SFC regulations, there are NFTs on the market that have crossed the boundary between a collectible and a financial asset.

Some NFTs are fractionalized and structured in a way similar to “securities” or interest in a “collective investment scheme,” it said.

As defined in the Securities and Futures Ordinance (“the Ordinance”), “collective investment scheme” generally refers to investment products of a collective nature where:

  1. There are some arrangements in respect of property;
  2. The participants of such arrangements do not have day-to-day control over the management of property;
  3. The property involved is managed as a whole by or on behalf of the person operating the arrangements or the contributions of the participants and the profits or income from which payments are made to them are pooled; and
  4. The purpose or effect of which is for participants to participate in or receive profits, income or other returns from the acquisition, holding, management or disposal of the property.

If an NFT constitutes an interest in a collective investment scheme, distributing such an NFT might fall within the scope of “regulated activities” under the Ordinance. Accordingly, persons carrying on such regulated activities are required to obtain a license from the SFC.

Authorization requirements under the Ordinance may also be triggered where an arrangement relating to NFTs involves an offer to the Hong Kong public to participate in a collective investment scheme.

Currently, it is an offence under section 103 of the Ordinance to issue an advertisement, invitation or document which is or contains an invitation to the Hong Kong public to acquire an interest in or participate in a collective investment scheme, unless the issue is authorized by the SFC or an exemption applies.

The SFC’s latest statement comes as the first specific notice on NFTs, suggesting that activities around NFTs could be bound by existing local regulations.  Following the Hong Kong Monetary Authority releasing a discussion paper on crypto-assets and stablecoins and launching a consultation seeking public feed on the scope of the regulatory regime applicable to stablecoins in January,[2] it appears that regulatory bodies are moving towards tighter control and regulations on cryptocurrencies and NFTs.  It remains to be seen when and how local regulators will introduce new regulatory regime targeting digital assets.

 

Written by: Karen Choi, Associate and Dorothy Fung, Trainee Solicitor

 

[1] https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=22PR34

[2] https://www.hkma.gov.hk/eng/news-and-media/press-releases/2022/01/20220112-3/

Written by:

Karen Choi

Associate

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