On 28 March 2019, the SFC issued a Statement on Security Token Offerings (the “Statement”).

The Statement serves as a reminder about the legal and regulatory requirements applicable to parties engaging in security token offerings (“STOs”).

STOs are offerings which are structured to have features of traditional securities offerings, and involve Security Tokens which are digital representations of ownership of assets (eg, gold or real estate) or economic rights (eg, a share of profits or revenue) utilising blockchain technology. Security Tokens are normally offered to professional investors only.

The SFC has taken the view that Security Tokens are likely to be "securities" under the Securities and Futures Ordinance (Cap.571) (“SFO”) and so subject to the securities laws of Hong Kong.

As such, 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. Breach of this is a criminal offence.

Intermediaries which market and distribute Security Tokens are required to ensure compliance with all existing legal and regulatory requirements, including compliance with the SFC’s Code of Conduct, Suitability FAQs and Guidelines on Online Distribution and Advisory Platforms and paragraph 5.5 of the Code of Conduct. This is because the SFC regards Security Tokens as "complex products" and therefore additional investor protection measures also apply.

The SFC expects intermediaries to observe requirements which are similar to those set out in the Circular to intermediaries on the distribution of virtual asset funds dated 1 November 2018. The requirements are highlighted as follows:

(A)  Selling restrictions

Where an intermediary markets or distributes Security Tokens, it must be licensed or registered for Type 1 regulated activity (dealing in securities) and the Security Tokens should only be offered to professional investors.

(B)  Due diligence

Intermediaries distributing Security Tokens should conduct proper due diligence in order to develop an in-depth understanding of the STOs. This should include, but is not limited to, the background and financial soundness of the management, development team and issuer as well as the existence of and rights attached to the assets which back the Security Tokens. Intermediaries should also scrutinise all materials relevant to the STOs including published information such as the whitepaper and any relevant marketing materials. Intermediaries should also ensure that all information given to their clients is accurate and not misleading.

(C)  Information for clients

To help clients make informed investment decisions, intermediaries should provide the information in relation to STOs in a clear and easily comprehensible manner. Intermediaries should also provide prominent warning statements covering risks associated with virtual assets.

The SFC also requires intermediaries to:-

1. implement adequate systems and controls to ensure compliance with the requirements before they engage in the distribution of STOs. Failure to do so may affect their fitness and properness to remain licensed or registered and may result in disciplinary action by the SFC; and
2. discuss with the SFC before engaging in any activities relating to STOs.

For any enquiries related to this article, please contact Chris Lambert or Charles Mok.