In a statement dated March 28th 2019, Hong Kong’s securities regulator— the Securities and Futures Commission (SFC)— has provided official guidance on security token offerings (STOs). Three key points were outlined for security token issuers and intermediaries, which ultimately highlighted how security tokens are subject to the existing securities laws in Hong Kong.

Hong Kong’s Security Token Offering Regulations Explained

The SFC’s guidance begins with a definition to clarify precisely what it means by ‘security token’:

“STOs typically refer to specific 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.”

Those who issue security tokens, along with intermediaries, must fulfill several requirements.

First, issuers must be type 1 licensed or registered to deal securities in Hong Kong, or must quality for an exemption.

Second, intermediaries are obliged to conduct comprehensive “due diligence” on the firms they list. The SFC went on to elaborate as to precisely what such diligence entails:

“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.”

Third, they can only sell to professional investors, and they have to provide clear information about the nature of STOs as well as their inherent risks:

“Investors are urged to be wary of the potential risks involved in virtual assets. The SFC has repeatedly reminded investors that virtual assets are exposed to heightened risks of insufficient liquidity or volatility, opaque pricing, hacking and fraud. These risks are also applicable to Security Tokens. As STOs are a nascent form of fundraising and the market is still evolving, investors should be cautious when deciding whether to invest. Investors may be exposed to significant financial losses in trading Security Tokens. If investors cannot fully understand the risks and bear the potential losses, they should not make an investment.”

The SFC also reminded brokers that conducting an STO without meeting the legal requirements— including registration and licensing— is a criminal offense in Hong Kong.

How Security Tokens Frequently Fall Under Existing Securities Laws

Importantly, the document also explained how security tokens fall under Hong Kong’s existing securities laws:

“In Hong Kong, Security Tokens are likely to be ‘securities’ under the Securities and Futures Ordinance (SFO) and so subject to the securities laws of Hong Kong.”

Such a classification has become a common theme among the world’s largest securities regulators.

In the United States, Securities and Exchange Commission (SEC) Chairman Jay Clayton has publicly stated that besides Ethereum, virtually all Initial Coin Offerings he has seen, constitute securities. They therefore must abide by existing securities laws, since Clayton says he is “not going to change rules just to fit a technology”.

The idea behind such a notion implies the following: regardless of how funds are raised— meaning which technology is used— the raising of capital from investors who make speculative investments, is fundamentally uniform.

The situation has resulted in a diversion from the ICO, and a transition towards to the STO as a compliant means to raise capital.

For a complete explanation on security token functionality, be sure to review our comprehensive security token guide.

What do you think of the SFC’s stance on security tokens? What will it take for securities regulators to form a global standard of security token laws and regulations? We want to know what you think in the comments section below.

Image courtesy of the SFC.