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SFC’s response to initial coin offerings in Hong Kong

2018-03-30

The Background

On 19 March 2018, the Securities and Futures Commission (the “SFC”) published a press release in relation to its regulatory action taken against Black Cell Technology Limited (“Black Cell”), an Initial Coin Offerings (“ICO”) issuer. As a result of the action taken, Black Cell has halted its ICO and undertaken not to devise, set up or market any scheme that constitute collective investment scheme (“CIS”) as defined under the Securities and Futures Ordinance (Cap. 571) (the “SFO”) without complying with the relevant statutory requirements. The SFC has again reminded investors for the risk of investing in ICO and digital tokens.


Recap on ICO, Securities and CIS

As discussed in our previous newsletter regarding ICO in September 2017, ICO is a fund raising mechanism that comes in various forms, with one typical form being investment funding involving the issuance of digital coins (i.e. cryptocurrencies) created and disseminated using blockchain technology. Depending of the rights attached to such digital coins, they may be regarded as “securities” defined under the SFO and accordingly subject to the securities law in Hong Kong.

In addition, ICO itself may also be regarded as a CIS defined under the SFO (and is therefore subject to the SFO) if (i) it involves property arrangement; (ii) its participants do not have day-to-day control over the management of the property (whether or not they have the right to be consulted and to give directions); (iii) the property is managed as a whole by or on behalf of the person operating the arrangements for the contributions of the participants and the profits or income form which payments are made to them are pooled and (iv) its purpose or effect is for participants to participate in or receive profits, income or other returns from the acquisition on management of the property.


The Black Cell Case & SFC’s Action
against other Issuers of ICOs

The Black Cell Case

In the Black Cell case, the cryptocurrency issued under the ICO is available for sale to investors through Black Cell’s website accessible by the Hong Kong public. The digital token concerned is known as KorpCoins and is described in the relevant whitepaper (a prospectus-like document which may set out the technological, commercial and financial terms on which the ICO should operate) as tokenised shares of Black Cell.  As claimed in its whitepaper, the proceeds of the ICO will be used to fund the development of a mobile application and token holders will be eligible to redeem equity shares of Black Cell registered under the Companies Registry of Hong Kong. This factual pattern has led to the SFC’s suspicion that the ICO constitutes a CIS and is therefore subject to the regulatory regime under the SFO.

On top of the SFC’s observation regarding the nature of ICO as similar to that of a CIS, the fact that the holders of cryptocurrency are entitled to shares of Black Cell suggest that the relevant cryptocurrency would fall within the definition of securities under the SFO.

Other Actions Taken by the SFC

The Black Cell case is not the first occasion where the SFC has taken actions against ICO issuers. In its press release dated 9 February 2018 (the “February Press Release”), the SFC announced that it has issued letters to seven ICO issuers in Hong Kong or with connections to Hong Kong. In response to the action taken by the SFC, the majority of those issuers either confirmed compliance with the SFC’s regulatory regime or ceased to offer tokens to Hong Kong investors.

On top of action taken against ICO issuers, the SFC has also issued warning letters to seven cryptocurrency exchanges in Hong Kong or with connections to Hong Kong. In those letters, the SFC has reminded those exchanges not to trade cryptocurrency categorised as securities under the SFO if they have not obtained the necessary licences and/or authorisation. As a result, most of the exchanges either confirmed that they did not provide trading services for the relevant digital tokens or took immediate remedial measures including but not limited to removing the relevant tokens from their exchange platforms.


Conclusion

While no substantial reformation has been implemented to the existing regulatory regime for ICO and cryptocurrency so far, the SFC’s action taken against Black Cell and other ICO issuers and exchanges clearly demonstrate its determination in supervising the nascent market of ICO. As suggested by Mr. Ashley Alder, Chief Executive Officer of the SFC, in the February Press Release, SFC will continue to police the market and enforce when necessary. Investors are also urged not to invest in ICOs and cryptocurrencies unless they fully understand the risk involved and are prepared for significant loss. We echo the SFC’s comments in this rapidly developing market space where investors’ protection has not caught up with market development. The investing public is advised to obtain professional advice before they make any investment decisions as to cryptocurrencies.




For enquiries, please contact our Litigation & Dispute Resolution Department:

E: regcom@onc.hk                                                          T: (852) 2810 1212
W:
www.onc.hk                                                                F: (852) 2804 6311

19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2018


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