In recent years, the market for nonfungible tokens (NFTs), or crypto assets that represent the ownership of unique digital versions of assets, has exploded. Many NFTs have sold out in seconds in the sports and digital-arts sectors, and their creators have made millions.

Regulatory Overview

In recent years, the market for nonfungible tokens (NFTs), or crypto assets that represent the ownership of unique digital versions of assets, has exploded. Many NFTs have sold out in seconds in the sports and digital-arts sectors, and their creators have made millions. The creation of new forms of digital property through NFTs can facilitate new revenue streams, as well as provide businesses and digital creators with new channels for connecting with customers, fans, and audiences. The new trend also enables physical assets to be monetized, subject to limitations in any relevant jurisdiction. As the number of NFT issuance grows rapidly across the globe, the legal and regulatory frameworks of NFTs continue to evolve. One must consider the potential risks associated with NFTs, despite their promising prospects for growth.

A joint circular issued by the Hong Kong Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority on virtual-asset intermediaries’ activities was released on January 28, 2022 to provide guidance for SFC-licensed intermediaries that engage in virtual asset–related activities (read our briefing for details). In June 2022, the SFC issued a statement that summarizes the legal and regulatory requirements applicable to NFTs and the associated risks. Financial Services and the Treasury Bureau also proposed that virtual-asset service providers be granted a license under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615), and the relevant laws will be updated if the proposal in the consultation paper has passed.

What should issuers know about selling NFTs in Hong Kong?

It is possible for NFTs to be regulated under the Hong Kong Securities and Futures Ordinance (SFO) as well as under the regulatory authority of the SFC if they are structured similarly to regulated financial products such as securities and interests in collective-investment schemes (CIS). The issuer should take extra precautions to ensure they are not breaching any laws in Hong Kong with their product offerings.

Securities are defined as:

  • shares, stocks, debentures, loan stocks, funds, bonds, or notes of, or issued by, a body, whether incorporated or unincorporated, or a government or municipal-government authority;
  • rights, options, or interests in, or in respect of, such shares, stocks, debentures, loan stocks, funds, bonds, or notes;
  • certificates of interest or participation in, temporary or interim certificates for, receipts for, or warrants to subscribe for or purchase such shares, stocks, debentures, loan stocks, funds, bonds, or notes;
  • interests in any CIS; and
  • interests, rights, or property, whether in the form of an instrument or otherwise, commonly known as securities.

A CIS basically includes four elements:

  1. There must be an arrangement involving property.
  2. Participants do not have control over the management of the property on a daily basis.
  3. The property is managed in its entirety by or on behalf of the person managing the arrangements or the contributions, and profits from which payments are made to them are pooled.
  4. Arrangements are intended to enable participants to participate in the acquisition or management of property or to receive profits, income, or other returns.

If the NFTs involved are securities, then dealing in or advising on them, or managing or marketing a fund investing in them, may be considered a “regulated activity.” Parties engaging in a “regulated activity” are required to be licensed by or registered with the SFC irrespective of whether the parties involved are located in Hong Kong, so long as such business activities target the Hong Kong public.

Participating in a CIS may be subject to registration or authorization requirements under the law unless an exemption applies. Secondary traders of such NFTs are also subject to the SFC’s licensing and conduct requirements. Unless certain exemptions are provided, a person commits an offense if he issues, or has in his possession for the purposes of issuing, whether in Hong Kong or elsewhere, an advertisement, invitation, or document that is or contains an invitation to the public (i) to enter into or offer to enter into an agreement to acquire securities/structured products or (ii) to acquire an interest in a CIS.

What should investors know about buying NFTs in Hong Kong?

With crypto markets experiencing a significant correction, the SFC keeps reminding investors that NFTs involve certain risks—including illiquid secondary markets, volatility, opaque pricing, hacking, and fraud—and that investors should not invest if they cannot comprehend these risks or bear the potential losses.

In addition to the risks highlighted by the SFC, investors should be aware of the following:

  • Investors are strongly urged to do their own due diligence and make sensible decisions about their risk exposure.
  • Contracts without clear or specific terms and conditions, as well as vague, generic, “zero responsibility” clauses.
  • A contract must be written using the natural language terms so that there are no discrepancies between the legal contract and the technological mechanism of transfer.
  • The description of NFTs is often unclear about the rights associated with intellectual property, as references to standard-form licenses fail to inform inexperienced users of what they are buying.
  • Insufficient practicable enforcement mechanisms and complicated issues include unknown counterparties and unfamiliar governing laws.
  • Risks associated with custody, such as a lack of regulated custody options in the market.
  • The risk of trademark and copyright infringement when NFT issuers leverage others’ brands.

Josie Ma, a Paralegal in Winston’s Hong Kong office, assisted with this post.