Hong Kong classifies NFTs as financial asset, mandates licensing

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Hong Kong’s Securities and Futures Commission (SFC) recently published an advisory paper that recognized NFTs as “collective investment schemes” rather than collectibles.

The recognition brings NFTs under the SFC’s jurisdiction. The regulator considers NFTs highly risky investments that require a specific type of license.

The letter recognized the nature of NFTs and their current trajectory to become an investment tool similar to securities. The letter stated:

“The SFC has recently noted NFTs […] structured in a form similar to “securities” […], or in particular, interests in a ‘collective investment scheme’ (CIS)”

This shift towards becoming an investment tool subjected NFTs under the SFC’s jurisdiction. With the new approach, for any NFT that constitutes an interest in a CIS, marketing, or distributing, NFT requires specific SFC licensing.

Collective investment scheme

SFC defines collective investment schemes as schemes that involve an arrangement in respect of property managed as a whole; the participants don’t have any control over the management of the property and participate in seeking financial returns.

By this definition, all NFT collections released in Hong Kong or target Hong Kong investors fall under the definition of CIS and, therefore, will require licensing from now on.

Hong Kong regulatory framework

The SFC and the Hong Kong Monetary Authority (HKMA) jointly issued the 2022 Crypto Regulation Circular on January 28, 2022. The Circular includes a definition of virtual assets and addresses issues around virtual-asset-related products.

Virtual asset products include all assets that either have an investment objective, derive their value from virtual assets,  or replicate investment returns that correspond to that of virtual assets.

The Circular also includes detailed guidance for organizations who plan on distributing or dealing with virtual assets. Each business must obtain a specific license depending on its target customer segment, whether it is professional investors or private clients.

Risks of NFTs

SFC considers NFTs as a virtual asset-related product, as they replicate investment returns that correspond to that of virtual assets.

With that, however, SFC still considers NFTs as particularly risky. The recent letter warns NFT investors as they are prone to losing revenue due to illiquid secondary markets, price volatility, opaque pricing, hacking, and fraud.