Expanding Mainland China NFT platforms into Hong Kong – What do you need to know?

This article discusses: (a) an overview of the recent NFT landscape in Mainland China; and (b) the key issues to consider when issuing NFTs, launching an NFT platform, or providing NFT-related services in Hong Kong.

1. Introduction

First things first – what is a “non-fungible token”?

Currently, there is no legal definition of “non-fungible token” or “NFT” under Hong Kong laws. That said, the Financial Action Task Force (“FATF”)^[1] describes an NFT (as is generally accepted in Hong Kong) as a digital asset, which:

is digitally linked to a tangible collectible (eg digital image, artwork, audio-visual file, video clip, avatar or gear of online games, animation, physical collectible, etc);
is recorded on a blockchain; and
is not intended to be used as a payment or investment instrument, or otherwise backed by any fiat value or asset.^[2]

The recent policy statement^[3]issued by the Government of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”) signals Hong Kong’s open and embracing attitude towards NFT-related businesses. The Hong Kong Government also recognises further opportunities can be realised on more use cases of virtual assets such as trading digital arts and collectibles.

With this clear vision and regulatory support taken by the Hong Kong Government, we observe a substantial increase in the number of Mainland China-based companies expanding their NFT platforms and other relevant NFT-related businesses into Hong Kong. Their business expansion includes operating an NFT platform out of, or marketing the platform in, Hong Kong. These NFT platforms typically offer the following key functionalities:

primary market: facilitating issuance of NFTs based on:
- artwork (the creation of the artwork is done through cooperation with artists or IP right owners);
- social digital content (eg digital image, audio-visual file, video clip, music, etc); and
- in-game assets (eg virtual avatars, player headshots or other virtual items), which may be used in outside-the-platform virtual reality games; and
secondary market: (following the primary issuance) facilitating subsequent NFT sale and NFT transfer to other secondary NFT marketplaces operated in or outside Hong Kong.

The current regulatory position in Hong Kong is that, generally, where an NFT is a “genuine digital representation of a collectible”^[4], the activities related to it do not fall within the existing regulatory remit under Hong Kong law.

This article discusses:

an overview of the recent NFT landscape in Mainland China; and
the key issues to consider when issuing NFTs, launching an NFT platform, or providing NFT-related services in Hong Kong.

2. An overview of the NFT landscape in Mainland China

2.1 General prohibition of “virtual currencies” in Mainland China

In order to understand the attitude and policies of the Mainland Chinese Government in virtual currencies, it is essential to examine the regulatory development over the past decade. Notably, the Mainland Chinese Government has displayed an increasingly restrictive attitude over time towards virtual currencies, as summarised in the timeline below.

Available at: http://www.gov.cn/gzdt/2013-12/05/content_2542751.htm
Available at: http://www.gov.cn/xinwen/2017-09/04/content_5222657.htm
Available at: http://www.gov.cn/fuwu/2018-08/27/content_5316810.htm
Available at: https://www.court.gov.cn/zixun-xiangqing-242911.html
Available at: http://www.gov.cn/zhengce/zhengceku/2021-10/08/content_5641404.htm

The restrictive approach taken by the Mainland Chinese Government reflects the general trend of heightened scrutiny over virtual currencies and their associated activities targeting residents in Mainland China. Importantly, the 2021 Notice superseded the earlier 2013 Notice and made clear that virtual currencies such as Bitcoin, Ethereum and Tether issued by non-monetary authorities, should not and cannot be circulated in the Mainland China market as currencies. Any virtual currency-related businesses are illegal financial businesses.

2.2 The ambiguity of the NFT landscape in Mainland China

Despite the stringent prohibition on virtual currencies in Mainland China, NFTs are not explicitly included in the category of “virtual currency” from the Mainland Chinese regulatory perspective. More often, NFTs are referred to as “digital collectibles” or “digital assets” rather than “tokens” in Mainland China to be distinguished from “virtual currencies” as banned under the current regulations in Mainland China.

Based on the premise that NFTs are purely vehicles that “carry” corresponding digital content (such as images, videos, audio, etc), there is a general understanding that NFT issuance and related activities do not explicitly fall within the scope of regulatory bans in Mainland China. However, the unique characteristics of NFTs (including their irreplaceable, indivisible, and tamper-proof nature) do not completely negate their nature as “tokens”. In the case where the NFT issuance and related activities have an impact on disrupting financial order, regulators in Mainland China may also take the view that such NFTs are “virtual currencies” or “virtual currency derivatives” and regulate them accordingly.

Consistent with the restrictive approach taken by the Mainland Chinese Government, the industry shares a similarly cautious view on NFT-related developments. On 13 April 2022, three industry self-regulatory associations, namely the National Internet Finance Association of China, the China Banking Association and the Securities Association of China, jointly issued the Initiative to Prevent Financial Risks related to NFTs, and pointed out that NFTs, as an innovative application of the blockchain technology, are subject to risks relating to speculation, money laundering and illegal financial activities. With this background, the industry self-regulatory associations proposed to prohibit activities such as:

the use of virtual currencies including Bitcoin, Ethereum and Tether as the pricing and settlement instruments for the issuance and trading of NFTs;
the division of ownership or bulk minting (ie to weaken the non-fungible characteristics of NFTs) in order to carry out initial coin offering (“ICO”) in disguise; and
the provision of services in relation to NFT transactions such as concentrated trade, continuous listed trading and trading under standardised contracts.

Also, it is noteworthy that if NFTs are minted in batches and methods such as “premium repurchase”, “appreciation commitment” or “speculation on circulation transactions” are employed, NFT purchasers may potentially recover their capital and may even profit from such NFT transactions as there is sufficient liquidity of the NFTs created in the market. In this case, the NFTs may be regarded as financing tools, and such NFT transactions may be characterised as “creating NFTs in batches to carry out ICO in a disguised form” and would then be subject to relevant financial laws and regulations.

Despite the absence of blanket prohibitions (like the ones on virtual currencies), we recommend adopting a cautious approach when designing the trading mechanism for NFTs (especially trading of NFTs in secondary market, which is currently prohibited in Mainland China).^[5] This approach aligns with the general market understanding that NFTs are digital collectibles only, and any investment or speculative features (such as any scarcity or tradability of NFTs which may contribute to their perceived investment or financial values) should strictly observe other general regulations of investment activities in Mainland China, and not be encouraged.

With the evolving regulatory environment and uncertainty of the regulatory approach to NFTs and virtual currencies in the Mainland China market (in comparison with the embracing attitude for NFTs and virtual currencies in Hong Kong), we have observed recent increasing interests of Mainland China-based NFT operators in expanding their NFT-related businesses and operations to Hong Kong.

3. Key legal issues to consider when expanding China NFT platforms into Hong Kong

Despite the open and positive attitude towards NFT-related businesses from the local regulators in Hong Kong, any party interested in launching NFT platforms and related business in Hong Kong should pay attention to a range of legal and regulatory risks as summarised below.

Currently, there are no existing or pending NFT-specific laws or regulations in Hong Kong and therefore, NFTs are not regulated as a distinct asset class in Hong Kong. In other words, whether an NFT (and the relevant NFT platform) are regulated in Hong Kong largely depends on whether the offering of the NFTs and the platform functionalities triggers any existing licensing / regulatory regimes under Hong Kong law.

We summarise below the frequently asked questions relating to NFTs, and the key legal issues that you should take into consideration when issuing NFTs, launching an NFT platform, or providing NFT-related services in Hong Kong.

The summary is only intended to cover some of the key issues to consider for NFT-related businesses. It is not intended to cover all of the legal or regulatory issues that may be involved in, or risks that may arise from, an issuance of NFTs, a launch of an NFT platform, and the provision of NFT-related services in Hong Kong. It is also important to consider the commercial and practical aspects of the NFT-related business (eg whether the NFT platform operator / content contributors are entitled to “royalties”, etc).

	Key question to ask	Further explanation	Example uses 2
Product: considerations on the legal nature of the NFTs	Whether the NFTs to be minted, traded and distributed via the NFT platform are regulated under any existing legal and regulatory regime in Hong Kong?	This is one of the most important threshold questions to ask – whether the relevant NFTs are merely digital collectibles, or the NFTs may fall within different categories of regulated assets or financial products under Hong Kong laws – eg money instruments[6], regulated financial products (in particular interests in a collective investment scheme)[7], or virtual assets[8], etc. The substance is more important than the labels used to describe the NFTs, and a legal assessment on the legal nature of the NFTs is essential in order to determine whether the NFTs provide rights, benefits or interests in any underlying portfolio of assets to NFT holders which may render them regulated assets / products under Hong Kong law.
Platform: considerations on the functionalities and services offered via the NFT platform	Whether the functionalities / services provided via the NFT platform constitute regulated activities under any existing legal and regulatory regime in Hong Kong?	This assessment largely hinges on the product categorisation considerations above. In other words, if the relevant NFTs are regulated under Hong Kong law, certain functionalities / services (eg marketing activities, distribution, and provision of automated trading services, relating to the NFTs) provided by the NFT platform operator may constitute regulated activities and therefore, triggering the relevant licensing / regulatory regimes. Also, it is important to note that regardless of whether the relevant NFTs to be minted and traded via the NFT platform are considered money instruments, regulated financial products or virtual assets, there may be other licensing / regulatory requirements attaching to certain ancillary services offered via the NFT platforms. For example, if the platform operator provides custodian services of the NFTs, it may need to consider if such custodian services also trigger other specific licensing requirements.
Cross-border payment considerations	Whether the NFT platform operator will facilitate payment transactions of NFTs (including processing cross-border payments) itself, or partner with a payment service provider to process such payment transactions?	If the NFT platform operator provides money services (ie money changing services or money remittance services) to the platform users (rather than engaging a licensed payment service provider to provide such services), there may be licensing implications under the money service operator regulatory regime. Additionally, care should be taken to ensure that any cross-border payment does not contravene any law of the relevant foreign jurisdiction (eg capital control requirements). This is particularly relevant if the NFT platform operator or user transfers “income” or “profits” arising from the NFT-related businesses or NFT transactions.
Data protection considerations	Whether the sale and distribution of NFTs and the functionalities of the NFT platform involve any domestic or cross-border data transfer?	Data protection issues may arise under a broad range of scenarios – eg an NFT itself contains an individual’s personal data such as facial image, an NFT transaction involves an exchange of personal data (eg an individual’s name, email address, contact number, etc). Also, under Hong Kong law, the NFT platform operator is required to make available its data protection policies, along with proper implementation of data protection controls.
Operational standards: considerations on imposing know your client (“KYC”) process and procedures	To what extent will the NFT platform operator conduct KYC on its users?	Regardless of whether the strict legal requirements on KYC apply to the NFT platform, NFT issuers and NFT-related service providers may prefer conducting KYC on their customers (eg NFT platform users) as good practice from reputation perspective to address potential anti-money laundering/counter-terrorist financing and sanctions issues, and to attract reputable institutional investors and facilitate its cooperation with other financial institutions.
Gambling risk considerations	Whether the distribution of NFTs is randomised, or the NFT distribution mechanism is equally favourable to all platform users, and the NFT purchasers know what they are getting before or at the point of the NFT sale?	Gambling and lottery activities are generally prohibited under Hong Kong law. It is key that the NFT platform operator ensures that the transaction of NFTs is an ordinary sale, which does not involve any element of “luck”, in order to avoid triggering the prohibitions of gambling and lottery activities. For legitimate trade promotion activities (eg business promotion, product sale, etc by way of a game that distributes or allots prizes by lot/chance – such as lucky draws, it is possible to obtain a trade promotion competition licence from the Television and Entertainment Licensing Authority (TELA) prior to the launch of any promotion events.
Addressing issues and risks relating to intellectual property rights	How to assess whether the issuer of the NFT / digital collectible has the intellectual property rights (IP rights) and/or other necessary rights required for NFT issuance? How to effectively document digital transactions involving IP rights issues under the existing legal framework for IP rights protection?	The basis for NFT issuance is that the issuer has the IP rights and/or other necessary rights required for NFT issuance of the relevant digital collectibles. Given the NFT platform’s control over transactions, assessment costs, technical feasibility, and monetisation of trading activities in NFTs, there is a general expectation for the NFT platform to assume more responsibility (as compared with ordinary e-commence platforms) to assess risks of IP rights infringement and other IP rights-related issues. Therefore, as part of its risk management, it is essential for the NFT platform to establish an effective mechanism for verifying the authenticity of rights and handling IP rights infringement complaints, and impose technical or contractual control to prevent the creation and/or distribution of NFTs that infringe third-party IP rights. Under the existing legal framework for IP rights protection, the core feature of issuance of a subject matter is the transfer of ownership (or a licence for use) of the original or copy of the “tangible carrier” of the subject matter. Digital issuance only involves transfer of virtual objects, which does not constitute issuance in the traditional sense, and may therefore affect an NFT purchaser’s right to exhibit and resell the NFT / underlying digital collectible. Such defects may affect the value of the NFT and must be effectively addressed through contractual agreements covering IP rights issues.

4. KWM capabilities

KWM Hong Kong and PRC offices have extensive experience in:

advising on the legality of issuance or distribution of NFTs, operation of NFT trading platforms and relevant licensing/regulatory regimes;
advising on issues relating to cross-border payments;
advising on issues relating to data privacy law and preparing data protection statements and policies; and
reviewing and drafting terms of use and community guidelines for NFT trading platforms.

Speak to us - we would be delighted to assist you in navigating your business expansion into the Hong Kong NFT market and share our market observations in this field.

In this article:

“Hong Kong” or “Hong Kong SAR” should be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China”.
The Mainland of China is described as “Mainland China”.

This publication is intended to highlight potential issues and provide general information and should not be construed as legal advice.

Reference

[1] The FATF is an intergovernmental organisation founded in 1989 to combat money laundering by (among other things) setting international standards that aim to prevent money laundering and illegal activities. Both Mainland China and Hong Kong are members of the FATF.

[2] Paragraphs 36 and 37 of Targeted Update on Implementation of the FATF Standards on Virtual Asset and Virtual Asset Service Providers issued by the FATF (dated June 2022), available at: https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Targeted-update-virtual-assets-vasps.html.

[3] The Policy Statement on Development of Virtual Assets in Hong Kong issued by the Hong Kong’s Financial Services and the Treasury Bureau (dated) 31 October 2022, available at: https://gia.info.gov.hk/general/202210/31/P2022103000454_404805_1_1667173469522.pdf (English version) / https://www.info.gov.hk/gia/general/202210/31/P2022103000455.htm?fontSize=1 (Chinese version).

[4] The Securities and Futures Commission (“SFC”) of Hong Kong expressly acknowledged that most NFTs are not regulated in Hong Kong under the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong) in a statement issued by the SFC dated 6 June 2022, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=22PR34.

[5] Several industrial associations, including the National Internet Finance Association, Securities Association, and the China Banking Association jointly issued the Initiative to Prevent Financial Risks related to NFTs on 13 April 2022, which includes a commitment by members of these three associations not to financialise or securitise NFTs, and not to provide trading services or related financial services for NFTs in any form.

[6] Under the Banking Ordinance (Cap 155 the Laws of Hong Kong).

[7] Under the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong).

[8] Under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615 of the Laws of Hong Kong). The virtual asset service provider (VASP) licensing regime takes effect on 1 June 2023.