A new guidance creates a regulatory framework for tokenisation of retail investment products and provision of services for tokenised financial instruments.

By Simon Hawkins and Adrian Fong

On 2 November 2023, the Securities and Futures Commission (SFC) issued two widely anticipated circulars on tokenisation during the 2023 Hong Kong FinTech Week.

One circular provides conduct-related guidance to intermediaries engaging in tokenised securities-related activities (Activities Circular). The other circular addresses the tokenisation of SFC-authorised investment products (Products Circular), such as retail investment funds.

Before the circulars were released, the SFC’s chief executive spoke of the regulator’s evolutionary rather than revolutionary approach to addressing digital asset-related activities. The circulars indeed reflect this gradual, incremental approach rather than a big-bang moment of regulatory change, and we expect market participants to welcome the SFC’s new guidance as some of them consider exploring tokenised products and services.

A proposed rule would increase Treasury’s insight into non-US crypto mixing transactions to combat illicit activities by malicious actors.

By Parag Patel, Eric S. Volkman, Douglas K. Yatter, and Deric Behar

On October 19, 2023, the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) announced a Notice of Proposed Rule Making (NPRM) that would designate as a “primary money laundering concern” all non-US convertible virtual currency[1] mixing (CVC mixing). The NPRM would impose enhanced reporting and recordkeeping requirements for any financial transactions involving international mixers, intended to mitigate the risks of money laundering and terrorist financing.

The proposed designation is pursuant to Section 311 of the USA PATRIOT Act, which empowers the Secretary of the Treasury to require domestic financial institutions and domestic financial agencies to take certain “special measures” against foreign jurisdictions, foreign financial institutions, classes of international transactions, or types of accounts designated as a primary money laundering concern. Section 311 has heretofore been employed only against non-US financial institutions and jurisdictions rather than an individual class of transactions.

As regulatory thinking evolves, firms must ensure that any current or planned use of AI complies with regulatory expectations.

By Fiona M. Maclean, Becky Critchley, Gabriel Lakeman, Gary Whitehead, and Charlotte Collins

As financial services firms digest FS2/23, the joint Feedback Statement on Artificial Intelligence and Machine Learning issued by the FCA, Bank of England, and PRA (the regulators), and the UK government hosts the AI Safety Summit, we take stock of the government and the regulators’ thinking on AI to date, discuss what compliance considerations firms should be taking into account now, and look at what is coming next.

The FCA recently highlighted that we are reaching a tipping point whereby the UK government and sectoral regulators need to decide how to regulate and oversee the use of AI. Financial services firms will need to track developments closely to understand the impact they may have. However, the regulators have already set out how numerous areas of existing regulation are relevant to firms’ use of AI, so firms also need to ensure that any current use of AI is compliant with the existing regulatory framework.

Licensees, exchanges, and other market participants should prepare to comply with the listing, disclosure, capital, and other requirements that the new law imposes.

By Jenny Cieplak, Nima Mohebbi, Parag Patel, Stephen P. Wink, Ian Irlander, Adam Zuckerman, Luca Marquard, and Deric Behar

On October 13, 2023, California Governor Gavin Newsom signed California State Assembly Bill 39, which establishes the Digital Financial Assets Law (DFAL). The new law, which goes into effect on July 1, 2025, makes California only the second state after New York to adopt comprehensive regulation of digital financial assets[1] and associated service providers.

The DFAL authorizes the California Department of Financial Protection and Innovation (DFPI) to administer its provisions and requirements, which apply to the digital asset business activity of a person or entity (Covered Persons) engaging in, or holding itself out as being able to engage in, activities with California residents relating to the exchange, transfer, storage or “administration” of a digital asset,[2] whether indirectly or through a vendor.

Revamped SFC and HKMA guidance applies to intermediaries that distribute products or provide dealing, advisory, and asset management services related to virtual assets.

By Simon Hawkins and Adrian Fong

On 20 October 2023, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) issued a joint circular (Joint Circular) to provide updated guidance to intermediaries conducting virtual asset (VA) activities. The Joint Circular revises a previous joint circular issued on 28 January 2022 (see Latham’s Client Alert).

The need to update the 2022 joint circular emerged after a new regulatory regime for virtual asset trading platforms (VATP) was launched in June 2023, which allowed such platforms to onboard retail investors (see Latham’s Client Alert) for the first time.

The Proposed Guidance would require enhanced criteria for coin-listing and delisting procedures for New York-licensed virtual currency entities.

By Jenny Cieplak, Arthur S. Long, Yvette D. Valdez, Stephen P. Wink, Ian Irlander, and Deric Behar

On September 18, 2023, the New York Department of Financial Services (DFS) issued Proposed Updates to Guidance Regarding Listing of Virtual Currencies (the Proposed Guidance) pursuant to its ongoing VOLT initiative to strengthen the oversight of virtual currencies.

The Proposed Guidance updates DFS’s general framework for the creation of firm-specific policies by virtual currency entities[1] (VCEs) with respect to the adoption, listing or delisting of a virtual currency. It provides for a self-certification process for listing coins provided such VCE has a DFS-approved coin-listing policy. Notably, VCEs that do not have an approved coin-listing policy may only list coins that are included in the DFS virtual currency “Greenlist” or that are individually approved by DFS for listing by such VCE as part of an application for a material change to business under NYCRR 200.10. However, DFS may at any time and in its sole discretion require VCEs to delist or limit New Yorkers’ access to specific coins.

DFS’s stated goals under the policy include consumer protection as well as safety and soundness of VCEs.

The new standard aims to improve accounting treatment of certain digital assets under GAAP and may pave the way for increased institutional adoption.

By Jack Barber, Robert J. Malionek, Marlon Q. Paz, Heather Waller, and Deric Behar

On September 6, 2023, the Financial Accounting Standards Board (FASB)[1] voted to approve Accounting for and Disclosure of Crypto Assets, an Accounting Standards Update (ASU) to FASB Accounting Standards Codification (ASC) Topic 350 (Intangibles—Goodwill and Other), originally proposed in March 2023. The ASU will standardize the treatment of certain digital assets under US generally accepted accounting principles (GAAP) (the Update).

According to FASB, market feedback indicated concern with the current accounting methodology for crypto assets under ASC 350 as indefinite-lived intangible assets (whereby assets must be calculated at a historical cost less impairment, such as for trademarks). The methodology reflects “only the decreases, but not the increases, in the value of crypto assets in the financial statements until they are sold,” and therefore “does not provide investors . . . with decision-useful information . . . that reflects (1) the underlying economics of those assets and (2) an entity’s financial position.”

To address FASB’s concern, the Update now requires an entity to measure crypto assets at fair value[2] each reporting period with changes in fair value recognized in net income.

The Update also mandates enhanced disclosure requirements concerning an entity’s crypto asset holdings, intended to improve information available to investors.

In its second action involving NFTs, the SEC targets an offering tied to fundraising and promises of future value.

By Ghaith Mahmood, Nima H. Mohebbi, Stephen P. Wink, Douglas K. Yatter, Adam Zuckerman, Luca Marquard, and Deric Behar

On September 13, 2023, the Securities and Exchange Commission (SEC) issued a cease-and-desist order (the Order) against Stoner Cats 2, LLC (SC2) for an alleged unregistered securities offering relating to SC2’s sale of $8.2 million worth of non-fungible tokens (NFTs). The SEC alleged that the NFTs were issued to the public to finance the production of a web-based animated series by the same name.

SC2 agreed to a settlement that includes a civil monetary penalty of $1 million and ceasing and desisting from violating the Securities Act of 1933. SC2 neither admitted nor denied any wrongdoing as part of the settlement, which does not include any allegations of misleading or fraudulent statements.

The SEC obtained this settlement a few weeks after its first enforcement action against an NFT issuer (for more information, see this Latham post). This second action may signal a meaningful escalation in the area of NFTs.

An appeals court panel rules that the SEC rejection of a proposed spot bitcoin ETP was arbitrary and capricious, opening the door for the potential launch of numerous ETPs in the near future.

By Jack BarberAaron Gilbride, Marlon Paz, Stephen P. Wink, and Deric Behar

On August 29, 2023, a three-judge panel on the District of Columbia Circuit Court of Appeals ruled in favor of Grayscale Investments, LLC On Petition for Review of an Order of the Securities and Exchange Commission (SEC).

Grayscale proposed to the SEC in October 2021 that Grayscale would convert its Bitcoin Trust into an exchange traded product (ETP) based on the spot bitcoin market (rather than bitcoin futures). As ETPs are traded on stock exchanges, and investors in the ETP would not need to buy the digital asset directly, an ETP could potentially accelerate retail and institutional adoption.

The SEC rejected Grayscale’s proposal in June 2022 because it asserted that the ETP failed to meet consumer protection requirements, including measures “designed to prevent fraudulent and manipulative acts and practices.” Grayscale subsequently sued the SEC under the Securities and Exchange Act of 1934, petitioning the Court of Appeals to review the SEC’s denial. In its decision, the Court of Appeals panel vacated the SEC’s denial.

A new publication from the UK’s financial regulator signals to firms that they should take steps to manage risks in the use of AI.

By Stuart Davis, Fiona M. Maclean, Gabriel Lakeman, and Imaan Nazir

The UK’s Financial Conduct Authority (FCA) has published its latest board minutes highlighting its increasing focus on artificial intelligence (AI), in which it “raised the question of how one could ‘foresee harm’ (under the new Consumer Duty), and also give customers appropriate disclosure, in the context of the operation of AI”. This publication indicates that AI continues to be a key area of attention within the FCA. It also demonstrates that the FCA believes its existing powers and rules already impose substantive requirements on regulated firms considering deploying AI in their services.