China's Impact on RWA Investors: Risks and Solutions
Tokenization of Real-World Assets (RWA) in China: Regulatory Environment Analysis and Practical Recommendations
Last Updated: October 2024
Legal Disclaimer: This document is for informational purposes only and does not constitute legal, tax, or investment advice. The regulatory environment in the PRC is subject to rapid and significant changes. Before making any decisions, it is necessary to consult with qualified legal counsel specializing in PRC and Hong Kong law.
Introduction
This document provides an analysis of regulatory risks and practical models for Real-World Asset (RWA) tokenization projects involving assets located in Mainland China (PRC).
- Objective: To assess the legal environment, identify key barriers (foreign exchange control, data laws, taxation), and propose a viable legal structure to minimize risks.
- Target Audience: Asset owners in the PRC, international investors, token issuers, and legal consultants working in the digital asset space.
- Methodology: The analysis is based on current PRC regulations, including the Securities Law, notices from the People's Bank of China (PBOC), the State Administration of Foreign Exchange (SAFE), and the Cyberspace Administration of China (CAC), as well as enforcement practices and regulatory requirements of the Hong Kong Securities and Futures Commission (SFC).
1. Key Findings (TL;DR)
- Direct public issuance of RWA tokens in Mainland China is effectively prohibited and is highly likely to be classified as illegal financial activity.
- The most viable model is the use of an offshore structure (SPV) in Hong Kong, provided there is complete legal and technical isolation from PRC residents.
- Project success critically depends on compliance with PRC laws regarding cross-border data transfer (PIPL), foreign exchange control (SAFE), and taxation.
- Hong Kong provides a regulated environment for security token issuance, but only for professional investors and subject to strict licensing requirements.
2. Regulatory Evolution and Enforcement Practice
The position of PRC regulators regarding digital assets has moved from restrictions to a near-total ban on operations for the general public.
- Key Regulations:
- "Announcement on Preventing Financial Risks from Token Issuance" (Joint Notice by PBOC and six other departments, September 4, 2017): Classified Initial Coin Offerings (ICOs) as illegal fundraising activities.
- "Notice on Further Preventing and Disposing of Speculative Risks in Virtual Currency Transactions" (Joint Notice by PBOC and nine other departments, September 24, 2021): Declared all virtual currency-related activities (including trading, exchange, and information provision) as illegal financial activities.
- Enforcement Examples (2022–2024):
- Illegal Fundraising Case: Organizers of a platform offering tokenized real estate shares were convicted under the relevant article of the PRC Criminal Code. The court found evidence of a public offering and promises of returns, which formed the basis for the charges (Source: Official PRC court registry, Case No. [insert number if available]).
- Money Laundering via OTC Case: A group was prosecuted for using cryptocurrencies to illegally move funds abroad, highlighting strict scrutiny over foreign exchange control compliance (Source: PRC Ministry of Public Security press release).
3. Classification of Token as a Security
The PRC lacks a formalized test for tokens; however, the China Securities Regulatory Commission (CSRC) applies principles from the Securities Law, which are inherently similar to the Howey Test in the US.
| Criterion (Howey Analog) | Application in Chinese Practice |
|---|---|
| 1. Investment of money | Any form of investment (fiat, digital assets). |
| 2. Common enterprise | Collective investment scheme. |
| 3. Expectation of profit | Key indicator. Direct or indirect promise of yield. |
| 4. Profit from efforts of others | The investor is passive; income depends on the issuer or manager. |
The defining factor in the PRC is the "public" nature of the offering. Any offering addressed to an "unspecified circle of persons" without a CSRC license is illegal. In practice, "unspecified circle" refers to public marketing, advertising in open sources, and offerings to more than 200 non-qualified investors.
4. Viable Model: Offshore SPV Structure
This model minimizes risks by moving the issuance outside the PRC and legally isolating it from PRC residents.
- Underlying Asset in PRC: Real estate, equity in a company, debt obligation.
- Contractual Framework: The asset owner in the PRC enters into an agreement with a Special Purpose Vehicle (SPV) registered in Hong Kong.
- Token Issuance: The Hong Kong SPV issues security tokens, legally representing rights to the income generated by the underlying asset.
- Compliance with PRC Laws: The structure must strictly adhere to PRC rules regarding foreign exchange, data transfer, and taxation.
4.1. Legal Nature of the Token and Rights Enforcement
Under this model, the security token represents a contractual right of claim to a share of the income generated by the underlying asset. The token does not provide direct ownership of the asset in the PRC but secures the right to receive cash flows from the SPV.
- Enforcement Mechanism: Token holders' rights are realized through the SPV's contractual obligations. In the event of a default by the asset owner in the PRC, the SPV (acting on behalf of token holders) can initiate arbitration proceedings in accordance with the contract terms.
- Enforceability Risks: Awards from foreign arbitrations (e.g., HKIAC) are generally enforceable in the PRC. However, direct foreclosure on the underlying asset can be difficult due to regulatory restrictions and remains a complex legal procedure.
4.2. Templates for Key Contract Provisions (SPV — Asset Owner)
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Revenue Transfer Mechanism:
"The Asset Owner agrees to remit [95]% of the net income derived from the operation of the Asset to the SPV's bank account within [15] business days after the end of each calendar quarter. The transfer shall be conducted in accordance with the prevailing regulations of the State Administration of Foreign Exchange (SAFE) and after the payment of all applicable taxes in the PRC."
-
Escrow/Trust Mechanism:
"To ensure the fulfillment of obligations, the Asset Owner shall place a security deposit of [amount] into an escrow account held by an independent agent [Agent Name]. Funds from the escrow account may be utilized by the SPV in the event the Asset Owner fails to fulfill income transfer obligations."
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Confirmation of "Substance" for the SPV:
"The Asset Owner recognizes that the SPV is an independent operating company registered in Hong Kong, with a physical office, employees, and accounts. The Asset Owner agrees to provide all necessary documentation to confirm the SPV's status upon request from PRC or Hong Kong tax authorities."
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Force Majeure:
"Force majeure events include, but are not limited to, changes in PRC legislation or regulatory policy that render the performance of this Agreement impossible, including but not limited to the introduction of new restrictions on cross-border payments or digital asset operations."
5. Key Regulatory Barriers in the PRC
5.1. Data Laws: PIPL and DSL
The cross-border transfer of personal information (e.g., investor KYC data) is regulated by the Personal Information Protection Law (PIPL).
Practical Procedure (Most Common Path):
- Obtain separate informed consent from the data subject for cross-border transfer.
- Conduct a Data Protection Impact Assessment (DPIA).
- Enter into a Standard Contract with the data recipient (SPV) approved by the Cyberspace Administration of China (CAC).
- File a certified copy of the contract and the DPIA report with the provincial CAC branch within 10 business days of the contract's effective date. The procedure is notification-based, but the CAC may request additional information.
- Timeline: Registration takes an average of 1–2 months.
- Recommendation: Minimize the transfer of personal data. Use pseudonymous identifiers for offshore systems and store original KYC data on servers within the PRC or with a trusted local partner.
5.2. Foreign Exchange Control (SAFE)
Transferring income from an asset in the PRC to a Hong Kong SPV must be economically justified and documented (contracts, invoices, tax returns). Any attempts to bypass controls through illegal schemes carry risks of administrative and criminal liability.
5.3. Taxation
- Withholding Tax: A withholding tax applies when paying dividends/income from the PRC to Hong Kong. The standard rate is 10%. This may be reduced to 5% under the Double Taxation Agreement (DTA) if the SPV proves it has real economic substance.
- Calculation Example: For $100,000 in income, withholding tax would be $10,000 (10%) or $5,000 (5%) after applying the DTA.
- "Substance" Criteria for the Hong Kong SPV:
- Possession of a registered office.
- Employment of staff with sufficient qualifications.
- Key management decisions made within Hong Kong.
- Possession of an active bank account.
- Supporting Documents: Office lease, employment contracts, board meeting minutes, bank statements.
6. Risk Matrix and Mitigation Measures
| Risk | Likelihood | Consequences | Priority Mitigation Measures |
|---|---|---|---|
| 1. Classification as illegal financial activity in the PRC | High (if targeting PRC residents) | Criminal liability, asset confiscation, project shutdown. | Immediate: Complete legal and technical isolation from PRC residents. Structure via offshore SPV. |
| 2. Violation of data laws (PIPL) | Medium | Fines up to 5% of annual turnover, suspension of operations, personal fines. | Immediate: Develop a data management policy. Implement pseudonymization. Sign the CAC Standard Contract. |
| 3. Violation of FX controls (SAFE) | Medium | Administrative fines, transaction rejection, criminal liability. | High Priority: Engage PRC foreign exchange legal consultants. Structure cash flows through legal channels. |
| 4. Tax reassessments and denial of benefits | Medium | Fines, penalties, reputational damage. | High Priority: Conduct tax due diligence. Ensure and document "substance" for the SPV. |
7. Hong Kong: A Regulated Hub for RWA
Hong Kong is actively developing a regulated environment for digital assets. The SFC Circular "On intermediaries engaging in tokenised securities-related activities" dated November 2, 2023, sets clear rules.
- Key SFC Requirements:
- Audience: Offering available only to professional investors.
- Custodian: Assets must be held by a qualified and insured custodian that has passed audits (e.g., SOC 2 Type II).
- Licensing: Issuance and trading must be conducted through SFC-licensed platforms (VASPs).
- Technical Isolation Measures for PRC Residents:
- Robust KYC: Verification of documents proving non-PRC residency (passport, residence permit, utility bills).
- Multi-layer Geoblocking: Blocking PRC IP addresses, traffic analysis to detect VPNs and proxies. Regular access log audits are recommended.
- Business Logic Control: Refusal of registration for phone numbers with the +86 code, requesting additional proof of residency if suspicions arise.
8. Action Plan
| Timeline | Actions |
|---|---|
| Immediate (Month 1) | 1. Conduct legal consultation with PRC and Hong Kong lawyers. 2. Design project architecture considering PRC isolation. 3. Begin the process of incorporating the Hong Kong SPV with "substance" provisions. |
| Short-term (Months 1–3) | 1. Conduct tax and foreign exchange due diligence. 2. Develop and agree upon the contractual framework between the PRC and the SPV. 3. Develop PIPL policy, prepare DPIA and CAC Standard Contract. |
| Medium-term (Months 3–6) | 1. Select a licensed custodian and VASP in Hong Kong. 2. Implement technical solutions (KYC, geoblocking, traffic analysis). 3. File documents for CAC contract registration. |
| Long-term (Months 6–12) | 1. Conduct audit of smart contracts and technical architecture. 2. Prepare marketing materials with clear restriction disclosures. 3. Launch project for professional investors outside the PRC. |
9. Research Limitations and Regulatory Risks
This analysis is based on legislation in effect as of October 2024. The regulatory environment in the PRC is highly dynamic and opaque. Sudden changes in regulator policy could significantly impact project viability. It is recommended to implement a system for continuous monitoring of regulatory changes and have a response plan that includes rapid legal support and communication channels with regulators.
10. Conclusion
Tokenization of real-world assets from the PRC is a legally complex but potentially feasible task, provided an offshore structure in Hong Kong is used and regulatory requirements are strictly followed. Key success factors include total isolation from PRC residents, thorough development of the contractual base, and ensuring the SPV has real economic substance. Given the high risks, projects should begin with detailed legal and tax consultations to build a robust and sustainable structure.
11. Glossary
- RWA (Real-World Assets): Real assets represented in token form.
- SPV (Special Purpose Vehicle): A company formed for a specific, limited purpose.
- PIPL (Personal Information Protection Law): The PRC law on personal data protection.
- SAFE (State Administration of Foreign Exchange): The PRC administrative agency responsible for foreign exchange activities.
- CAC (Cyberspace Administration of China): The central internet regulator of China.
- SFC (Securities and Futures Commission): The statutory body that regulates the securities and futures markets in Hong Kong.
- VASP (Virtual Asset Service Provider): A provider of services related to virtual assets.