Hong Kong SFC Tightens Virtual Asset Regulations

We have published an update to this analysis in our article Hong Kong's licensing regime for virtual asset service providers takes shape.

Following the introduction of virtual asset (VA) exchanges regulatory regime by the Hong Kong Securities and Futures Commission (SFC) in 2019, the SFC granted its first virtual asset trading platform license in Hong Kong to OSL, Asia’s leading digital asset platform. The license was granted to OSL after the company chose to opt into the SFC's virtual asset regime and successfully underwent the SFC's rigorous vetting process. The license permits OSL to provide regulated brokerage and automated trading services for digital assets to professional investors. 

One year after SFC’s announcement on the VA exchanges regulatory regime, Hong Kong is tightening its regulation of VA with a newly proposed scheme. In November 2020, the Hong Kong Financial Services and the Treasury Bureau (FSTB) issued a consultation paper which outlined a new regulatory framework that will bring operators of VA exchanges within the formal regulatory perimeter of the SFC, hoping to gauge the public’s view on legislative proposals to enhance anti-money laundering and counter-terrorist financing (AML/CTF) regulations in Hong Kong. 

Currently, virtual asset services providers (VASPs) are regulated only by a voluntary opt-in licensing mechanism which provides platform operators with the option of attaining a regulated status [1]. In addition, the SFC’s regulatory perimeter only extends to products that qualify under the Securities and Futures Ordinance (SFO) (including traditional securities such as stocks and bonds, futures contracts, and funds) and to intermediaries that provide services relating to those products. Most popular virtual assets, such as Bitcoin, other stablecoins, or alt-coins, fall outside of the SFO and therefore, the SFC’s regulatory perimeter. 

To address the limitations and the heightened inherent risks associated with VA trading such as money laundering, terrorist financing, and fraud, a new VASPs licensing regime is proposed by the HK FSTB on 3 November 2020. The consultation paper outlined businesses that conduct regulated VA activity will be required to apply for a VASP license from the SFC and are subject to requirements under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO). 

The new regulatory framework aims to widen the existing supervisory approach over virtual asset trading platforms and fulfil the latest requirements of the Financial Action Task Force (FATF) in relation to VASPs.

Who does this affect? 

VASPs that

1. operate for the purpose of allowing an offer or invitation to be made to buy or sell any VA in exchange for any money; 
2. comes into custody, control, power or possession of, or over, any money or any VA at any point in time during its course of business. 

Peer-to-peer trading platforms are not within the scope of VA exchange and are therefore not subject to the VASP regime, but only to the extent that the actual transactions are conducted outside the platform and the platform is not involved in the underlying transaction by having possession of any money or any VAs at any time.

Scope of VA 

A VA is defined as a digital representation of value that satisfies each of the following: 

(i) a unit of account or a store of economic value; 

(ii) functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purpose; 

(iii) can be transferred, stored, or traded electronically. 

This definition will capture VAs backed by some form of assets for the purpose of stabilizing their value (such as stablecoins), but it will not capture digital representations of fiat currencies (including digital currencies issued by central banks) or financial assets that are already regulated under the SFO, such as securities and authorized structured products. Closed loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible (e.g., air miles, credit card rewards, gift cards, customer loyalty programmes, gaming coins etc.) will also be excluded from the definition as it is not the FATF’s intention to catch these items.

Clients for licensed VASPs

At the initial stage, the licensed VASP can only offer services to professional investors. Professional investors are defined as individuals with a portfolio of no less than HK$8 million, and for corporations, a portfolio of no less than HK$8 million or total assets of no less than $40 million.

Regulatory requirements

• Only locally incorporated companies with a permanent place of business in Hong Kong will be considered for the granting of a SFC license. For details of licensing conditions, please refer to our article on SFC virtual asset trading platforms licensing
• A licensed VASP will be required to observe the AML/CTF requirements stipulated in Schedule 2 to the AMLO

Fit and proper requirement

• A licensed VASP must satisfy a fit and proper test that is applicable to other financial institutions regulated under the AMLO
• This will apply to all responsible officers and ultimate owners of the corporate applicant, and any change will require SFC’s prior approval. 
• In addition, a licensed VASP will need to appoint at least two responsible officers to assume general responsibility of ensuring AML/CTF requirements, and all executive directors must be made responsible officers upon SFC approval
   

The consultation period runs until 31 January 2021 and a bill to bring the new regime into effect will most likely be introduced to Hong Kong’s Legislative Council in 2021. With the effective date to be determined, there will be a transitional period of 180 days to allow market participants to apply for and obtain the necessary SFC license or withdraw from the market. 

With consideration of the high inherent risks, the consultation paper outlined that ‘’the penalty level for unlicensed VA activities should be high enough to achieve the necessary deterrent effect’’. Those who conduct a regulated VA activity without a license shall be guilty of a criminal offence, punishable on conviction on indictment to a fine of HK$5,000,000 and to imprisonment for 7 years; and, in the case of a continuing offence, a further fine of HK$100,000 would be imposed for every day during which the offence continues. 

The proposed SFC regime on the virtual assets in Hong Kong is expected to help position Hong Kong in the global virtual assets trading market. As indicated by the SFC, it will continue to monitor the evolution of crypto-assets and work with the Hong Kong government to explore the need for legislative changes in the longer term. 

Given the limited transition period, stringent requirements and potentially large penalty for non-compliance for VA activities, it is imperative that operators of VA exchanges who wish to continue to offer their services in Hong Kong to understand the impact and assess changes it has to make following the HK FSTB’s consultation period. 

Sia Partners will share with you more of our insights and perspectives as and when future developments occur.