Hong Kong SFC paves the way for retail access to crypto platforms … provided safeguards are in place

A major virtual asset (VA) regulatory milestone occurred last week when the Hong Kong Securities and Futures Commission (SFC) published its much anticipated Consultation Paper on the proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission (Consultation Paper). Among other things, the SFC proposes to allow all types of investors, including retail, to access VA trading platforms (VATP) provided the VATP comply with a range of robust investor protection measures.

The Hong Kong Financial Secretary also announced in his 2023-24 Budget speech that he will establish and lead a task force on VA development to provide recommendations on the sustainable and responsible development of the sector. With the Consultation Paper and proposed guidelines (see below), which run to over 350 pages, the SFC is seeking to strike a balance between investor protection and market development, but is it enough to ensure a vibrant VA sector in Hong Kong?

VASP licensing regime and draft VATP guidelines

The new licensing regime for virtual asset service providers (VASPs) under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) will come into effect on 1 June 2023 (VASP Licensing Regime). As a result, all centralised VATP carrying on business in Hong Kong, or actively marketing their services to Hong Kong investors, will need to be licensed by the SFC.

The Consultation Paper sets out the proposed regulatory requirements for VATP operators, including draft Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines) that cover both licensing and conduct requirements and are based on the existing regulatory requirements applicable to VATP operators licensed under the Securities and Futures Ordinance (SFO) and the Terms and Conditions for VA Trading Platform Operators (VATP Terms and Conditions). However, certain modifications have been made to take into account feedback received from the industry.

From 1 June 2023, all VATP operators, whether licensed under the SFO and/or the AMLO, will be subject to the VATP Guidelines.

Other draft guidelines

The SFC has also issued in draft:

• a stand-alone chapter (Chapter 12) in the existing Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations). This will be renamed as the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers (SFC AML Guidelines); and
• the Disciplinary Fining Guidelines.

Responses to Consultation Paper

Interested parties should respond to the Consultation Paper by 31 March 2023.

The Consultation Paper forms part of the Hong Kong Government’s policy towards developing a vibrant VA sector and ecosystem in Hong Kong. For additional information, please refer to our December, November and June 2022 briefings.

Key takeaways

• Allowing retail access to eligible large-cap VAs – Licensed VATP operators may provide trading services to retail investors, provided that the VAs offered are “eligible large-cap VAs” (ie, VAs which are included in at least two “acceptable indices” issued by at least two independent index providers). Licensed VATP operators must seek the SFC’s advance approval before admitting VAs which would be made available to retail clients.
• Token due diligence and admission criteria – Before admitting VAs for trading, licensed VATP operators must ensure that the VAs comply with the general token admission criteria.
• Governance – Licensed VATP operators should set up a token admission and review committee to govern the criteria for VA to be admitted for trading, and to make final decisions as to whether to admit, halt, suspend and withdraw a VA for client trading. Where VAs are made available to professional investors only, SFC approval will not be required where a decision is made to add or remove such VAs, and only advance notification will be required.
• Client onboarding – Except for institutional¹ and qualified corporate professional investors², licensed VATP operators should assess whether it is suitable for a client to participate in the trading of VAs and set a VA exposure limit for each client.
• Disclosure obligations – Licensed VATP operators are required to disclose various information in relation to their operations, trading rules and fees. They must also disclose material information for each VA.
• Insurance / compensation arrangements – Licensed VATP operators should have in place a compensation arrangement approved by the SFC to provide an appropriate level of coverage for risks associated with the custody of client VAs. The arrangement should include any or a combination of third-party insurance and funds of the licensed VATP or a corporation within the same group of companies which are set aside on trust and designated for such purpose.
• Trading in VA derivatives – Under the existing SFO regime, licensed VATP operators are not allowed to offer, trade or deal in VA futures contracts or VA-related derivatives. The SFC is seeking views through the consultation to better understand the type of business models and VA derivatives which VATP may offer first as well as market demand. The SFC will then conduct a separate review exercise to formulate appropriate policies.
• Anti-money laundering (AML) / counter-financing of terrorism (CFT) requirements – Detailed guidance for licensed VATP operators has been added as a new chapter in the existing SFC AML Guidelines, including the SFC’s regulatory expectations for the statutory requirement on VA transfers (ie, Travel Rule).
• Timing – VATP which qualify for the transitional licensing arrangements may continue to operate in Hong Kong during the non-contravention period (ie, from 1 June 2023 to 31 May 2024), and will be subject to a deeming arrangement from 1 June 2024 provided they comply with the relevant criteria, eg, have submitted their licence application by 29 February 2024. For existing SFO-licensed VATP operators, the SFC proposes to provide a 12-month transitional period for compliance with the new VATP Guidelines in relation to existing clients and VAs currently made available by them. A timeline can be found in Appendix E of the Consultation Paper.
• Publication of VATP lists – the SFC intends to publish lists on its website to inform the public of the different regulatory statuses of the VATPs. Further detail is set out in paragraphs 86 to 88 of the Consultation Paper.
• Dual licences – Given that the terms and features of VAs may evolve over time, the SFC has said that VATPs should apply for approvals under both the existing SFO regime (which regulates the trading of security tokens) and the AMLO VASP Licensing Regime (which regulates the trading of non-security tokens) and become dually licensed and approved.
• External assessment – VATP applicants are required to engage an external assessor to assess their proposed structure, governance, operations, systems and controls and submit reports to the SFC when (i) submitting their licence application (Phase 1 Report) and (ii) after approval-in-principle is granted by the SFC (Phase 2 Report). Further detail is set out in Appendix F of the Consultation Paper. The SFC will grant final approval only if it is satisfied with the findings of the Phase 2 Report.

Further details on the VASP Licensing Regime are provided here.

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¹ “Institutional professional investor” as defined under the SFO.

² “Qualified corporate professional investors” refers to corporate professional investors who have passed the assessment requirements under paragraph 1 of Schedule 1 to the VATP Guidelines and gone through the procedures under paragraph 2 of Schedule 1 to the VATP Guidelines.