Hong Kong gives green light to retail access to crypto platforms as guardrails are finalised

With only days left before the commencement of the new virtual asset service provider (VASP) licensing regime on 1 June 2023, the Hong Kong Securities and Futures Commission (SFC) announced the finalised regulatory requirements on virtual asset trading platform (VATP) operators in its Consultation Conclusions on 23 May 2023 (Conclusions).

This is against the backdrop of the global effort in standardising the regulation of virtual assets – the International Organisation of Securities Commissions (IOSCO) issued a consultation report on policy recommendations for crypto and digital asset markets on the same day. The new Hong Kong regulatory framework is also the result of the continuous collective effort of the Government, the regulators and the industry in fostering growth of the fintech community and establishing Hong Kong as a premier crypto hub.

We have deep knowledge of the issues concerning the regulation of virtual assets (VA) across our firm’s network, and have been working with industry associations and clients on the SFC’s consultation paper over the past few months. Please refer to our February 2023 briefing for the key takeaways from the consultation paper. For additional information on the development of Hong Kong’s VASP licensing regime, please refer to our December, November and June 2022 briefings.

In view of the public’s general support for allowing retail access to VATPs and the proposed regulatory requirements, the SFC has also published the new and revised guidelines below in the Gazette. These guidelines will become effective on 1 June 2023.

New and revised guidance

• (New) Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines)
• (Revised) Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers) (AML Guidelines)
• (Revised) Prevention of Money Laundering and Terrorist Financing Guideline issued by the Securities and Futures Commission for Associated Entities of Licensed Corporations and SFC-licensed Virtual Asset Service Providers
• (New) Disciplinary Fining Guidelines – Part 5B of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance Considerations relevant to the level of a disciplinary fine

The SFC took into account 152 written submissions received during the consultation period and made amendments to the proposed guidelines. The marked-up texts of the guidelines can be found in Appendices A, B and C to the Conclusions. No amendments were made to the proposed Disciplinary Fining Guidelines which can be found in Appendix D to the Conclusions.

Further guidance

The Conclusions bring clarity and certainty to the finalised regulatory requirements applicable to VATP operators. We also expect further guidance from the SFC to be made in the form of circulars, frequently-asked-questions and a licensing handbook to cover topics including:

• the onboarding requirements (eg, how to assess a client’s risk tolerance and exposure to VAs);
• due diligence requirements (eg, general token admission criteria);
• the managers-in-charge regime to augment accountability of licensed VATPs’ senior management;
• the approach the SFC will take regarding the approval of responsible officers, recognising the potential shortage of talent having both VA and traditional securities experience;
• the scope of the external assessment report required for the licence application (Phase 1 report) and after approval-in-principle is granted (Phase 2 report);
• the regulatory expectations regarding the adoption of interim measures prior to the full implementation of the Travel Rule on 1 January 2024; and
• transitional arrangement-related matters.

The SFC will also revise the current requirements on intermediaries’ VA-related activities under the joint circular (with appendices) to align the different VA-related regulatory frameworks.

Key takeaways

We have summarised the proposed regulatory framework in the consultation in our February 2023 briefing with details of the proposal set out here. The key takeaways and amendments announced in the Conclusions are highlighted below.

• Retail access – A significant majority of the respondents agree to the SFC’s proposal to allow retail access to eligible large-cap, high liquidity VAs through licensed VATPs, and that it is essential to have proper regulatory oversight and robust investor protection measures, such as requirements regarding onboarding, governance, disclosure and token due diligence and admission.
• General token admission criteria – The proposal required a VATP to consider the regulatory status of a VA in each jurisdiction in which the operator provides trading services. Recognising the onerous burden on licensed VATPs, the SFC’s finalised guidelines only require VATPs to consider the VA’s regulatory status in Hong Kong, although VATPs are reminded that their operations should be compliant with local laws and regulations wherever they operate.
• Specific token admission criteria for retail access – The SFC will not publish lists of VAs eligible for retail trading, acceptable indices or index providers. VAs intended for retail trading should be included in at least two acceptable indices. The SFC included an additional requirement that at least one of the two indices must comply with the IOSCO Principles for Financial Benchmarks, in addition to having experience in publishing indices for the conventional securities market. The SFC also removed the default position of requiring VATPs to obtain and submit written legal advice confirming that each VA for which the VATP is seeking approval for retail access does not fall within the definition of “securities” under the Securities and Futures Ordinance (Cap 571) (SFO). The SFC may make specific requests for such legal advice on specific tokens during the approval process.
• Onboarding requirements – Investors will no longer be considered to have sufficient VA knowledge only on the basis that they have executed five or more VA transactions within the past three years. The SFC stresses the need for VATPs to conduct a holistic assessment of an investor’s understanding of the nature and risks of VAs.
• Proprietary trading – The SFC agrees that liquidity on the VATPs is important for clients and revised the requirements to allow proprietary trading by affiliates other than trading through the licensed VATP.
• Insurance / compensation arrangements – The coverage threshold for client VAs held in cold storage has been lowered to 50%, provided that 98% of the client VAs are held in cold storage. Bank guarantees, funds held in the form of demand deposits or fixed deposits, and VAs are acceptable as the types of assets forming part of a compensation arrangement.
• Trading in VA derivatives and stablecoins – The SFC is aware of the importance of VA derivatives to institutional investors and will conduct a separate review in due course. Prior to stablecoins being subject to regulation in Hong Kong (arrangements are expected to be implemented in 2023/24), stablecoins will not be admitted for retail trading.
• Anti-money laundering and counter-financing of terrorism requirements – As an interim measure pending the full implementation of the Travel Rule, VATPs acting as the ordering institution may submit the required information as soon as practicable than “immediately” (ie, before or when the VA transfer is conducted) before 1 January 2024.
• Dual-licensing regime – The SFC has confirmed that it would be prudent for VATPs to apply for approval under both the existing licensing regime under the SFO and under the new VATP licensing regime under Part 5B of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615) (AMLO). The SFC will adopt a streamlined application process so that only a single consolidated application needs to be submitted for a dual-licence application. The SFC also clarified that one individual may be concurrently approved under both the SFO and the AMLO so that dual-licensed VATPs are not required to maintain four different responsible officers.
• Disciplinary Fining Guidelines – The senior management of a VATP (including directors, responsible officers and managers-in-charge) should bear primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures. The SFC will consider all circumstances (including the conduct of the VATP and the individuals in question) in deciding whether to take disciplinary action against individuals, VATPs or both.

Further details on the finalised requirements are provided here