Year of the Dragon: Round up of recent developments to the regulatory framework for virtual asset activities in Hong Kong and Singapore

In this bulletin, we set out recent regulatory developments in relation to virtual asset activities in both Hong Kong and Singapore.

In Hong Kong, to reflect the increasing demand for investment products providing exposure to virtual assets (VAs) which are available to both retail and professional investors, the government and the financial regulators have taken swift action to formulate new regulatory frameworks and provide additional guidance on a wide range of VA-related activities and products. In less than three months, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) have issued four circulars to provide new/updated guidance, and the Financial Services and the Treasury Bureau (FSTB) and the HKMA have launched three consultations to address additional areas relating to VAs.

The Monetary Authority of Singapore (MAS) concluded two consultations on updated regulatory measures for digital payment token services in 2023 and are in the process of finalising the legislative amendments and preparing new guidelines.

These developments reflect the desire by the governments and regulators of both jurisdictions to facilitate the development of an innovative and responsible VA ecosystem while at the same time protecting investors and ensuring market integrity.

We highlight the developments below.

1. (Updated) SFC circular on SFC-authorised funds with exposure to VAs of 22 December 2023
2. (Updated) SFC-HKMA joint circular on intermediaries’ VA-related activities (with appendices) of 22 December 2023
3. (New) HKMA-FSTB joint public consultation paper on legislative proposal to regulate stablecoin issuers in Hong Kong of 27 December 2023
4. (New) HKMA consultation paper on cryptoasset exposures of 7 February 2024
5. (New) FSTB consultation paper on legislative proposals to introduce a licensing regime for providers of over-the-counter trading services of VAs of 8 February 2024
6. (New) HKMA circular on provision of custodial services for digital assets by authorised institutions of 20 February 2024
7. (New) HKMA circular on the sale and distribution of tokenised products by authorised institutions of 20 February 2024
8. (Updated) MAS regulatory measures for digital payment token services
9. Highlights of other developments

1. (Updated) SFC circular on SFC-authorised funds with exposure to VAs of 22 December 2023 (SFC-Authorised VA Funds Circular)

This circular sets out the requirements under which the SFC would consider authorising investment funds with exposure to VAs of more than 10% of their net asset value for public offerings in Hong Kong (SFC-Authorised VA Funds).

The requirements are applicable to new and existing funds intending to have VA exposure of more than 10% of their net asset value, which will require prior consultation and approval of the SFC. It sets out the requirements for SFC-authorised funds to:

• Invest directly in the same spot VA tokens accessible to the Hong Kong public for trading on SFC-licensed virtual asset trading platforms (VATPs); and/or

• Acquire indirect investment exposure to such VA, for example, through futures traded on conventional regulated futures exchanges and other exchange-traded products.

In particular, the SFC is prepared to accept applications for the authorisation of other funds with exposure to VAs, including VA spot exchange-traded funds (ETFs).

The circular includes details on requirements relating to:

• Management companies of SFC-Authorised VA Funds;
• Eligible underlying VAs that the SFC-Authorised VA Funds can invest in;
• Investment strategy;
• Transactions and direct acquisitions of spot VA;
• Custody;
• Valuation;
• Service providers; and
• Disclosure and investor education.

The SFC-Authorised VA Funds Circular supersedes the SFC’s previous Circular on VA Futures ETFs issued on 31 October 2022.

2. (Updated) SFC-HKMA joint circular on intermediaries’ VA-related activities (with appendices) of 22 December 2023 (Further Updated Joint Circular)

In light of the SFC-Authorised VA Funds Circular, the SFC has issued the Further Updated Joint Circular, which provides updated guidance in relation to the distribution of VA-related products, including SFC-Authorised VA Funds. In particular, the updated circular:

• Clearly specifies the requirements applicable to intermediaries when distributing VA-related products; and
• Sets out the standards of conduct expected of intermediaries when distributing SFC-Authorised VA Funds.

The Further Updated Joint Circular permits retail access to SFC-Authorised VA Funds, provided that the prescribed distribution requirements are satisfied. The Further Updated Joint Circular supersedes the previous versions (with appendices) issued in October 2023 and January 2022 (see our December 2023 and March 2022 briefings).

Further details on the requirements under the SFC-Authorised VA Funds Circular and the Further Updated Join Circular are provided here.

3. (New) HKMA-FSTB joint public consultation paper on legislative proposal to regulate stablecoin issuers in Hong Kong of 27 December 2023 (Stablecoin Consultation)

The Stablecoin Consultation proposes to regulate issuers of fiat-referenced stablecoins (FRSs) and the offering and marketing of FRSs in Hong Kong. The public is invited to provide comments on the legislative proposals by 29 February 2024.

In brief, the Stablecoin Consultation proposes to:

• Introduce a new piece of legislation to implement a licensing regime requiring all FRS issuers who (i) issue an FRS in Hong Kong; (ii) issue a stablecoin that purports to maintain a stable value with reference to the value of the Hong Kong dollar; or (iii) actively market their issuance of FRS to the public of Hong Kong, to be licensed by the HKMA;

• Require that FRS can only be offered by specified licensed entities in Hong Kong (eg, licensed FRS issuers, authorised institutions, SFC-licensed corporations and SFC-licensed VATPs), and only FRS licensed by the HKMA can be offered to retail investors;

• Prohibit the advertising of (i) FRS issuance by unlicensed entities; or (ii) non-specified licensed entities’ offering of FRS;

• Provide the necessary powers for the authorities to adjust the parameters of in-scope stablecoins and activities having regard to the rapid VA market development; and

• Provide a six-month transitional arrangement to allow eligible, pre-existing FRS issuers with meaningful and substantial presence in Hong Kong to migrate to the new regulatory regime in an orderly manner, on the condition that they have submitted a licence application to the HKMA within the first three months of the commencement of the regulatory regime. Those who do not submit a licence application within the stipulated timeframe will need to close down their business by the end of the fourth month of the commencement of the regime.

It is worth noting any FRS issuer that is based outside of Hong Kong that (i) issues an FRS in Hong Kong; (ii) issues a Hong Kong dollar-referenced stablecoin; or (iii) actively markets their issuance of FRS to the public of Hong Kong, will fall within the scope of the proposed licensing regime.

Further details on the key proposals under the Stablecoin Consultation are provided here.

4. (New) HKMA consultation paper on cryptoasset exposures of 7 February 2024

In December 2022, the Basel Committee on Banking Supervision (BCBS) issued its new standard “Prudential treatment of cryptoasset exposures” (BCBS Cryptoasset Standards), which aims to provide banks with a regulatory framework for banks with exposures to cryptoassets. Since then, the BCBS published two additional consultative documents.

The HKMA has now issued a consultation paper on cryptoasset exposures to incorporate some of the requirements proposed by the BCBS. The consultation proposes to implement new regulations on the prudential treatment of cryptoasset exposures to classify cryptoassets into two broad groups, with qualifying tokenised assets and stablecoins (Group 1 cryptoassets) generally being subject to the risk-based capital requirements of the BCBS Cryptoasset Standards, and other cryptoassets that fail to meet the Group 1 cryptoasset classification conditions (Group 2 cryptoassets) being subject to more conservative capital treatment. The public is invited to provide comments on the legislative proposals by 6 May 2024.

The key features of the consultation are set out below:

• The proposed framework sets out the requirements for how much regulatory capital AIs must hold for their cryptoasset exposures. Under the proposed framework, unbacked cryptoassets and stablecoins with ineffective stabilisation mechanisms will fall into Group 2 cryptoassets and be subject to a conservative regulatory capital treatment.

• The prudential treatment of central bank digital currencies is not covered by this new framework.

• While most parts of the new framework set out the capital and liquidity requirements in respect of AIs’ direct exposures to cryptoassets, certain parts of the framework, such as the operational risk requirements and the risk management and supervisory review, are also applicable to AIs’ cryptoasset activities, such as custodial services involving the safekeeping or administration of client cryptoassets on a segregated basis, that do not generally give rise to credit, market or liquidity requirements.

• The HKMA intends to put the local implementation of the BCBS Cryptoasset Standards into effect no earlier than 1 July 2025. In terms of the local implementation, the HKMA will check the need for potential legislative amendments to various sets of rules, including the Banking (Capital) Rules, Banking (Disclosure) Rules, Banking (Liquidity) Rules and Banking (Exposures Limits) Rules. Where appropriate, technical provisions and supervisory guidance will also be set out in Code of Practices, Supervisory Policy Manuals, etc.

• AIs are responsible (on an ongoing basis) for assessing whether the cryptoassets to which they are exposed are compliant with the classification conditions set out in the new framework, which will determine whether the cryptoassets are classified as Group 1 or Group 2. To this end, AIs must have in place the appropriate risk management policies, procedures, governance, human and IT capacities to evaluate the risks of engaging in cryptoassets and implement these accordingly on an ongoing basis and in accordance with established standards. AIs must fully document the information used in determining compliance with the classification conditions prescribed by the BCBS Cryptoasset Standards and make this available to the HKMA on request. In advance of any acquisition of a new type of cryptoassets, an AI must inform the HKMA of its classification assessment of the cryptoassets.
• Where the HKMA does not agree with the assessments undertaken by AIs, the HKMA will have the power to override AIs’ classification decisions.

5. (New) FSTB consultation paper on legislative proposals to introduce a licensing regime for providers of over-the-counter (OTC) trading services of VAs of 8 February 2024 (VA OTC Trading Consultation)

The VA OTC Trading Consultation proposes to regulate OTC spot trading of certain VAs in Hong Kong under the Anti-Money Laundering Ordinance (AMLO) to mitigate money laundering and terrorist financing (ML/TF) risks and increase investor protection. The public is invited to provide comments on the legislative proposals by 12 April 2024.

In brief, the proposed legislative framework:

• Requires any person who conducts a business in providing services of spot trade of any VA for money in Hong Kong or who actively markets the provision of VA OTC services to the Hong Kong public to be licensed by the Commissioner of Customs and Excise (CCE);

• Covers all VA OTC services irrespective of whether the services are provided through a physical outlet and/or other platforms;

• Provides powers for the CCE to supervise the anti-money laundering and counter-terrorist financing conduct of licensees, and enforce the statutory and regulatory requirements under the proposed regime; and

• Provides transitional arrangement to facilitate the effective implementation of the proposed regime.

Further details on the key proposals under the VA OTC Trading Consultation are provided here.

6. (New) HKMA circular on provision of custodial services for digital assets (DAs) by AIs of 20 February 2024 (DA Custody Circular)

The DA Custody Circular applies to AIs that conduct DA custodial activities and sets out the expected standards which should be applied by AIs in safeguarding client DAs, whether the DAs are received in the course of conducting VA-related activities as an intermediary, distributing tokenised products, or providing standalone custodial services. This circular does not apply to the custody of proprietary assets of an AI or its group companies which are not held on behalf of clients.

The expected standards cover:

• Governance and risk management;
• Segregation of client DAs;
• Safeguarding of client DAs;
• Delegation and outsourcing;
• Disclosure;
• Record keeping and reconciliation of DAs;
• Anti-money laundering and counter-financing of terrorism; and
• Ongoing monitoring.

AIs which intend to provide DA custodial services should discuss with the HKMA in advance and demonstrate that they meet expected standards and requirements in this circular.

AIs that are already engaging in DA custodial services should review and revise as necessary their systems and controls in line with the expected standards and confirm to the HKMA that they meet the expected standards within six months from the date of this circular.

Further details on the expected standards under the DA Custody Circular are provided here.

7. (New) HKMA circular on the sale and distribution of tokenised products by AIs of 20 February 2024 (Tokenised Product Offering Circular)

The Tokenised Product Offering Circular sets out the supervisory standards for AIs on the sale and distribution of tokenised products to their customers. The scope of this circular does not apply to tokenised products regulated under the Securities and Futures Ordinance and governed by the requirements issued by the HKMA and the SFC.

As a general principle, the prevailing supervisory requirements and consumer/investor protection measures for the sale and distribution of a product are also applicable to its tokenised form as it has terms, features and risks (other than any risks arising from tokenisation itself) similar to those of the underlying product.

The HKMA noted that while some tokenised products are traditional products with a tokenisation wrapper, there could be situations where the nature, features and risks of a tokenised product are altered by how the product is structured and arranged in the tokenisation process. Therefore, AIs should ensure that they evaluate and understand the terms, features and risks of each tokenised product and should exercise professional judgment to ascertain the applicable legal and regulatory requirements.

Before selling and distributing a tokenised product to customers, AIs should put in place adequate systems and controls to ensure that all the applicable requirements are complied with, and implement appropriate additional internal controls to address the specific risks and unique nature of the tokenised product.

AIs are expected to implement the consumer/investor protection measures in respect of due diligence, disclosure and risk management for tokenised products. Further details on the requirements under the Tokenised Product Offering Circular are provided here.

8. (Updated) MAS regulatory measures for digital payment token (DPT) services

MAS published Part 1 and Part 2 of its response (MAS Response) to the feedback received on its consultation commenced in October 2022 on proposed regulatory measures for DPT services. The consultation paper highlighted MAS’ focus on developing an innovative and responsible digital asset ecosystem in Singapore and reflects its clear stance to protect investors and ensure market integrity.

• Part 1 of the MAS Response, which was published on 3 July 2023, focused on the requirements for segregation and custody of customers’ assets.

• Part 2 of the MAS Response, published on 23 November 2023, addresses other regulatory measures including business conduct and consumer access safeguards. As an initial step towards implementing the conduct and consumer access measures, MAS will issue guidelines setting out its expectations for DPT service providers (DPTSPs). MAS will also expand the scope of the Notice PSN05 Technology Risk Management under the Singapore Payment Services Act 2019 (PS Act) to implement technology and cyber risk measures.

Highlights of the measures set out in the MAS Response include:

• Measures relating to segregation and custody of customers’ assets;
• Measures relating to lending and staking of retail customers’ assets;
• Customer access measures;
• Business conduct measures; and
• Measures relating to managing technology and cyber risks.

MAS published proposed amendments to the Payment Services Regulations 2019 (which is subsidiary legislation to the PS Act) in July 2023 to implement certain key asset segregation and custody measures. The final subsidiary legislation will be published in due course with a six-month transition period for implementation. Details for the implementation of other measures will be provided in the guidelines for DPTSPs to be published in mid-2024 with a nine-month transition period for implementation.

Further details on measures set out in the MAS Response are provided here.

9. Highlights of other developments

• On 29 November 2023, MAS updated its Guidelines on Licensing, Registration and Conduct of Business for Fund Management Companies. In the updated guidelines, MAS has clarified the minimum disclosures applicable to fund management companies which invest in digital assets.

• On 21 February 2024, the SFC updated its Frequently Asked Questions relating to Open-ended Fund Companies to include a new question 19A on tokenisation of Open-ended Fund Companies (OFC). In the response to the question, the SFC has clarified that applicants or parties who are interested in tokenising an OFC should discuss or consult with the SFC in advance and sets out references to the relevant guidance and requirements in SFC circulars.

• The deadline for VATPs to submit a VATP licence application under the transitional arrangements is 29 February 2024.

• On 23 February 2024, the SFC published updated VATP licensing forms which will take effect on 1 March 2024, after the deadline for submitting a VATP licence application under the transitional arrangements.

How we can help

For intermediaries which plan to extend their businesses to VA-related activities, or intermediaries which already carry on VA-related activities and wish to extend this to retail investors, we can assist in the following ways:

• Advise on your compliance with the relevant VA related requirements, including the revised requirements under the Further Updated Joint Circular;

• Design, review, and update your internal systems and controls to align them with the regulatory requirements;

• Assist with the advance notification to the SFC and/or HKMA of your intention to engage in activities involving VAs, including VA funds;

• Assist with licensing requirements arising from the carrying on of VA-related activities; and

• Review offering documents and disclosure materials to clients relating to VA products.

If you have any questions or are interested to know more about how we can assist, please reach out to any of our key contacts below.