HONG KONG TO SUPERVISE ALL VIRTUAL ASSET TRADING PLATFORMS

In November 2019, the SFC issued a position paper setting out a new regulatory framework for virtual asset trading platforms. Platforms which operate in Hong Kong and offer at least one security token may apply to be licensed with the SFC under an opt-in system. Importantly, the regime proposed in the 2019 position paper only applies to platforms that deal in “securities”. This means that platforms that only deal with digital assets that fall outside of the definition of “securities” largely fell outside of the ambit of Hong Kong’s regulatory regime.

This is likely to change. Earlier this week, the Financial Services and Treasury Bureau, or “FSTB”, issued a consultation paper which sets out the government’s proposal to widen Hong Kong’s supervisory net with respect to digital assets.

We summarise below the key highlights in relation to virtual assets:

• Under the proposed licensing regime, any virtual asset service providers [1] ("VASPs") seeking to conduct regulated virtual assets [2] ("VA") activity in Hong Kong will be required to apply for a VASP licence from the SFC.

• VASPs will be subject to a fit-and-proper test similar to that of other financial sectors. This includes the appointment of two Responsible Officers [3]

• The "regulated VA activity" covered by the proposed regime are businesses operating a VA exchange, defined as any trading platform operated for the purpose of "allowing an offer or invitation to be made to buy or sell any VA in exchange for any money or any VA…, and which comes into custody, control, power or possession of, or over any money or any VA at any point in time during the course of business".

• At present this definition does not appear to cover VA activities outside of VA exchanges as the consultation paper notes that they have a "negligible" presence in Hong Kong. However, the paper proposed to build flexibility into the licensing regime to be expanded to cover other VA activities if necessary.

• At the initial stage, the licensed VASP should offer services only to professional investors.

• Once licensed, the VASP will be subject to the AML/CTF requirements under Schedule 2 of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, or "AMLO".

TAKEAWAYS

The proposals, if implemented, will inevitably influence strategic business decisions of crypto-players in Hong Kong or targeting Hong Kong investors. Whilst some may welcome a clearer legal framework, others may not be able to meet the SFC's and AMLO's high regulatory standards, and will choose to re-structure their business models.

It is important to understand that being an SFC licensee requires a sound understanding of Hong Kong's regulatory requirements, the appointment of experienced senior management and the establishment of robust compliance systems.

In particular, it should be noted that the Hong Kong regulators have not hesitated to enforce AMLO's requirements regarding customer due diligence, dealing with high-risk situations and the establishment and maintenance of effective AML/CTF controls.

We will be hosting an AML/CTF webinar on 14 January 2021 (Thursday) (12:30pm to 2:00pm). Please register here if you would like to attend.

Furthermore, the SFC's restriction that VASP's should only offer services to professional investors may, effectively, exclude many genuine users who, although may not qualify as "professional investors" under the SFO, are tech-savvy with a sophisticated understanding of blockchain technology. Several factors are likely to play into the investor protection regime; amongst other things, financial standing of the investor, the investor's understanding of investments in financial products as well as an appreciation of the technology underpinning such products and the investor's risk appetite for such products.

The full consultation paper is available here. The FSTB welcomes comments on or before 31 January 2021.

- Jill Wong & Sonya Mahbubani

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[1] Defined by the FATF as "a person who, as a business, engages in specified activities involving VAs".
[2] The proposed definition is "a digital representation of value that is expressed as a unit of account or a store of economic value; 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 purposes; and can be transferred, stored or traded electronically." This definition includes stablecoins, but does not cover (i) digital representations of fiat currencies, (ii) financial assets already regulated by the SFC, and (iii) closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible.
[3] Similar to the current regulatory regime.

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Disclaimer: The information contained in this article is intended to be a general guide only and is not intended to provide legal advice.  Please contact [email protected] if you have any questions about the article.