Hong Kong Government Announcement on Virtual Asset Exchange – Hong Kong FinTech Week 2022 | Hogan Lovells

by James · November 3, 2022

On 31 October 2022, at the launch of Hong Kong’s Fintech Week, the Financial Services and Treasury Bureau issued a policy statement (“Policy Statement”) provides some further details on the government’s plans for the development of a regulatory regime for virtual assets (“VA”) in Hong Kong.

Many are closely following developments in this area. On the one hand, Hong Kong is one of the region’s leading financial hubs, having made significant investments in recent years in digital banking infrastructure and various policy initiatives aimed at fostering a stronger environment for fintech startups. On the other hand, commentators worry that Hong Kong will lack the freedom to properly defend the VA, given mainland China’s subsequent crackdown on cryptocurrencies and its prioritization of the state-backed digital currency, e-CNY. Hong Kong’s conservative regulatory environment for financial services, in many respects an advantage, also stands as a potential weakness for policy development in the VA space, where regulatory innovation is believed to be critical to success.

The policy statement provides good grounds for believing that Hong Kong will be in a position to continue charting its own course for VA trade. Critically, the policy statement suggests that the government may take a more flexible approach to allow a retail market to emerge (albeit gradually), with initial room to offer exchange-traded funds (“ETF”) trades in Bitcoin and Ether futures. A critical sticking point for VA development in Hong Kong has been the government’s proposal to limit the VA service providers (“WASP”) licensed to deal with or advise on VA to clientele who are professional investors (ie individuals holding portfolios of at least HK$8 million (approximately US$1 million)). We discuss this limitation and the latest government comment on this point in more detail below.

A quick summary of the current status of the Hong Kong VA Regulation

Under existing regulations, virtual asset trading platforms operating in Hong Kong may opt for a licensing regime regulated by the Securities and Futures Commission (“SFC”), provided that at least one of the virtual assets traded on the platform falls within the definition of “securities” under the Securities and Futures Ordinance (“Kindergarten“). While Bitcoin is currently unregulated in Hong Kong and has been labeled by regulators as just a virtual commodity, tokens that represent underlying economic rights, such as a share of profits or revenue, will be seen as “securities”.

The bill

On 24 June 2022, the Anti-Money Laundering and Anti-Terrorism Financing (Amendment) Bill 2022 (“Bill”) was made public. The bill introduces a new licensing regime for virtual asset exchanges that will come into effect on March 1, 2023.

Under the Bill, any person carrying on a business of providing (or appearing to provide) a VA service in Hong Kong must be licensed with the SFC. The ban extends to persons who actively market a VA service from outside Hong Kong to the public in Hong Kong. The details of the scope of the license regime can be found in our publication in July – Do you need a license? SFC to license virtual asset service providers in Hong Kong.

Timing

VA service providers operating in Hong Kong before 1 March 2023 will be able to continue their operations under a transitional arrangement until 29 February 2024. Thereafter, they will need to obtain a license from the SFC in order to continue their operations.

Professional Investor Limitation

During the meetings of the Legislation Committee on the Anti-Money Laundering and Counter-Terrorism Financing (Amendment) Bill 2022 following the Bill’s gazettal, significant concerns were raised about the proposal that VASPs would only be able to offer their services to professional investors, which which would prevent VASPs in Hong Kong from engaging in retail business. The SFC was asked to consider relaxing this restriction to allow VASPs to provide VA services to retail customers in low-risk situations, including where the products are not complex, or where a customer, despite not meeting the HK$8 million ( US$1 million) ) monetary threshold is required if a professional investor demonstrates sufficient knowledge of VAs to manage risk effectively. There was a concern that the professional investor restriction could drive Hong Kong retail trading to overseas VA exchanges, resulting in a potential loss of capital and talent from Hong Kong, and also provide insufficient protection for Hong Kong investors if the market moves offshore. The SFC has indicated that it will conduct a public hearing to further explore this proposal. Note that this requirement for professional investors is not a statutory restriction, but rather a condition that the SFC seeks to impose on all licensed VASPs.

Active marketing

The Bill extends the licensing requirement to persons actively marketing a VA service from outside Hong Kong to the public in Hong Kong. There are similar provisions in the Securities and Futures Ordinance (“Kindergarten”) which prohibits active marketing of regulated activities to Hong Kong investors. It is expected that the current uncertainty with the interpretation of “public” and “active marketing” in the SFO context will apply similarly to the new VA licensing regime due to similar concepts and provisions.

application

As the details of the VASP license regime were prepared with reference to existing regulations for automated trading services under SFO (Type 7 regulated activity), many application requirements for a VASP license are similar to those that apply to applicants for a license to operate. regulated activity under SFO. For example:

All VASP license applicants and their directors must be fit and proper.
All VASP license applicants must either be incorporated in Hong Kong, or registered as a Part 16 non-Hong Kong company under the Companies Ordinance.
The premises to be used for record keeping must be approved by the SFC. The SFC has not yet confirmed the ability of VASPs to use offshore service providers to store regulatory records, but if the VASP regime falls in line with current SFC policy, VASP managers will need to provide undertakings that arrangements will be in place to ensure that the records will remain. available for inspection.
All VASP license applicants must appoint at least two responsible officers (“Praise”) to supervise VA operations. The SFC also requires that at least one RO ordinarily resides in Hong Kong and is available at all times. This is similar to the requirement that applies to persons with SFC to carry on a regulated business. Applicants should bear in mind that although the requirement is to have two responsible persons, in practice at least three responsible persons are recommended to ensure continuity. Where an RO terminates its appointment for any reason (for example, due to resignation or death), if a VASP licensee does not appoint a replacement on or before the departure of the existing RO, the SFC is likely to ask the VASP to suspend its operations until a new RO has been appointed.

The policy statement

The policy statement contains promising initiatives to take the Hong Kong VA market and regulatory framework forward to align with international standards and practices. Key points include:

Regarding the potential to allow retail clients to access VA under the new VASP licensing regime, the Government indicated that the SFC will soon launch a public consultation to examine how retail investors could be granted access to VA under the new licensing regime. As a first step, exchange-traded funds on VA authorized by the SFC will be made available to the public in Hong Kong. On the same day, the SFC announced a new authorization regime for ETFs that provide exposure to Bitcoin futures and Ether futures traded on the Chicago Mercantile Exchange. A circular on Virtual Asset Futures ETFs, which sets out the details and criteria for such exchange-traded funds to be authorized under sections 104 and 105 of the SFO, has also been issued.

The government indicated that it is ready to engage with global VA exchanges and invite them to enter Hong Kong for new business opportunities.
In the policy statement, the government also indicated that it is open to future review of property rights for tokenized assets and the legality of smart contracts, and referred to the discussion paper that the Hong Kong Monetary Authority published in early 2022 on the regulation of payment-related stablecoins that may not fall under the licensing regime of stored value facility.
To demonstrate its support for the global VA community, the government has announced certain pilot programs that it is exploring launching, including the issuance of NFTs for Hong Kong FinTech Week 2022 that give holders a chance to create their own avatar to experience the Metaverse , tokenizing government green bond issue for subscription by institutional investors and issuance of Hong Kong Central Bank Digital Currency, e-HKD, in three phases.

Conclusions

The policy statement is a welcome move for those interested in the development of the VA market in Hong Kong. Hong Kong’s “opt-in” approach to VA regulation resulted in few successful applications and raised concerns that Hong Kong was focused on developing a difficult halfway house for VA regulation, driving a number of key players to Singapore and other destinations regionally.

With Singapore moving in recent months to tighten its VA regulatory regime, the policy statement suggests the two financial hubs are converging in their approach to regulation, and marks a concerted effort by Hong Kong to re-establish itself as a leading fintech hub regionally. Much remains to be determined in detail, but if there was an opening in Hong Kong’s retail market and this was recognized as an accepted destination for Chinese crypto investment, Hong Kong would have clear lines of sight for the successful development of a VA market.