On 31 October 2022, at the launch of Hong Kong’s Fintech Week, the Financial Services and the Treasury Bureau released a policy statement (the “Policy Statement”) providing some additional detail on the Government’s plans for the development of a regulatory regime for virtual assets (“VA”) in Hong Kong.
Many are closely watching developments in this space. On one hand, Hong Kong is one of the region’s leading financial hubs, having made significant investment in recent years in digital banking infrastructure and various policy initiatives directed at fostering a stronger environment for fintech start-ups. On the other hand, commentators are concerned that Hong Kong will lack the freedom to properly champion VA, given mainland China’s successive crackdowns on cryptocurrencies and its prioritization of its state backed digital currency, the e-CNY. Hong Kong’s conservative regulatory environment for financial services, in many respects a benefit, also stands as a potential weakness for policy development in the VA space, where regulatory innovation is thought to be critical for success.
The Policy Statement provides a sound basis to believe that Hong Kong will be in a position to continue to chart its own course for VA trading. Critically, the Policy Statement suggests that the Government may take a more flexible approach in allowing a retail market to emerge (albeit gradually), with initial scope to offer exchange traded funds (“ETF”) dealing in Bitcoin and Ether futures. A critical sticking point for VA development in Hong Kong has been the Government’s proposal to restrict the VA service providers (“VASP”) licensed to deal in or advise on VA to clientele who are professional investors (i.e., individuals having portfolios of at least HK$ 8 million (approximately US$ 1 million)). We discuss this restriction and the latest Government commentary on this point in more detail below.
A quick recap on the current status of Hong Kong VA regulation
Under the existing regulations, virtual asset trading platforms operating in Hong Kong can opt into 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 (“SFO”). Whilst Bitcoin is not currently regulated in Hong Kong and have been labelled by the regulators as just a virtual commodity, tokens which represent underlying economic rights, such as a share of profits or revenue, would be regarded as “securities”.
On 24 June 2022, the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (the “Bill”) was gazetted. The Bill introduces a new licensing regime for virtual asset exchanges which will take effect on 1 March 2023.
Pursuant to the Bill, any person who carries on a business of providing (or holding out himself as providing) a VA service in Hong Kong is required to be licensed with the SFC. The prohibition is extended to persons who actively market a VA service from outside of Hong Kong to the Hong Kong public. The details of the scope of licensing regime can be found in our July publication - Do you need a licence? The SFC to licence virtual asset service providers in Hong Kong.
VA service providers who are operating in Hong Kong prior to 1 March 2023 will be able to continue their operations under a transitional arrangement until 29 February 2024. Thereafter, they must obtain a licence from the SFC in order to continue their business.
Professional investor restriction
During the meetings of the Bills Committee on Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 after the gazettal of the Bill, significant concerns were raised with respect to the proposal that VASPs would only be able to offer their services to professional investors, 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 required, is an investor who demonstrates sufficient knowledge of VAs to effectively manage risks. There was a concern that the professional investor restriction might drive the Hong Kong retail public to overseas VA exchanges, resulting in a potential loss of capital and talent from Hong Kong, and also leave inadequate protection for Hong Kong investors if the market moves offshore. The SFC has indicated that it will conduct a public consultation to further explore this suggestion. Note that this professional investors requirement is not a statutory restriction, but rather, a condition which the SFC is seeking to impose on all licensed VASPs.
The Bill extends the licensing requirement to persons who actively market a VA service from outside of Hong Kong to the Hong Kong public. There are similar provisions in the Securities and Futures Ordinance (the “SFO”) which prohibit the 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 context of the SFO would apply similarly to the new VA licensing regime due to the similar concepts and provisions.
As the details of the VASP licensing regime were compiled with reference to the existing regulations for automated trading services under the SFO (Type 7 regulated activity), many application requirements for a VASP licence are similar to those which apply to applicants for a licence to conduct regulated activities under the SFO. For example:
All VASP licence applicants and their directors must be fit and proper.
All VASP licence 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 purposes must be approved by the SFC. The SFC is yet to confirm the VASP’s ability to use offshore service providers to store regulatory records, but if the VASP regime falls in line with current SFC policy, VASP managers would need to provide undertakings that arrangements will be in place ensuring that records will remain available for inspection.
All VASP licence applicants must appoint at least two responsible officers (“ROs”) to supervise the VA business. The SFC also requires that at least one RO ordinarily reside in Hong Kong and be available at all times. This is similar to the requirement which applies to persons with the SFC to conduct regulated activities. Applicants should bear in mind that although the requirement is to have two responsible officers, in practice, to ensure business continuity, at least three responsible officers are recommended. Where one RO ceases his/her appointment for whatever 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 will very likely request the VASP to suspend its business until a new RO is 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:
- In respect of the potential of allowing the retail public to access VA under the new VASP licensing regime, the Government indicated that the SFC will soon launch a public consultation to explore how retail investors may be given access to VA under the new licensing regime. As an initial step, exchange traded funds on VA authorised by the SFC will be made available to the public in Hong Kong. On the same day, the SFC announced a new authorisation regime for ETFs providing exposure to Bitcoins 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 obtain authorisation under section 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 it is open to future review on property rights for tokenized assets and legality of smart contracts, and referred to the discussion paper which the Hong Kong Monetary Authority published in early 2022 on the regulation of payment-related stable coins which might not fall under the stored value facility licensing regime.
- To demonstrate its support of the global VA community, the Government has announced certain pilot programs which it is exploring to launch, including the issuance of NFTs for Hong Kong FinTech Week 2022 which offer holders a chance to create their own avatar to experience the Metaverse, tokenizing Government Green bond issuance for subscription by institutional investors and the issuance of the Hong Kong Central Bank Digital Currency, e-HKD, in three phases.
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 an awkward 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 that the two financial hubs are drawing closer in their approach to regulation, marking a concerted effort by Hong Kong to re-establish itself as a leading fintech hub regionally. Much remains to be settled in the detail, but if there were an opening in Hong Kong’s retail market and this became recognized as an accepted destination for Chinese crypto investment, Hong Kong would have clear line of sight for successful development of a VA market.