Hong Kong Virtual Assets Regulatory Update: Consultation Conclusions issued on New Virtual Asset Trading Platform Operators Licensing Regime
Legal Development 2023年6月7日 2023年6月7日
On 23 May 2023, the Securities and Futures Commission (“SFC”) issued the Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission (“Consultation Conclusions”). These were issued following consultation on the regulatory requirements in connection with the licensing regime for virtual asset trading platforms (“VATPs”) introduced by the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022 (“Amendment Ordinance”).
In this article, we discuss the new licensing regime for VATPs in Hong Kong and highlight the regulatory requirements finalised in the Consultation Conclusions, which have become effective on 1 June 2023.
Dual licensing regime for VATPs
- Securities and Futures Ordinance (“SFO”) regime – A platform that operates a centralised online trading platform in Hong Kong and offers trading of security tokens on its platform should be licensed for Type 1 (dealing in securities) and Type 7 (providing automated trading services) regulated activities under the SFO.1
- Anti-Money Laundering and Counter-Terrorist Financing Ordinance (“AMLO”) regime – Under the AMLO as amended by the Amendment Ordinance, the SFC now also regulates the trading of non-security tokens by VATPs effective from 1 June 2023. A person is required to be licensed by the SFC under the AMLO2 if he or she carries on or holds himself or herself out as carrying on a business of providing a virtual asset service3, or actively markets their services to Hong Kong investors.
To ensure business continuity in case of changes to a virtual asset’s classification from a non-security token to a security token (or vice versa) over time, the SFC stated that it would be prudent for VATPs to be dual licensed under both the SFO and the AMLO regimes.
VATPs applying to be dual licensed only need to submit a single consolidated application. With respect to responsible officers, one individual may be concurrently approved under both the SFO and the AMLO.
Regulation of intermediaries engaging in virtual asset-related activities
Intermediaries under the SFO providing virtual asset-related activities shall continue to comply with the requirements as set out in Joint circular on intermediaries’ virtual asset-related activities (“Joint Circular”). These include that virtual asset advisory services may only be provided to SFO-licensed intermediaries’ existing clients to which they provide services in Type 1 (dealing in securities) or Type 4 (advising on securities) regulated activities.
In the Consultation Conclusions, the SFC has noted the need to maintain consistency between the different virtual asset-related regulatory frameworks. The regulator will revise the Joint Circular to clarify the regulatory requirements applicable to intermediaries engaging in virtual asset-related activities.
Following the consultation, the revised proposed regulatory requirements as set out in a number of guidelines4 have become effective on 1 June 2023.
Effective from 1 June 2023, compliance with the Guidelines for Virtual Asset Trading Platform Operators (“VATP Guidelines”) is now a licensing condition for VATPs. The VATP Guidelines has on the same date superseded the Terms and Conditions for VA Trading Platform Operators (“Terms and Conditions”) applicable to SFO-licensed VATPs.
Existing SFO-licensed VATPs will be entitled to a 12-month transitional period for compliance with the requirements in the VATP Guidelines. The existing corresponding licensing conditions will not be removed from the SFO-licensed VATPs’ licenses until such VATPs can fully comply with the VATP Guidelines or by the deadline of a 12-month transitional period, whichever is earlier.
Retail access and investor protection measures
Licensed VATPs are allowed to provide services to retail investors provided that robust investor protection measures are in place.
- Onboarding requirements – In respect of both professional and retail investors, licensed VATPs engaging in virtual asset-related activities should conduct a suitability assessment of an investor’s knowledge and risk tolerance.
- Governance – Licensed VATPs should set up a token admission and review committee which should at least consist of managers-in-charge principally responsible for managing the key business line, compliance, risk management and information technology functions of the VATPs.
- Disclosure – Licensed VATPs are expected to exercise due skill, care and diligence when disclosing product specific information and take all reasonable steps to ensure that the information is not false, biased, misleading or deceptive.
- Token admission criteria and other token due diligence
- General token admissible criteria – Licensed VATPs should exercise due skill and care in conducting due diligence on each token before admission for trading. The SFC has relaxed the scope of due diligence and does not require the VATPs to consider the regulatory status of a virtual asset in jurisdictions outside of Hong Kong.
- Specific token admissible criteria – A minimum criterion before tokens can be offered to the retail investors is that they must be eligible large-cap virtual assets included in at least two acceptable indices issued by two independent index providers.
- Stablecoins – Stablecoins would not be admitted for retail trading prior to being subject to regulation in Hong Kong.
- Other investor protection requirements – Offering of gifts tied to the trading of a specific virtual asset is prohibited with the exception of discounts of fees and charges.
Handling of client assets
To ensure the safe custody of client assets:
- Cold-to-hot storage ratio – 98% of the client assets must be held in cold storage and at most 2% held in hot or other storages, except under limited circumstances permitted by the SFC on a case-by-case basis.
- Seeds and private keys – All seeds and private keys (and their backups) must be securely stored in Hong Kong with appropriate certification such as in a certified Hardware Security Module.
Insurance or compensation arrangement
Licensed VATPs are required to put in place an SFC-approved insurance or compensation arrangement for risks associated with custody of client assets.
- Coverage threshold – Compensation arrangement should cover potential loss of 50% of client virtual assets in cold storage and 100% of client virtual assets in hot and other storages.
- Types of assets – Compensation arrangement should include any or a combination of (1) third party insurance, (2) funds (held in the form of a demand deposit or fixed deposits with a maturity of 6 months or less) or virtual assets held by a VATP or any of its group companies which are set aside on trust and designated for such a purpose, and (3) bank guarantee provided by an authorised financial institution in Hong Kong.
- Segregation of assets – Licensed VATPs may set up an escrow arrangement for the compensation arrangement or hold the funds set aside with an authorised financial institution, provided that the funds set aside are segregated from the assets of the VATPs and its group companies and are set aside on trust and designated for such purpose. Virtual assets which form part of a compensation arrangement should also be segregated from the virtual assets of the VATPs and its group companies and be held in cold storage by its associated entity.
Anti-money laundering and counter-financing of terrorism (“AML/CFT”) matters
Travel rule – In case of a virtual asset transfer, licensed VATPs are required to, when acting as the ordering institution, obtain, hold and submit required information about the originator and recipient to the beneficiary institution immediately and securely; and when acting as the beneficiary institution, obtain from the ordering institution and hold required information. Where the required information cannot be submitted to the beneficiary institution immediately, the SFC considered that submission as soon as practicable after the virtual asset transfer to be acceptable as an interim measure until 1 January 2024.
Due diligence on counterparty – Where the virtual asset transfers are conducted with several virtual asset transfer counterparties that belong to the same group, a licensed VATP should conduct due diligence on each of them independently and apply risk-based measures as appropriate.
We will continue to monitor the developments in the virtual assets regulatory space. For advice on compliance-related issues, please contact Joyce Chan or your usual Clyde & Co contact.
1 Section 116 of the SFO.
2 Section 53ZRD of the AMLO.
3 “Provision of virtual asset service” means operating a virtual asset exchange under section 1, Schedule 3B of the Amendment Ordinance. The Consultation Conclusions further clarified that “providing a virtual asset service” will cover virtual asset trading platforms which are centralised and operate in a manner similar to traditional venues licensed under the SFO. Such platforms typically provide virtual asset trading services to clients using an automated trading engine which matches client orders and also provide custody services as an ancillary service to their trading services. Over-the-counter virtual asset trading activities and virtual asset brokerage activities would not fall under the scope of the AMLO regime.
4 These are the Guidelines for Virtual Asset Trading Platform Operators; the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers); the 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; and the Disciplinary Fining Guidelines.