Why is the Hong Kong Government looking to develop the virtual asset industry?
For one, virtual assets will most definitely become the racetrack on which future economic innovation will develop. Statistics show that, as of September 2022, the global virtual asset market value has surpassed one trillion USD. Many of the international financial centres have announced plans to launch; within Asia alone, this includes Singapore, Tokyo, Seoul and Bangkok. Outside of Asia, these include Switzerland, USA (New York, Miami) and UK.
A second reason may be that family offices and high net worth individuals have shown keen interest in digital and virtual assets, as reflected in the diagram below:
For these reasons, the Hong Kong government has put in place a comprehensive licensing regime for virtual asset transactions.
Firstly, given the general trend towards compliance and legitimatisation of virtual assets, and in light of the fact that virtual assets have yet to be fully recognised in Mainland China, Hong Kong’s new regime will provide, on the one hand, new opportunities for Web3 users in the Mainland. On the other hand, the regime may serve to provide policy makers more material with which to formulate effective policies in the future.
Second of all, virtual assets represent an unprecedented combination of digital technology and cultural innovation in the form of NFT digital collectibles.
Thirdly, in view of the newly launched digital Hong Kong Dollar (e-HKD), the synergy between the e-HKD and the virtual asset regime is an opportune development in the push for greater interrelation between the digital currencies of Hong Kong and Mainland. Other arrangements in a similar vein, such as dual-currency digital wallets in the Greater Bay Area (“GBA”) and seamless cross-border payments, are also geared towards promoting cross-border investment and closer Hong Kong-Mainland financial relations.
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The above objectives can be seen from the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (“Amendment Bill”) that was passed by the Hong Kong Legislature on 7 December 2022, which paved way for the virtual asset service providers (“VASP”) regime to commence this 1 June 2023. As a follow-up to the Amendment Bill, the Securities and Futures Commission (“SFC”) published on 20 February 2023 the “Consultation Paper on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licenced by the Securities and Futures Commission” (“Consultation Paper”), and the conclusions to this on 23 May 2023 (“Consultation Conclusions”), providing for the Guidelines for Virtual Asset Trading Platform Operations (“VATP Guidelines”) to come into effect on 1 June 2023.
The cumulative effect of the above is to require that all persons operating or actively marketing to the investing public in Hong Kong any decentralised virtual asset exchange, whether or not they are providing services for securitised token transactions, to be licenced and regulated by the SFC.
In the second half of 2023, the SFC intends to permit the provision of services by licenced virtual asset exchanges to retail consumers, although this will be limited to non-securities tokens that are highly liquid in traditional financial indices. The said services must also comply with, inter alia, the following requirements:
- – Virtual Asset Trade Platforms (“VATPs”) should, prior to the provision of services, evaluate the knowledge of retail investors regarding virtual assets and/or provide knowledge training;
- – Retail investors may only engage in “eligible large-cap virtual asset” transactions;
- – VATPs are expected to set up a token admission and review committee, responsible for conducting various audits (including a smart contract audit). The Committee is also in charge of submitting to the SFC a written legal opinion confirming that the virtual asset does not fall within the SFO definition of “securities”. Ultimately, however, it falls on the retail investor to manage their own exposure to risk.
Specific regulations targeting stablecoins, on the other hand, are expected between 2023-2024. Such regulation will likely consist of a licensing and permit regime in relation to activity in the stablecoin sphere. Prior to regulation, the SFC believes that stablecoins should not be available for retail sale and purchase.
In contrast to Hong Kong’s existing securities legislation, by which only security tokens are regulated (via Type 1 and 7 licences), the new regime provides comprehensive regulation on the emerging virtual asset industry as follows:
Tokens are broadly split into two categories: securitised tokens (which include tokenised bonds), and non-securitised tokens (for example, Bitcoin). Given that the nature of a token may be subject to change, if a non-securitised token is to become securitised, the virtual asset exchange is required to apply to the SFC for a licence (VASP Type 1 and 7 licences) under the Securities and Futures Ordinance (“SFO”) and Anti-Money Laundering and Counter-Terrorist Financing Ordinance (“AMLO”) – known as the Dual Licence Arrangement. Applicants need only submit one combined application form, specifying that the application is made for both licences.
Existing VATPs in operation prior to 1 June 2023 with a “meaningful and substantial presence” may, in the 12 months from 1 June onwards, continue to operate. VATPs beginning operations from 1 June onwards, however, will not partake in the transitional arrangements and must obtain a licence from the SFC before commencing operations. ROs and LRs of eligible VATPs are required to apply to the SFC before 29 February 2024. Notably, an application made before the February deadline, if found to be incomplete or with fundamental issue, may be returned to the applicant during the requisition process (instead of being rejected outright by the SFC). Existing VATPs should, therefore, endeavour to submit their applications early and allow for ample time before the deadline of 29 February 2024.
The core requirements of the licensing regime include:
- That all directors, responsible officers (“RO”), licenced representatives (“LR”), managers-in-charge of core functions (“MIC”) and ultimate beneficial owners (“UBO”) must satisfy the “fit and proper” test. At least one LR must be resident in Hong Kong.
- The requirements for capital are set at HKD 5 million paid-up share capital and HKD 3 million liquid capital, in addition to another 12 months of operating expenses, which is provided by the Hong Kong Exchanges and Clearing (“HKEX”) to the SFC.
- Platform operators may only hold client assets on trust for its clients through a Trust of Company Service Provider (“TCSP”), and the TCSP shall not conduct any business other than that of receiving or holding client assets on behalf of the Platform operator.
- There are no mandatory rules requiring data storage centres to be located in Hong Kong. However, if records are kept with an electronic data storage provider, it should have prior written approval from the SFC.
Moreover, according to the VASP guidelines, virtual asset exchanges will need to ensure the following:
- – That all client virtual assets are properly safeguarded. Platform Operators must not deposit, transfer, pledge, repledge or otherwise deal with or create any encumbrance over a client’s virtual assets. These are in addition to making insurance and compensation arrangements to protect against any losses arising from the custody of client virtual assets;
- – Know Your Customer (“KYC”) requirements are met;
- – Risk management measures are in place;
- – Anti-money laundering and counter-terrorist funding measures are met;
- – Conflicts of interests are avoided, which includes the rule against trading and market-making on a proprietary basis;
- – Reasonable due diligence is performed on all virtual assets before including them for trading;
- – Accounting and auditing requirements are met.
It is an offence to provide virtual asset services in Hong Kong without a VASP licence. If convicted on indictment, a person committing the above offence is liable to a fine of HKD 5 million and to 7 years’ imprisonment, and a further fine of HKD 100,000 for every day during which the offence continues. If the act contravenes the anti-money laundering and counter-terrorist provisions, a licenced service provider and its responsible officers will be liable to a fine of HKD 1 million and 2 years’ imprisonment if convicted. Aside from criminal liability, they may also be subject to SFC disciplinary action, which includes licence revocation, reprimands, restitution orders, and fines. Any other misconduct perpetrated by the VASP in its operation may also attract disciplinary action and fines by the SFC.
As global financial centre, the VASP is crucial for the robust development of Hong Kong’s virtual asset industry. Beginning with the VASP application process and throughout licence period, it is prudent to seek professional legal advice in order to ensure that your firm’s operations are in compliance with regulatory requirements.