Since 1 June 2023, centralized virtual asset trading platforms (VATP) carrying on business in Hong Kong, or actively marketing their services to Hong Kong investors, are required to be licensed and regulated by the SFC.
This new regime represents the collective efforts of the government, regulators, the industry, and other interested stakeholders in fostering the orderly and sustainable growth of the crypto community in Hong Kong.
The licensing regime is structured as a two-tier framework comprising:
1. The Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (the AMLO) as amended by the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022, being Hong Kong’s first virtual asset specific legislation that provides a broad VATP regulatory framework to be overseen by the SFC; and
2. The Guidelines for Virtual Asset Trading Platform Operators (the VATP Guidelines) appended in the Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission dated 23 May 2023, which provide detailed implementing details of the VATP regulatory framework in Hong Kong.
Objective of the new VATP licensing regime
The new VATP licensing regime aims to regulate non-security crypto asset trading, which previously fell outside the purview of the Securities and Futures Commission (SFC).
This new regulation complements the existing SFC rules for security tokens, creating a dual system.
To ensure business continuity and compliance, the SFC advises VATP operators to secure licenses under both the SFO and VATP regimes.
Key regulatory requirements
Retail access
One of the key elements of the new regime is that in addition to professional investors, licensed VATPs may provide services to retail investors, insofar as robust investor protection measures, as summarized below, are in place.
Onboarding requirements: VATPs should
(i) Conduct holistic assessments on an investor’s understanding of the nature and risk of virtual assets;
(ii) impose an exposure limit such that the client’s exposure to virtual assets is reasonable.
Governance: VATPs must establish a token admission and review committee responsible for the following functions, establishing, implementing, and enforcing:
(i) the criteria for admitting a virtual asset for, and halting, suspending, and withdrawing a virtual asset from, trading and
(ii) the rules setting out the obligations of and restrictions on virtual asset issuers;
Disclosure obligations: VATPs shall disclose sufficient product information to enable clients to consider their investment position.
General token admission criteria: in line with the fundamental principle that an intermediary shall know the products offered, VATPs shall exercise reasonable care and conduct product due diligence in:
(i) admitting virtual assets for trading
(ii) monitoring the status of the admitted virtual assets, based on the VATP Guidelines. VATPs are only required to consider the regulatory status of the virtual assets in Hong Kong, and not in other jurisdictions.
Specific token admission criteria: VATPs shall meet additional minimum criteria if the virtual assets are open for trading by retail investors. These criteria include, amongst others, the tokens being eligible large cap virtual assets that are included in at least two acceptable indices issued by at least two independent index providers.
Each of the independent index providers shall:
(i) have experience in publishing indices for the conventional securities market that complies with the International Organization of Securities Commission (IOSCO) for Financial Benchmarks;
(ii) be independent of each other, the issuer of the virtual asset and the platform operator.
Insurance / compensation requirements
VATPs must have in place insurance / compensation arrangements approved by the SFC to cover for the risks associated with the clients’ virtual assets.
The compensation arrangements can be made in the form of bank guarantees, along with funds held in the form of demand deposits or fixed deposits with a maturity of six months or less, and virtual assets are an acceptable form of assets that can form part of the compensation arrangements.
The SFC has made it clear that insofar as 98% of the client’s assets are held in cold storage (which is generally free from hacking and other cybersecurity risks), the coverage threshold for the clients’ virtual assets held in cold ratio can be not less than 50%.
Proprietary trading
To avoid conflict of interests, VATPs must not engage in any proprietary trading activities in virtual assets for its own account or any account in which it is interested, except for:
(i) proprietary trading by affiliates which is not conducted through the licensed VATPs
(ii) off-platform back-to-back transactions entered with a third party for the purposes of effecting purchase / sell orders from clients.
Trading in virtual assets derivatives
Currently, the prohibition against offering, trading, or dealing in virtual asset future contracts or related derivatives are preserved in the VATP Guidelines.
Trading in stablecoins
Stablecoins are more volatile and unstable. At present, stablecoins are not subject to regulation in Hong Kong (arrangements are expected to be implemented in 2023/24) and therefore should not be admitted for retail trading for the moment.
Anti-money laundering and counter-financing of terrorism requirements (AML-CFT requirements)
VATPs will be required to observe additional AML-CFT requirements. Particularly, they are required to comply with the Travel Rule which provides fundamental information for carrying out sanctions screening and transaction monitoring, as well as other risk mitigation measures.
Under the Travel Rule, VATPs shall:
(i), when acting as an ordering institution, obtain, record, and submit the required information of the originator and recipient to the beneficiary institution
(ii) when acting as a beneficiary institution, obtain and record the required information submitted by the ordering institution or intermediary institution.
Transitional arrangements
Pre-existing VATP operators which are in operation in Hong Kong before 1 June 2023 with a “meaningful and substantial presence” will be eligible for the transitional arrangement.
They will be provided with a one-year transitional period (i.e. until 31 May 2024) to either:
- apply for a license
- close their virtual assets trading operations in an orderly manner.
Under the deeming arrangements, upon making the licensing application, they will be deemed to be licensed from 1 June 2024 until their applications are approved, withdrawn, or refused.
If the SFC formally rejects the application, VATP operators will be required to close the business with respect to Hong Kong within a specified time period.
Qualifications
For VATP applicants to be qualified for the application, they must prove to the SFC that they can satisfy the following criteria including:
- fit and proper;
- competence requirements;
- requirements on responsible officers (ROs)
- financial resources and soundness.
Fidinam can help
In conclusion, the introduction of the VATP licensing regime represents a significant step forward in the regulation of cryptocurrency trading in Hong Kong, bridging previous regulatory gaps and ensuring the sector's orderly and sustainable growth.
While this regulatory shift may pose new challenges for VATP operators, it also provides opportunities for those ready to adapt.
If you’d like further insights or assistance on the application process, please don't hesitate to reach out via the form below or email info@fidinamgw.com.
Our team of experts is always available to support you in understanding and navigating these regulatory changes effectively.
