Hong Kong SFC to Regulate Virtual Asset Trading Platforms

    

The virtual asset market has seen its share of upheaval recently. By the end of 2022, the global decentralised virtual asset (cryptocurrency) market had slumped by 64.1% to $829 billion, down from $2.3 trillion at the start of the year, according to a 2023 report by CoinGecko.

The Luna token and Terra stablecoin collapses, defaults and bankruptcies of virtual asset fund managers, and the implosion of FTX (see our detailed eBook for more information about 2022’s time of turmoil in crypto) sent shockwaves throughout the industry, with the Hong Kong virtual asset market also feeling the effects.

The Hong Kong SFC (Securities and Futures Commission) is now hyper-aware of the risks posed by the interconnectedness of the virtual asset ecosystem and the relationship between those assets and traditional finance systems. SFC news announcements just last month revealed its plans for a heightened focus on Hong Kong SFC regulations and oversight of the virtual asset industry.

 

Hong Kong SFC Releases Consultation for Virtual Asset Trading Platforms

MCO-Blog-Small-Compliance-Team-Priorities-for-2023-Hong-KongHong Kong SFC has launched a consultation on the proposed requirements for operators of virtual asset trading platforms. From 1 June 2023, every centralised virtual asset trading platform that conducts business in Hong Kong (or that actively markets to Hong Kong investors) must be licensed by the SFC.

Many jurisdictions around the globe are transitioning from a light-touch approach, such as regulating from an anti-money laundering (AML) or payment perspective, to a more comprehensive method of regulating from an investor protection perspective. The SFC has been at the forefront of this shift, being one of the first major financial regulators to introduce a comprehensive framework for regulating various virtual asset-related activities. The SFC’s proposed changes include trading on centralised virtual trading platforms to services provided by SFC-licensed intermediaries, such as virtual asset fund management, discretionary account management, and the provision of virtual asset dealing and advisory services.

Julia Leung, Hong Kong SFC Chief Executive Officer, explains, “As has been our philosophy since 2018, our proposed requirements for virtual asset trading platforms include robust measures to protect investors, following the ‘same business, same risks, same rules’ principle.”

She continues, “In light of the recent turmoil and the collapse of some leading crypto trading platforms around the world, there is clear consensus among regulators globally for regulation in the virtual asset space to ensure investors are adequately protected and key risks are effectively managed,” she continues.

The SFC says it will publish lists of the different regulatory statuses of virtual asset trading platforms on its website, and will continue working with the Investor and Financial Education Council to enhance investor education for the Hong Kong public.

 

Conflicts of Interest Surfacing in Virtual Asset Trading

MCO-Blog-MAS-Bans-PFOF-Payment-for-Order-Flow-01The risk of conflicts of interest within virtual asset trading greatly reflects traditional securities trading risks while posing new challenges to authorities. In July 2022, the US DOJ (Department of Justice) charged three people over the first-ever cryptocurrency insider trading tipping scheme. The case alleges that a former employee of a crypto firm tipped his brother and a friend about virtual assets that were set to be listed on the firm's exchanges.

In the DOJ’s press release about the case, US Attorney Damian Williams comments, “Today’s charges are a further reminder that Web3 is not a law-free zone. Just last month, I announced the first ever insider trading case involving NFTs, and today I announce the first ever insider trading case involving cryptocurrency markets. Our message with these charges is clear: fraud is fraud is fraud, whether it occurs on the blockchain or on Wall Street.”

During the 2022 fiscal year, the SEC (US Securities and Exchange Commission) filed 760 enforcement actions arising from various conflicts of interest with fines totalling a record-breaking USD $6.4 billion. Over the same period in Hong Kong, the SFC imposed HKD $410.1 million in penalties with 28 criminal charges laid.

As authorities continue to bolster regulations around virtual asset-related activities, it will not be surprising to see a greater number of enforcement cases coming to light.

 

How to Reduce Your Firm’s Risk of Virtual Asset Conflicts of Interest

Some of the areas involving severe conflicts of interest that may arise within activities involving virtual assets include:

  • The use of MNPI (material non-public information) for personal and financial gain.
  • Insider trading and market abuse.
  • Misconduct involving misleading behaviours to digital investments.
  • Misinformation and deceptive or false advertising of virtual asset products and services.
  • A lack of access to competing market makers on digital trading platforms.

MCO-Blog-MAS-Bans-PFOF-Payment-for-Order-Flow-FIAdditionally, virtual asset trading platforms that combine functions of marketplace trading, lending, derivatives, and collective investment vehicles may also heighten conflict of interest risk.

Every firm must be able to identify, monitor, and act appropriately on any conflicts of interest arising from virtual asset activity to protect employees and the organisation against unethical and unlawful behaviours. 

In a recent press release, US SEC Chair Gary Gensler comments, “Since the 1930s, such recordkeeping has been vital to preserve market integrity… As technology changes, it’s even more important that registrants appropriately conduct their communications about business matters within only official channels, and they must maintain and preserve those communications.”

Review and Enhance Your Existing Trading Policy

Firms that create or sell digital assets may wish to enhance or adopt new policies that focus on digital assets to provide clarity and guidance to employees. Such policies can also help reduce your firm’s risk of compliance breaches as new and updated regulations emerge.

Monitor Personal Trade Activity for Virtual Assets

Irregularities in the trading patterns of employees can sometimes be an early indicator of insider trading activity. Such trades may be incongruent with established trading patterns due to MNPI being acted upon. While this does not confirm that insider trading is happening, it may suggest further investigation is needed. Automated monitoring tools, such as MyComplianceOffice (MCO)’s Personal Account Dealing Software, can make these tasks much more manageable for compliance teams of all sizes.

Record and Maintain Insider Lists

A list of people with access to MNPI (material non-public information) is called an “insider list”. Employees, contractors, and anyone outside your organisation (such as advisors, accountants, and resources coming in contact with MNPI during business dealings) should be placed on your insider list to know who has access to MNPI, when they gained this access, and when it was relinquished. These lists are vital in identifying and actively monitoring potential risks and responding to requests for information from regulatory bodies during market surveillance activities (which will likely increase in frequency as regulators continue to build out virtual asset policies).

Consider Extending Blackout Periods to Virtual Asset Trading

Trading blackout periods should already be communicated to employees for traditional securities trading. These blackout periods help minimise the risk of anyone privy to sensitive company information making trades or providing information to connected persons that could unfairly benefit the individuals involved. The recent example of a Coinbase employee tipping connected persons about virtual assets set to be listed on Coinbase exchanges shows a compelling reason for firms to review policies and inclusions, such as blackout periods.

Build Ethics Into Your Firm’s Foundations

As authorities and lawmakers race to meet the pace of technological change and implement robust regulation, firms and their compliance teams must do everything they can to enhance self-regulation of virtual asset-related activities, starting with building solid ethical foundations.

The 2022 Global Business Ethics Report reveals that a shocking 54% of employees in small, 71% in medium, and 55% in large organisations have observed misconduct. More specifically, looking at conflicts of interest, these figures show 23% (small), 40% (medium), and 22% (large) of employees observing these activities.

MCO-The-Evolution-of-Regulatory-Compliance-and-Risk-Management-CultureAs identified in the same report, ECI research shows that organisations with high-quality E&C (Ethics & Culture) programs are more likely to have strong ethics cultures while having a noticeable impact on the four major ethics outcomes in the following ways:

  • Less observed misconduct.
  • Less pressure to compromise ethical standards.
  • More reporting of misconduct observed.
  • Less retaliation for reporting.

Employee compliance with virtual asset policies (both company and emerging regulatory policies) is vital. Just as important, however, is helping employees make ethical decisions by driving organisation-wide ethics and culture programs.

 

Another Cutting-Edge Technology: Using RegTech to Reduce Conflicts of Interest Risk

As global and Hong Kong SFC regulations continue to develop policies that address new risks posed by virtual assets, firms must stay ahead of the market’s evolution and implement the proper policies and processes to monitor and reduce conflicts of interest and market abuse risk.

Regulatory Technology (RegTech) solutions, such as MCO’s Personal Trade Manager (PTM), can be implemented to automate the monitoring, detection, and automatic alerts of suspicious trade activity. Compliance resources can save significant time while ensuring full audit trails of all transactions by using a compliance management software solution instead of manual processes.

PTM is part of the Know Your Employee Compliance Suite, allowing firms to address transactional and personal conflicts of interest in a single platform. MCO brings the only fully integrated, comprehensive compliance management platform that uses a global company and security master dataset to identify conflicts across firm transactions (deals, research, and trades), employees, and third parties.

Discover how MCO can help you stay ahead of virtual asset regulation and significantly reduce risk. Download your Crypto Asset Compliance brochure now.

Uncover the strategies you need to reduce risk and strengthen your overall compliance management process. Download your complimentary eBook, The Ultimate Guide to Conflicts of Interest.

MCO-APAC-eBook-Ultimate-Guide-to-Conflicts-of-Interest-CTA

 

Also, see our recent eBook exploring the recent developments of Cryptocurrency in Singapore, a look back at the Luna crash and Terra sell-off, the FTX debacle, and the road ahead for crypto confidence.

MCO-eBook-Cryptocurrency-in-Singapore-FI