After challenges with strict COVID restrictions and political issues in the last several years, Hong Kong is fighting to bolster its status as a global financial hub - and prove its unique advantage as the gateway between mainland China and the rest of the globe. As a result, technological developments and the regulations required to stay ahead of a rapidly evolving financial landscape are now a priority in the region.
Regarding virtual assets (i.e., digital assets and cryptocurrency), the financial industry faces significant challenges due to regulators catching up to the “crypto craze”. For example, just last year, the virtual assets and cryptocurrency markets gained global news headlines - for all the wrong reasons. The collapse of the Luna Token, Terra Stablecoin, the epic implosion of the FTX crypto exchange, and the high volatility of virtual asset prices have all emphasised the risks associated with virtual assets. See our recent eBook, Cryptocurrency in Singapore: a Time of Turmoil or Hope Ahead, for more detail on these and other crypto issues experienced in the region.
The headlining crypto woes of 2022 have made it more apparent than ever that proper regulation must exist to protect investors and customers - and enable long-term stability within the virtual asset space. Accordingly, Hong Kong’s SFC (Securities and Futures Commission) is taking a forward-thinking stance, developing and enhancing policies to effectively regulate virtual assets within the region.
This article explores the SFC Consultation Conclusions on the Proposed Regulatory Requirements for VATPs with summary highlights with a particular focus on conduct, CTP, conflicts of interest, and compliance management.
Hong Kong regulators refer to digital assets and crypto assets as “virtual assets”. Other jurisdictions may reference the same technology as “digital assets” or “crypto assets”.
Virtual assets can include:
The SFC has so far faced limitations in its regulation abilities of Virtual Asset Trading Platforms (VATPs). The regulatory remit of the SFC thus far under the Securities and Futures Ordinance (SFO) has only extended to activities relating to securities and futures contracts. In 2019, the SFC created an opt-in framework under the SFO for centralised VATPs that provide trading services for at least one security token. And although the SFC maintains a licensed VATP listing, only two Platform Operators have so far signed up.
The SFC’s limited scope has also prevented it from issuing licences or regulating the many VATPs that only provide non-security tokens and trading services. This limitation means that many VATPs in Hong Kong have primarily been unlicensed.
To address these constraints, the Hong Kong government passed legislative amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) in 2022 to regulate virtual asset service providers (VASPs) dealing in non-security tokens.
Finally, under the new regime, every centralised VATP conducting business in Hong Kong or actively marketing to Hong Kong investors must be licensed by the SFC - irrespective of whether or not they provide trading services in security tokens. This new regulatory regime was enacted on 1 June 2023, with a transitional period for VATPs to become licensed.
As Ms Julia Leung, the SFC’s Chief Executive Officer, explains in a recent news announcement, “Hong Kong’s comprehensive virtual assets regulatory framework follows the principle of ‘same business, same risks, same rules’ and aims to provide robust investor protection and manage key risks. This will enable the industry to develop sustainably and support innovation.”
On 20 February 2023, the SFC published a consultation paper on the proposed regulations for VATPs. The SFC has now also published its consultation conclusions, which sets out the comprehensive regulatory framework to govern virtual asset trading platforms.
As the regulatory scope of virtual assets expands, firms dealing in these assets must understand and prepare for the changes ahead. For example, any Platform Operators licensed under both SFO and ALMO must now adhere to the more stringent requirements to remain compliant (further detail contained in section 1.5 - Interpretation of the Consultation Conclusions).
VATPs who obtain SFC licensing under the new regime will also be subject to ongoing supervision. This extended regulatory oversight may reassure clients of proper virtual asset governance and controls - a proposition that is now more critical than ever, given the tumultuous cryptocurrency environment seen in recent years.
Industry and professional associations, professional and consultancy firms, market participants, licensed corporations, individuals and other stakeholders responded with 152 written submissions during the consultation period.
The regulator has now considered comments and suggestions provided by respondents and further modified or clarified some of the proposed requirements.
The following provides a short overview of particular highlights from the Consultation Conclusions. VATPs and those dealing in virtual assets are encouraged to review the full detail of the regime, as published here: SFC Consultation Conclusions on the Proposed Regulatory Requirements for VATPs.
The SFC will determine whether a licence application satisfies the criteria to be deemed a “fit and proper” to carry out regulated activities. These criteria include areas such as financial status, education and experience, competency, honesty, reputation, reliability, and financial integrity.
See Section 2 - Fitness and Properness Requirements for further detail.
The SFC expects VATPs (and their representatives) to conduct themselves with high ethical standards, including:
See Section 5 - Conduct of Business Principles for further detail.
For more information about minimising conflict of interest and misconduct risk, see MCO’s detailed eBook, The Ultimate Guide to Conflicts of Interest in Financial Services.
VATPs will be required to maintain, at all times, adequate financial resources and assets within Hong Kong, which it beneficially owns and are sufficiently liquid. These assets may include cash, deposits, treasury bills and certificates of deposit (but not virtual assets). They must be equivalent to at least 12 months of the organisation’s actual operating expenses, calculated on a rolling basis.
Additionally, VATPs must meet minimum capital requirements of:
VATPs must also appoint an external auditor to conduct audits of their financial statements. Financial returns must also be submitted monthly.
See Section 6 - Conduct of Business Principles for further detail.
As part of an organisation’s assurance of competence, any individuals applying to carry out the Relevant Activities must satisfy the SFC that they have the necessary academic, professional or industry qualifications, sufficient relevant industry and management experience (where applicable), familiarity with the ethical standards expected of a financial practitioner, and possess a good understanding of the regulatory framework, including the laws, regulations and associated codes governing the virtual asset sector.
VATPs must also ensure proper regulatory compliance, including:
See Section 3 - Competence Requirements for further detail.
Individuals must comply with the continuous professional training (CPT) requirements, also known as Continuing Professional Development programs (CPD programs). Failure to satisfy any applicable CPT requirements will cast doubt on the fitness and properness of corporations and individuals to remain licensed and may lead to disciplinary action by the SFC.
See Section 4 - Continuous Professional Training Requirements for further detail.
Our in-depth article, Addressing Compliance Within Financial Firms’ CPD Requirements also provides further insight into CPD compliance.
VATPs will need to implement documented controls, policies, and procedures to ensure proper surveillance of trading activity. In addition, platform Operators must take appropriate measures to identify, prevent, and report market manipulation or trading activities causing market abuse.
The SFC specifies the minimum efforts for these requirements to include:
See Section 8 - Prevention of Market Manipulative and Abusive Activities for further detail.
VATPs must appropriately segregate duties within the organisation, particularly with multiple functions performed by the same individual, which may lead to conflicts of interest. For example:
The remit for compliance teams and/or Chief Compliance Officers, together with senior management of the organisation, is to:
See Section 11 - Management, Supervision and Internal Control for further detail.
The above summary provides only a brief interpretation of the Consultation Conclusions with a particular focus on conduct, CTP, conflicts of interest, and compliance management.
VATPs and firms dealing in virtual assets are encouraged to review the complete Consultation Conclusions document.
Existing VATPs operating within Hong Kong before 1 June 2023 will be allowed to continue operating in Hong Kong without a licence for up to 12 months (until 31 May 2024). During this time, the VATP must apply for a licence or plan to discontinue its operations. It is noted that the SFC’s requirement for existing VATPs applies to those it deems to have a “meaningful and substantial presence”.
The SFC will publish further guidance so the industry can better understand the implementation of the new regulatory regime and transitional requirements for VATPs.
VATPs considering their applicant for licensing under the new SFC regime must document and demonstrate upholding their regulatory compliance obligations.
MyComplianceOffice (MCO) enables firms to monitor and avoid internal virtual asset conflicts of interest, just like traditional securities. Part of the Know Your Employee Compliance Suite, MCO’s Personal Trade Manager solution allows organisations to seamlessly manage the preclearance and reporting of crypto investments.
Particularly in light of the cryptocurrency turmoil of recent years, a VATP’s ability to monitor, identify, prevent, and report trading abuse or market manipulation activities is crucial.
Find out how MCO can help you stay ahead of virtual assets regulation, demonstrate proper virtual asset governance and controls to regulatory bodies, and reduce non-compliance risk.
Download your detailed Virtual Asset Compliance Brochure or request your tailored demonstration of the MCO’s powerful compliance management platform now.