SFC consults on the proposed regulatory requirements for licensed virtual asset trading platform operators
Introduction
Currently, Virtual asset trading platforms
(“VA trading platforms”) which
provide trading service in security token or choose to opt-in to be regulated
is under the regulation of the SFC (“existing
SFO regime”). A new licensing regime
for all Hong Kong’s virtual asset trading platforms, irrespective of whether
they provide trading services in security token or not, is to be introduced by
the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022
(“Amendment Bill”). We have
previously examined the content of the Amendment Bill in the July 2022 edition
of our Technology Newsletter (read more here).
The new licensing regime i.e. the AMLO
VASP regime will come into effect on 1 June 2023 (with transition arrangements
and grace period). Upon its commencement, all centralised VA trading platforms
carrying on business in Hong Kong or actively marketing their services to Hong
Kong investors will need to be licensed and regulated by the SFC. In order to
prepare for this new regime, the SFC publishes a consultation paper on the
proposed regulatory requirements for licensed VA trading platforms, with a view
to striking a better balance between investor protection and market development.
This article will highlight several key
points in the consultation paper, including proposal to allow retail access to
VA trading platforms and transitional arrangement for the current VA trading
platforms upon the commencement of the AMLO VASP regime.
Proposal
to allow retail investors access to licensed VA trading platforms
In the Legislative Council Brief in
respect of the Amendment Bill dated 22 June 2022, the government indicated that
to further promote investor protection, the new regime will at the initial
stage stipulate that licensed VA trading platforms operators (“Licensed Platform Operators”) can only
provide services to professional investors. This requirement is not included in
the Amendment Bill itself but may be imposed by the SFC as licence conditions.
Nevertheless, in the consultation paper, the
SFC proposes to allow all types of investors, including retail investors, to
access trading services provided by the Licensed Platform Operators because of
the changing circumstances and opposite view received. Many are of the view
that denying retail access may in fact result in investor harm as it may push
retail investors to trade on unregulated VA trading platforms overseas, which could
easily be accessed online. If any of these unregulated VA trading platforms
collapses, retail investors would have difficulty withdrawing their assets or seeking
any recourse.
In addition, over the years the SFC has introduced
a number of virtual asset policies which gradually allowed retail investors to
gain limited exposure to virtual assets.
Several licenced brokers and fund managers in Hong Kong are also
providing virtual asset-related services to investors under the SFC’s
supervision. The virtual asset space is gradually being shaped through the introduction
of policies and procedures, systems and controls comparable to those in
mainstream finance.
In light of the above, the SFC proposes
that retail investors should also be allowed access to trading services
provided by Licensed Platform Operators, provided that the platforms comply
with a range of robust investor protection measures set out in the consultation
paper, which will be summarized below.
Investor
protection measures
Onboarding requirements
Similar to the existing SFO regime, SFC
proposes that Licensed Platform Operators are required to conduct a knowledge
assessment on investors before providing services to them. Where the investor
does not pass the assessment, the Licensed Platform Operators may provide
services to that investor only after providing training to that investor. In
addition, the Licensed Platform Operators should also consider if the provision
of its services is suitable for that investor by:
1.
assessing the investor’s risk tolerance level and risk profile and
assessing accordingly whether it is suitable for the investor to participate in
the trading of virtual assets; and
2.
setting a limit for each investor to ensure that the investor’s exposure
to virtual assets is reasonable with reference to the investor’s financial
situation and personal circumstances.
Token due diligence and
admission criteria
SFC proposes that a Licensed Platform
Operator should set up a token admission and review committee who should be
responsible for, among others, making the final decision as to whether to
admit, halt, suspend and withdraw a virtual asset for clients to trade based on
the criteria it establishes.
SFC lists out a number of general
non-exhaustive factors to be considered as follows:
1.
the background of the management or development team of a virtual asset;
2.
the regulatory status of a virtual asset in each jurisdiction in which
the platform operator provides trading services and whether its regulatory
status would also affect the regulatory obligations of the platform operator;
3.
the supply, demand, maturity and liquidity of a virtual asset, including
its market capitalisation, average daily trading volume, track record, whether
other platform operators also provide trading for the virtual asset, the
availability of trading pairs, and the jurisdictions where the virtual assets have
been made available for trading;
4.
the technical aspects of a virtual asset, including the security
infrastructure of its blockchain protocol, the size of the blockchain and
network and especially how resistant it is to common attacks, the type of consensus
algorithm, and the risk relating to code defects, breaches and other threats
relating to the virtual asset and its supporting blockchain, or the practices
and protocols that apply to them;
5.
the marketing materials for a virtual asset issued by the issuer, which
should be accurate and not misleading;
6.
the development of a virtual asset including the outcomes of any
projects associated with it as set out in its Whitepaper (if any) and any
previous major incidents associated with its history and development;
7.
the market risks of a virtual asset, including concentrations of virtual
asset holdings or control by a small number of individuals or entities, price
manipulation, and fraud, and the impact of the virtual asset’s wider or
narrower adoption on market risks;
8.
the legal risks associated with the virtual asset, including any pending
or potential civil, regulatory, criminal, or enforcement action relating to its
issuance, distribution or use; and
9.
whether the utility offered, the novel use cases facilitated, or
technical, structural or cryptoeconomic innovation exhibited by the virtual
asset appears to be fraudulent or scandalous.
Apart from
the above general criteria, where the Licensed Platform Operator intends to
make virtual assets available for trade among retail clients, it should ensure
that the virtual assets will satisfy the specific token admission criteria as
an eligible large-cap virtual asset, which means virtual assets which are
included in at least two “acceptable indices”[1] issued
by at least two independent index providers.
Transitional
arrangement for current VA trading platform
The SFC recognizes that the current VA
trading platform may require time to adapt to the new AMLO VASP regime. Hence,
it introduces a transitional arrangement with an aim to provide sufficient time
for VA trading platforms currently operating in Hong Kong to either apply for a
license or to shut down its service in an orderly manner.
Eligibility for the
transitional arrangement
Only VA trading platform which is pre-existing
i.e. in operation in Hong Kong prior to 1 June 2023 and with meaningful and
substantial presence will be eligible for the transitional arrangement. In
determining its eligibility, the SFC will consider:
1.
whether it is incorporated in Hong Kong;
2.
whether it has a physical office in Hong Kong;
3.
whether its Hong Kong staff have central management and control over the
VA trading platform;
4.
whether its key personnel (for example, those responsible for the
operation of the trading system) are based in Hong Kong; and
5.
whether the centralised trading platform’s operation is live with
considerable number of clients and volume of trading activities in Hong Kong.
Subject to the conditions set out in
Schedule 3G to the AMLO, VA trading platforms qualified for the transitional
arrangements may continue to operate in Hong Kong during the non-contravention
period (i.e., from 1 June 2023 to 31 May 2024), and will be subject to a
deeming arrangement from 1 June 2024.
Key dates and details of
the transitional arrangement
Any pre-existing VA trading platform who
intends to apply for a licence should beware of the following key dates and
details under the transitional arrangement:
1.
The AMLO VASP regime will commence operation on 1 June 2023;
2.
Between 1 June 2023 and 31 May 2024, qualified pre-existing VA trading
platforms will not be considered in breach of the licensing requirements under
the AMLO VASP regime pursuant to the non-contravention arrangement
3.
Between 1 June 2023 and 29 February 2024, any pre-existing VA trading
platform who intends to qualify for the deeming arrangement must submit a
completed licence application under the AMLO VASP regime. In the application,
the pre-existing VA trading platform will be asked to confirm:
a.
It has been a VA trading platform in Hong
Kong immediately before 1 June 2023.
b.
It will, on being deemed to be licensed,
comply with the regulatory requirements applicable to a licensed platform
operator and have arrangements in place to ensure the VA trading platform
complies with the regulatory requirements applicable to a licensed platform
operator.
4.
If the SFC is satisfied that the platform operator has
a reasonable prospect of successfully showing to the SFC that it is capable of
complying with the relevant legal and regulatory requirements, the applicant will
automatically be deemed to be licensed from 1 June 2024 until its licence
application is approved, withdrawn or refused (whichever is earlier).
Once a VA
trading platform is deemed to be licensed, the provisions of the AMLO VASP regime
will apply as if it is licensed under the AMLO, meaning that it will be subject
to the SFC’s supervisory, disciplinary, intervention and other applicable
powers and is also required to comply with all the relevant legal and
regulatory requirements under the AMLO VASP regime as if they were formally
licensed or approved.
Conclusion
SFO proposes a number of new regulatory
requirements comparing to the existing SFO regime including the due diligence
requirement on choice of virtual assets to be made available for trade.
Although details of the regulatory requirements have not yet been settled
pending the conclusion of this consultation, it is expected that VA trading
platforms will have to make a number of modifications to its operation and
policies so as to comply with the regulatory requirements under the AMLO VASP
regime.
In case you encounter any legal questions
in relation to the AMLO VSP regime or require any compliance advice, you are
advised to consult a technology lawyer.
For enquiries,
please feel free to contact us at: |
E: technology@onc.hk T:
(852) 2810 1212 19th Floor, Three Exchange Square, 8 Connaught
Place, Central, Hong Kong |
Important: The law and procedure on
this subject are very specialised and complicated.
This article is just a very general outline for reference and cannot be
relied upon as legal advice in any individual case. If any advice or
assistance is needed, please contact our solicitors. |
Published by ONC Lawyers © 2023 |
[1] An “acceptable index” is an index which has a clearly
defined objective to measure the performance of the largest virtual assets in
the market and fulfils the following criteria:
a) The index
should be investible, meaning the constituent virtual assets should be
sufficiently liquid.
b) The index
should be objectively calculated and rules-based.
c) The index
provider should possess the necessary expertise and technical resources to
construct, maintain and review the methodology and rules of the index.
d) The
methodology and rules of the index should be well documented, consistent and
transparent.