Introduction

After a 3-month public consultation, the Financial Services and the Treasury Bureau (“FSTB”) published the consultation conclusions (the “Consultation Conclusions”) on its proposal to enhance anti-money laundering and counter-terrorist financing (“AML/CTF”) regulations in Hong Kong, including the introduction of a new licencing regime for virtual assets service providers (“VASP”). Although most of the responses to the consultation agreed with the Government’s overall framework of the legislative proposals, some raised concerns over excessive regulatory burden being imposed on VASP that may drive up the cost of compliance. After considering the feedback received, the FSTB has made a few changes to the proposal.

This is the first licencing regime for virtual assets (“VA”) in a first-tier financial market in Asia. While regulation is inevitable, if done right, the licencing regime can potentially catapult Hong Kong into the leading VA market among financial centers in Asia. ONC Lawyers have submitted a response to the Consultation Paper in January 2021. Our views on the consultation paper and the consultation conclusions are summarized below.

 

Brief recap on our views on the Consultation Paper

In general, we view that the new regulations should be able to achieve the following objectives:

1. balance the interest of the public while maintaining Hong Kong as Asia’s leading first-tier financial centre; and
   
2. ensure existing VASPs can be eased into the new regulatory regime. 

The new regulation must not disrupt existing VASPs’ ability to continue operating in Hong Kong. We proposed to have a two-step approach (first by registration then by licensing after a specified time) in order to ease VASPs into the new set of regulations. A facilitative approach should be undertaken by the regulatory authority to provide resources for VASPs to be brought up to FATF standards.

Moreover, the 180-day transitional period for application of a VASP licence is unrealistic and instead, a multi-step approach to ease VASPs into the new regulatory regime should be considered. For example, regulators should assess existing VASP operators within Hong Kong on whether they qualify for a conditional license where regulators will work with such VASPs to raise their standards on AML/CTF measures and implement new internal controls as appropriate.

 

Consultation Conclusions

Scope and Coverage of the amended legislation

Pursuant to the Consultation Conclusions, VA exchange will be defined as “any trading platform which is operated for the purpose of allowing an offer or invitation to be made to buy or sell any VA in exchange for any money or any VA, and which comes into custody, control, power or possession of, or over, any money or any VA at any point in time during its course of business”. Thus, the scope of the new licencing regime covers only centralized VA exchange but not over-the-counter trades and decentralized peer-to-peer trading platforms where the platform only pairs up potential buyer and seller of VA and does not conduct the actual VA transaction.

VA will be defined as digital representation of value that (i) is expressed as a unit of account or a store of economic value; (ii) functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; and (iii) can be transferred, stored or traded electronically. The definition of VA applies equally to virtual coins that are stable (i.e. the so-called “stablecoins”), irrespective of the purported form of the underlying assets.

Thus, the definition of VA does not cover the following:

• Digital representations of fiat currencies and financial assets already regulated under the Securities and Futures Ordinance (Cap 571).
• Stored value facilities which are separately regulated under the Payment Systems and Stored Value Facilities Ordinance (Cap 584).
• Closed-loop, limited purpose items which are non-transferable, non-exchangeable and non-fungible in nature, such as air miles, credit card rewards, gift cards, customer loyalty programmes and gaming coins etc.

Given the rapidly changing nature of the VA ecosystem, the Securities and Futures Commission (the “SFC”) will be empowered to prescribe characteristics that constitute the definition of a VA and the Secretary for Financial Services and the Treasury may determine in general or in a particular case whether any digital representation of value is to be regarded as a VA or not. This brings in flexibility into the licencing regime of a market that thrives on innovation.

It is also stated that flexibility would be built in the licensing regime such that it might be expanded to cover forms of VA activities other than VA exchanges where the need arises in future.

 

Loosened Licensing Requirement for VASP

Originally, it was proposed that only Hong Kong incorporated companies with a permanent place of business in Hong Kong would be considered for the granting of a VASP licence. The consultation conclusions widened the licensing restrictions to allow non-Hong Kong incorporated companies to apply for VASP licence, as long as they are registered in Hong Kong under the Companies Ordinance (Cap 622). This amendment strikes a balance between effective supervision by the SFC while welcoming VASP business operators from foreign countries to set up business in Hong Kong.

 

Services remain to be limited to professional investors

The Consultation Conclusions continue to limit services provided by a VA exchange to professional investors only, unlike the regulatory regimes in Singapore, the United Kingdom and the United States that allow retail investors to take part in VA exchanges. Under sections 3 and 5 of the Securities and Futures (Professional Investor) Rules (Cap 571D), an individual falls under the definition of a professional investor when the individual has a portfolio (comprised of securities, certificate of deposits or money held by a custodian for an individual, corporation or partnership) of not less than HK$8 million.

This requirement shows that the FSTB may have missed the mark in terms of understanding the market of VA and providing protection to retail investors. A new definition of “professional investors” should be tailor-made for the new licencing regime as VA and traditional securities have different target audiences. It is impractical to require a professional investor in VA to have a portfolio of HK$8 million in traditional securities, the instrument that many of them view sceptically in the first place. Furthermore, the restriction renders services provided by VA exchange unavailable to the majority of the individuals in Hong Kong. As retail investors will not be able to trade VA in regulated platforms, this may drive interested retail investors to riskier options such as unregulated or foreign VASP exchanges.

However, interested retail investors need not be disheartened as FSTB suggests that the restriction may be a temporary measure for the initial stage of the licensing regime and FSTB will continue to monitor and review the licensing regime.

 

Exemption and Way forward

There will be no exemptions in respect of VASP licensing requirement except for VA exchanges that are already regulated under the voluntary opt-in regime being supervised by the SFC.

The FSTB targets to introduce the amendment bill into the Legislative Council in the 2021-2022 legislative session. Upon commencement of operation of the licensing regime, there will be 180-day transitional period for interested VASP platform operators to file applications.

 

Takeaway

While the stringent regulations proposed by the FSTB are not the most welcoming gesture towards interested VASP business operators, the Consultation Conclusions clarify the approach which will be taken by the regulators and the new licensing regime will strengthen Hong Kong’s AML/CFT system to match with international standards. While waiting for the detailed regulatory guidance to be provided by the SFC in the future, interested VA exchange platform operators should continue to assess and review their internal AML/CFT measures and protocols to keep up with any updates to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap 615) to ensure a smooth transition to becoming a licensed VASP trading platform.

 

 

For enquiries, please feel free to contact us at:

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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.