Introduction

In our previous newsletter titled “Latest crypto updates | Crypto 2.0 or Money 2.0 | Stark contrast of government attitudes towards Bitcoins and cryptocurrencies“ (October 2021 issue), we discussed the global regulatory landscape of cryptocurrencies and in particular, we highlighted the contrasting attitudes that China and Russia had adopted towards crypto. This article focuses on Hong Kong’s evolving regulatory landscape of virtual assets and the position of the Hong Kong Securities and Futures Commission (“SFC”) regarding cryptocurrencies.

The broader picture of Fintech

Technology has triggered the transformation of the financial industry. It has allowed firms to introduce a wide variety of innovative products and services which have enhanced customer experience and helped achieve better investor outcomes. For example, people can now open an account with a securities broker remotely from anywhere in the world. One can also use a mobile app on their smartphone to place orders with a stock broker or invest in a fund.

The SFC has recently conducted a survey on the sale of investment products in Hong Kong and it has found that about 54% of clients had bought funds from online platforms, and online sales accounted for about one-fifth of all funds sold. The number of SFC-licensed corporations selling funds online more than doubled last year. Not surprisingly, the pandemic and work-from-home arrangement have accelerated the use of technology in the distribution of investment products.

One advantage of using technology is that it lowers costs for consumers. Investors can resort to automated services at a lower cost instead of paying substantial fees for bricks-and-mortar financial advice. The SFC currently license several digital wealth management advisory platforms, also known as “robo-advisors” to help retail investors diversify their portfolios more efficiently and more affordably.

The emergence of cryptocurrencies

Virtual assets first appeared on the regulatory radar in 2017, when initial coin offerings (“ICOs”) first gained traction. Hong Kong was considered a potential hub for ICO activity in Asia following a boom in offerings in the first half of the year that had raised almost US$1.3 billion globally.

With the reports of a number of scams being found within the ICO ecosystem, such reports drew the attention of regulators. Having said that, as crypto was still a new innovation, it was also not easy for the regulators to draw the regulatory perimeter. For instance, Bitcoins do not typically fall within the definition of securities or currency.

However, it became clear that anonymous trading in these assets raised serious issues around money laundering and terrorist financing. Market integrity, consumer protection, cybersecurity and safe custody of assets were also among the problems posed by the crypto market.

The SFC’s approach to cryptocurrencies

It was against such backdrop that the SFC announced a regulatory regime for virtual assets in 2018. It included new requirements for funds supervised by the SFC which intend to invest more than 10% of a mixed portfolio in virtual assets and a requirement that only professional investors were allowed to participate.

In 2019, the SFC launched a conceptual framework for centralised virtual asset platform operators to opt-in for regulation, which applied the principle of “same business, same risks, and same rules”. The framework drew heavily on the standards applicable to conventional securities brokers and automated trading systems while it was adapted specifically to crypto technology. The framework aimed at addressing key investor protection concerns including safe custody of assets, know-your-client requirements, anti-money laundering, market manipulation, risk management and cybersecurity. To cater for the fast-changing nature of the crypto world, the SFC chose an opt-in approach, which allowed it to watch the space evolve and gain supervisory experience, before it decides how the wider virtual asset universe should be regulated in future.

The changing regulatory landscape

During the past three years, there have been significant developments in Hong Kong in relation to the regulatory regime for virtual assets. First, to comply with the standard imposed by the Financial Action Task Force (an International Anti-money laundering body of which Hong Kong is a member) which requires the virtual asset service providers to be subject to the same range of anti-money laundering obligations, the Hong Kong Government concluded earlier this year that the local anti-money laundering law should be amended to mandate all centralised virtual asset trading platforms to be licensed by SFC.

Second, regulators are paying more attention to market integrity and investor protection concerns. In line with the suggestion of The International Organization of Securities Commissions, the SFC identified considerations addressed access to crypto asset trading platforms; protecting customer assets; identifying and managing conflicts of interest and market integrity including rules governing trading and how compliance with such rules are monitored and enforced, etc. Third, the SFC has drawn its attention to stablecoins. Unlike Bitcoin, which has no intrinsic value and is extremely volatile, stablecoins are relatively stable (it could be pegged to a fiat currency like US dollars) and this is a key feature of the pitch that they can make cross-border payments far less expensive.

New market developments

The listing of the first Bitcoin ETF (i.e. the ProShares Bitcoin Strategy ETF (Exchange Traded Fund)) has boosted institutions’ interest in crypto investments. In recent months, the SFC has received a number of enquiries from financial institutions eager to offer virtual assets to their private bank clients or professional investors. The main concern is that: do these firms expose their clients to undue risks if the virtual asset platforms are unregulated or regulated for limited purposes?

As the regulatory landscape is still very uneven, the SFC is still evaluating the regulatory issues of crypto ETFs. The SFC is reviewing the regulatory regime for virtual assets introduced three years ago and will collaborate with the Hong Kong Monetary Authority (“HKMA”) to issue a joint circular later. It is expected that the SFC and HKMA will apply the principle of “same business, same risks and same rules” for banks, brokers and digital platforms conducting digital currency asset-related activities.

Conclusion

To accommodate the rapid development and wide scale application of virtual assets in Hong Kong, the SFC, together with other regulatory authorities, will maintain their practical approach to provide a well-defined regulatory environment which fosters innovation, market development and investor protection.