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 W: www.onc.hk                                                                    F: (852) 2804 6311 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