To prepare for commencement of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance regime for virtual asset service providers, the Hong Kong Securities and Futures Commission is conducting a consultation on the proposed regulatory requirements to be imposed on licensed virtual asset trading platform operators, whether or not they provide trading services in security tokens.
The Hong Kong Securities and Futures Commission (SFC) published on 20 February 2023 a consultation paper on the proposed regulatory requirements for operators of virtual asset trading platforms (VATPs) (the Consultation Paper). The consultation period will last until 31 March 2023.
Following the passage of the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 by the Legislative Council in December 2022 (the AMLO Amendment), under a new licensing regime for virtual asset service providers (VASPs) under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO), which is to come into effect on 1 June 2023 (the AMLO VASP regime), all centralized VATPs carrying on business in Hong Kong or actively marketing to Hong Kong investors will need to be licensed and regulated by the SFC, whether or not they provide trading services in security tokens.
To prepare for the commencement of the AMLO VASP regime, the SFC is now conducting a consultation on the proposed regulatory requirements to be imposed on licensed VATP operators. The SFC proposes that all licensed VATP operators comply with the Guidelines for Virtual Asset Trading Platform Operations (the VATP Guidelines), which are drafted based on and modified from the regulatory requirements of the existing opt-in regime under the Securities and Futures Ordinance (SFO) for centralized VATPs, which provide trading services in at least one security token (the SFO regime).
The existing regulatory requirements under the SFO regime followed the requirements applicable to licensed securities brokers and automated trading venues but adapted to address the specific risks posed by virtual assets, and, particularly, the Terms and Conditions for Virtual Asset Trading Platform Operators (the VATP T&C) are currently imposed as licensing conditions on SFO-licensed VATP operators.
The proposed VATP Guidelines cover both licensing requirements and conduct requirements applicable to VATP operators. After the AMLO VASP regime comes into effect, the VATP T&C will be superseded. The SFC will remove the corresponding licensing conditions from the licenses of the current SFO-licensed VATP operators.
Going forward, all VATP operators, whether licensed under the SFO regime and/or the AMLO VASP regime, will be subject to the VATP Guidelines.
By adding licensed VASPs to the definition of “financial institutions,” the AMLO Amendment imposes the existing requirements under the AMLO on customer due diligence and recordkeeping requirements applicable to traditional financial institutions on licensed VASPs.
The SFC has drafted additional virtual asset–specific anti-money laundering (AML) and counter-terrorist financing (CTF) requirements for licensed VASPs (including licensed VATP operators), to be included as a standalone chapter (Chapter 12) in the existing AML/CTF guideline for licensed corporations, which will be renamed as the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (for Licensed Corporations and SFC-licensed Virtual Asset Service Providers).
These new requirements focus on implementing the security of electronically facilitated virtual asset transfers and risk management, including applying the wire transfer requirements under FATF Recommendations No. 16 to virtual asset transfers in a modified form (i.e., the Travel Rule).
Under the existing SFO regime, a VATP operator is only allowed to provide its services to “professional investors.” In response to the significant change in dynamics of the virtual asset market, the SFC is now proposing that licensed VATP operators be allowed to serve retail investors as well, but on the condition that the VATPs comply with a range of robust investor protection measures, proposed under the VATP Guidelines, including ensuring suitability in onboarding clients and token admission, among others measures.
In this regard, it is proposed that there be specific requirements for licensed VATP operators to perform reasonable due diligence on the virtual assets and to ensure that, before admitting them for trading, they satisfy not only the general token admission criteria but also additional specific token admission criteria as “eligible large-cap virtual assets” (which refer to virtual assets included in at least two “acceptable indices” issued by at least two independent index providers), unless otherwise approved by the SFC on a case-by-case basis.
Except for virtual assets only made available to professional investors, a licensed VATP operator should obtain and submit to the SFC a written legal opinion or memorandum confirming that the virtual asset does not fall within the definition of “securities” under the SFO.
In the above context, the SFC specifically asked the public and relevant stakeholders to comment on whether licensed VATP operators should be allowed to serve retail investors, and if so, what measures should be implemented “in addition to” those which have been proposed under the VATP Guidelines.
The proposed VATP Guidelines also provide that licensed VATP operators no longer be required to submit a written legal opinion or memorandum for the virtual assets to be traded unless they are made available to retail clients.
Where the virtual assets are made available to professional investors only, the licensed VATP operators will only be required to notify the SFC in advance of any plan to add to or remove such products from its trading platform without the need to seek approval from the SFC. Where the virtual assets are made available to retail clients, the position will remain the same as before, meaning the licensed VATP operators should seek the SFC’s advance approval on such plan before admitting the virtual assets for trading.
Consistent with the existing SFO regime, under the proposed VATP Guidelines, licensed VATP operators will not be allowed to offer, trade, or deal in virtual asset futures contracts or related derivatives. Nonetheless, the SFC acknowledged that the industry is increasingly interested in offering virtual asset derivatives, particularly to institutional investors, and would like to better understand through this consultation exercise the type of business models and virtual asset derivatives that licensed VATP operators may offer first as well as market demand.
Also consistent with the existing SFO regime, under the proposed VATP Guidelines, licensed VATP operators should not provide any financial accommodation for their clients to acquire virtual assets. This means that margin trading and leverage trading will continue to be prohibited.
As newly proposed under the VATP Guidelines, licensed VATP operators will be prohibited from (1) providing algorithmic trading services to their clients, or (2) making any arrangements with their clients on using the client virtual assets held by the VATP operators or their associated entities for the purpose of generating returns for the clients or any other parties. The latter would likely mean that licensed VATP operators would be expressly banned from offering virtual asset “deposits,” “savings,” “earnings,” or “staking” services, which are likely to amount to “collective investment schemes” under the SFO (as pointed out by the SFC in a statement issued on 13 December 2022) and should be subject to SFC authorization under the SFO, unless exempted.
The SFC also proposed certain adaptations to the existing requirements to be incorporated into the VATP Guidelines, which are aimed to address the industry’s comments during the implementation of the existing SFO regime.
It is proposed that there will be a detailed 12-month period of transitional arrangements and implementations for the AMLO VASP regime, providing sufficient time for VATP operators now operating in Hong Kong to consider either applying for a license or closing down in an orderly manner. Eligible Hong Kong VATPs may continue to operate without a license until 31 May 2024. Provided that an eligible VATP submits its license application to the SFC on or before 29 February 2024, it will be able to continue to operate after 1 June 2024 under a deemed license if its license application is still pending until the earlier of (1) the SFC’s grant or refusal to grant a license, or (2) withdrawal of the license application.
To be eligible for the transitional arrangements, a VATP must be preexisting, i.e., in operation in Hong Kong prior to 1 June 2023 and with “meaningful and substantial presence.” Eligible VATPs will include platform operators currently licensed under the SFO and VATP applicants under the existing SFO regime that have commenced their VATP business in nonsecurity tokens in Hong Kong.
For other VATPs, the SFC will consider eligibility based on several factors, including, among others, (1) if it is incorporated in Hong Kong, (2) if it has a physical office in Hong Kong, (3) if its Hong Kong staff have central management and control over the VATP, (4) if the key personnel are based in Hong Kong, and (5) if the centralized trading platform’s operation is live with a considerable number of clients and volume of trading activities in Hong Kong.
If a preexisting VATP does not intend to apply for a license, it should start preparing to close down its business in Hong Kong in an orderly manner. While the strict deadline for these VATPs to close down is 31 May 2024, the SFC expects them to cease any active marketing of their services to Hong Kong investors and commence the closing down of their operations in Hong Kong.
Upon the commencement of the AMLO VASP regime, the SFC will regulate the trading of security tokens by VATPs under the existing SFO regime and regulate the trading of nonsecurity tokens by VATPs under the AMLO VASP regime.
Given that the terms and features of virtual assets may evolve over time and a virtual asset’s classification may change from time to time, VATPs should apply for approvals under both the existing SFO regime and the AMLO VASP regime and become dually licensed and approved to ensure business continuity. Applicants for licenses under both the existing SFO regime and the AMLO VASP regime will need to submit a single consolidated application online and indicate that they are applying for both licenses simultaneously.
The proposed new AMLO VASP regime is expected to benefit those interested in the development of the virtual assets market in Hong Kong. The SFC has taken the opportunity to review the existing regulatory requirements and consider potential modifications with a view to striking a better balance between investor protection and the constant market development of the virtual asset landscape. We expect that steps will be taken quickly to put the new changes in place after the closing of the consultation period.
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