Summary on the Virtual Assets Trading Platform Licensing Regime in Hong Kong

From 1 June 2023, the Hong Kong Securities and Futures Commission (the “SFC”) introduced a new licensing regime for centralised virtual asset trading platform operators under the Securities and Futures Ordinance (Cap. 571) (the “SFO”) and the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (the “AMLO”). The implementation of this regime is based on the SFC’s Consultation Conclusions on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the SFC published on 23 May 2023, amongst other regulatory guidance under AMLO.

The SFC continues to exercise caution in regulating virtual asset trading platforms (“VATPs”). The regime requires centralised VATPs using an automated trading engine and those providing custody services as an ancillary service to obtain a licence.  In general, other providers such as virtual assets traders, may not require a licence for over-the-counter and brokerage activities involving virtual assets.

Licensing requirements

All virtual asset platform operators, including those already licensed under the SFO, must comply with the AMLO licensing regime. The regime affects current platform operators registered under Types 1 and 7 Regulated Activities, which are actively regulated under the SFC’s licensing regime.

Given the rapidly evolving nature of virtual assets, the SFC strongly advises VATPs to obtain dual licences under both the SFO and AMLO regimes, although this is not mandatory. The SFC will provide a streamlined application process, enabling operators to submit one application for concurrent review and approval of both licences.

Retail trading

Scope

The SFC has expanded the scope of virtual assets trading with non-security tokens for retail investors, which has been widely welcomed. The new Guidelines for VATP Operators issued by the SFC in June 2023 (“VATP Operator Guidelines”) include requirements such as token due diligence and admissions, onboarding, prohibitions, compensation arrangements and governance.

Main changes in token admission criteria

When conducting due diligence on virtual assets for trading admissions, VATP operators should only consider the regulatory status of virtual assets within Hong Kong.

To be eligible for retail trading, the requirement for large-cap virtual assets must be met. The virtual assets involved should be included in at least two acceptable indices, with at least one index complying with the “IOSCO Principles for Financial Benchmarks”, along with experience in publishing indices for traditional securities markets. Further, the two index providers should be independent of the virtual asset issuer and the operator.

The SFC has abolished the requirement of verification for tokens that are not “securities” as defined in the SFO to reduce unnecessary costs. However, the SFC retains the right to request such legal advice on specific tokens during the approval process, if applicable.

Onboarding requirements

The SFC has raised the threshold for onboarding requirements: investors will now need to be assessed for their understanding of the nature and risks of virtual asset operations. The previous requirement of having executed five or more virtual asset transactions will no longer apply.

Prohibitions

Affiliates of a VATP are permitted to trade off-platform in the form of financial accommodation, but only with virtual assets that are not issued by the VATP operator or its investor.  VATP operations that use clients’ virtual assets to generate returns, such as staking, are prohibited.

Derivatives and stablecoins

The SFC recognises the significance of virtual assets derivatives to institutional investors and is currently reviewing their role. As such, stablecoins and similar tokens will not be admitted for retail trading until further guidance is issued.

Insurance and compensation arrangements

For compensation arrangements, the SFC has stated that funds in the form of demand deposits or fixed deposits, as well as virtual assets, are eligible. If 98% of the clients’ virtual assets are stored in a cold wallet, the compensation arrangement coverage threshold will be lowered to 50%. If the virtual assets are placed in hot storage or other storages owned by associated entities, 100% of the virtual assets must be covered.

The arrangements should include one or more of the following elements:

1. third-party insurance;
2. either funds (maturing in 6 months or less) or virtual assets of the VATP operator or any corporation within the same group of companies as the VATP operator, set aside on trust and designated for such a purpose; and
3. bank guarantees provided by an authorised financial institution in Hong Kong.

Revised Anti-Money Laundering and Counter-Financing of Terrorism requirements

The new VATP licensing regime was introduced under the updated AMLO. During the transitional period, an interim measure will be implemented for pre-existing VATPs, stating that they are not required to submit a re-application during the transitional period if they have already submitted an application to the SFC. These operators are allowed to conduct their businesses in the interim, provided that they strictly follow the rules and regulations under the updated AMLO.

In Chapter 12 of the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (for Licensed Corporations and SFC-Licensed Virtual Asset Service Providers) (the “AML Guideline“), additional customer due diligence requirements have been established. These requirements govern various areas such as the implementation of the “travel rule”, due diligence for virtual asset transfer counterparties, the involvement of unhosted wallets in virtual asset transfers, cross-border correspondent relationships and the screening of virtual asset transactions along with related wallet addresses.

In particular, with respect to the “travel rule”, the SFC has acknowledged the necessity of a transitional period for the adjustment and adaptation of existing systems. Consequently, the deadline for such modifications has been set as “as soon as practicable” before 1 January 2024.

Governance and oversight

The new VATP licensing regime also introduces stricter governance and oversight requirements for VATPs. Requirements include:

1. requiring VATPs to establish and maintain a comprehensive risk management system and internal control mechanisms;
2. the implementation of measures to ensure the integrity, security and functionality of the platform, including regular testing and audits; and
3. requiring VATPs to appoint a compliance officer and a money laundering reporting officer.

Conclusion

The new VATP licensing regime represents a significant step forward in the regulation of virtual asset trading platforms in Hong Kong. While the new regime introduces stricter requirements for VATPs, these changes are designed to enhance the oversight and transparency of the industry, protect retail investors and combat money laundering and terrorist financing.

For the purposes of facilitating a smooth transition, existing operators are permitted to apply for the new licence under AMLO during the transitional period, which extends until 31 May 2024.

It is important for VATP operators to familiarise themselves with the new licensing regime and its requirements and take the necessary steps to ensure compliance. This will not only help them to navigate the regulatory landscape more effectively but also build trust with consumers and contribute to the overall growth and development of the virtual asset industry in Hong Kong.