(5 min. read)
SFC/HKMA’s guidance in respect of Virtual Assets and Virtual Asset Service Providers
Over the last few months, we have received increased client interest and queries regarding transacting in virtual assets, including digital tokens, stablecoins and other crypto assets (“VAs”), whether for the purposes of trading or (speculative) investment, participating in non-fungible token (“NFT”) transactions or structuring innovative financing solutions.
As of 2021, an estimated 3.27% of the Hong Kong population (i.e. around 245,000 people) currently own VAs, with the figure expected to grow dramatically in years to come (TripleA, 2022). Participants should take note that opportunities in VAs come with risks, and in particular, risks as to suitability, adequate investor protection, potential anti-money laundering issues and related financial crime activities, etc.
The Securities and Futures Commission (“SFC”) and the Hong Kong Monetary Authority (“HKMA”) published a joint circular on 28 January 2022 (the “Joint Circular”) offering guidance on licensed intermediaries’ VA-related activities. The HKMA published a further circular on the same day to provide guidance to authorized institutions (“AIs”) when dealing with VA service providers.
This article provides a quick overview of the Joint Circular with aspects worth noting for participants of VAs-related activities.
1. The Joint Circular and HKMA Circular
The Joint Circular applies to intermediaries (i.e. SFC-licensed corporations and AIs and AIs registered with the SFC) and the HKMA Circular applies to AIs only. The circulars provide regulatory guidance on VA-related activities, which include:
- Distribution of VA-related products;
- Provision of VA-dealing services; and
- Provision of VA-advisory services.
It should be noted that some VAs service providers are currently unregulated, i.e. neither licensed with the SFC nor authorized by the HKMA. Unregulated service providers must ensure that their operations fall outside the regulatory ambit and do not require licensing, registration and/or authorization or else they may be in breach of relevant securities legislation.
2. Distribution of VA-related products
VA-related products are likely viewed by the regulators as “complex products” where the risks of investing in them may not reasonably likely be understood by a retail investor. As such, intermediaries are required to have in place additional investor protection measures when distributing VA-related products, which include:
- Suitability – intermediaries must comply with suitability obligations, including conducting thorough “know-your-client” assessments and product due diligence on the underlying VA-related products (see SFC’s Suitability FAQ).
- VA-knowledge test – intermediaries must assess whether their clients have adequate knowledge of investing in VA-related products prior to entering into such transactions, including the relevant nature and risks of engaging in VAs. Similar tests of knowledge apply to VA-related derivative products.
- Professional Investors – in general, complex products such as VA-related products should only be offered to professional investors, as defined under the Securities and Futures Ordinance (Cap. 571) (the “SFO”).
- Financial accommodation – intermediaries should be prudent and cautious when providing financial accommodation to clients for investments in VA-related products given the risks of holding leveraged or margined positions over potentially volatile products.
3. Provision of VA-dealing services
The Joint Circular highlighted the SFC and HKMA’s concerns that a large number of VA trading platforms are unregulated (or only partially regulated for AML/CFT purposes) and may therefore fall short of the SFC’s regulatory standards for VA trading platforms.
Pursuant to the Joint Circular, licensed intermediaries that provide VA-dealing services are required to comply with various obligations, including:
- SFC-licensed platform – intermediaries may only trade through SFC-licensed VA trading platforms to provide VA-dealing services.
- SFC Type 1 licence – intermediaries licensed or registered for Type 1 regulated activity (dealing in securities) may provide VA-dealing services to its current existing clients. Intermediaries are expected to comply with requirements for dealing in securities, regardless of whether the underlying VAs transacted in are “securities” as defined under the SFO.
- Relevant T&Cs – intermediaries providing VA-dealing services must comply with the SFC’s conditions set out at Appendix 6 to the Joint Circular, including the prescribed terms and conditions, if applicable under an omnibus account arrangement.
- Discretionary account management services – intermediaries will be required to comply with additional requirements of the SFC when providing VA discretionary account management services intending to allocate 10% or more gross asset value of portfolio in VAs.
4. Provision of VA-advisory services
The Joint Circular included guidance to intermediaries providing VA-advisory services. As a quick overview, these aspects (some of which have been discussed and will not be repeated) include:
- SFC Types 1 and 4 licenses – intermediaries licensed or registered for Types 1 (dealing in securities) or 4 (advising on securities) may provide VA-advisory services to its existing clients
- Compliance with regulatory requirements – similarly, intermediaries are expected to comply with relevant regulatory requirements for advising on securities, regardless of whether the underlying VAs transacted in are “securities”.
- VA-knowledge test
- Relevant T&Cs prescribed
- Professional investors only
5. Key takeaways
It is conceivable that the popularity of VAs will continue to rise, given VAs’ novel features such as fast transaction speeds, lower transaction costs and ease of use. The Joint Circular and the HKMA Circular reflect the SFC and HKMA’s welcomed and ongoing efforts to regulate VA-related activities, with a view to strengthening investor protection.
While some VA service providers currently remain unregulated, their operations are likely to be highly impacted, as licensed corporations and AIs are now required to follow regulatory guidance and potentially implement measures that limit transactions with them. In any case, those considering engaging in VA-related activities should:
- Analyse and understand the potential risks involved with VA-related products and receiving VA-dealing services and VA-advisory services;
- Have a general appreciation for the relevant regulatory regimes applicable to VAs in Hong Kong and how that affects their transactions;
- Conduct due diligence on and choose VA service providers carefully, with reference to their licensing / registration status, background, service terms and conditions and other policies in place; and
- Seek professional advice where required, especially for tailored VA-related transactions.
Contact us if you wish to discuss this topic or explore specific transactions in further detail.
This article is provided for informational purposes only. It is not intended to be, nor should it be substituted for, legal advice, which turns on specific facts.