Hong Kong’s Financial Services and Treasury Bureau (FSTB) issued a public consultation paper on 3 November 2020 (Consultation) proposing the introduction of a licensing regime for virtual asset services providers (VASPs), as well as other changes to Hong Kong’s anti-money laundering regime. The Consultation proposes the VASP licensing regime will be set out in the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) and will be administered by the Securities and Futures Commission (SFC). As part of the licensing regime, the SFC will be empowered to impose conduct requirements on, and exercise supervisory and disciplinary powers in respect of, licensed VASPs.

The FSTB proposals will have a significant impact on VASPs that have operations in Hong Kong and VASPs who are based outside Hong Kong but who market their services to the public in Hong Kong.

Current regulatory environment

The offering and trading of virtual assets in Hong Kong does not currently fall within the licensing regime under the Securities and Futures Ordinance (SFO), unless the virtual assets fall within the definition of either “securities” or “futures contract”. Since 6 November 2019, the SFC has adopted an opt-in regime under which virtual asset trading platform (VATP) operators may elect to be regulated by the SFC if they permit the trading of at least one securities token on their platform. The opt-in regime allows VATP operators to voluntarily submit to the SFC’s jurisdiction. In doing so, they will be subject to specific licensing terms that enable the SFC to regulate the entire platform operations (including investor qualification, product disclosure and trading and custody arrangements) of the VATP operator. However, as it is voluntary, VATP operators can avoid SFC oversight by limiting the types of tokens traded on their platform. For further detail of the SFC’s opt-in regulatory regime for VATP operators, please refer to our article of 19 November 2019.

Proposed licensing regime for VASPs

The Consultation sets out the proposed framework for the VASP licensing regime. The detailed requirements will be set out in the AMLO and will be subject to a separate consultation at a later stage. The SFC will be responsible for licensing and regulating VASPs.

What constitutes virtual assets for the purposes of the VASP licensing regime?

Virtual assets will be defined as “a digital representation of value that is expressed as a unit of account or a store of economic value; functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services or for the discharge of a debt, or for investment purposes; and can be transferred, stored or traded electronically”. The Consultation makes it clear that stablecoins will be virtual assets for this purpose.

The following will not be virtual assets:

• digital representations of fiat currencies (including digital currencies issued by central banks);

• financial assets regulated under the SFO (e.g. securities and authorized structured products);

• closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible (e.g. air miles, credit card rewards, gift cards, customer loyalty programmes, gaming coins).

Who will need a licence?

The Consultation proposes that anyone engaged in a “regulated VA activity” will need to be licensed. Initially, “regulated VA activity” will be limited to the business of operating a “VA exchange”. The definition of “regulated VA activity” may be expanded in future to cover other activities, such as virtual asset payment systems and virtual asset custodian services, as the market develops in Hong Kong.

A “VA exchange” is any trading platform which is operated for the purpose of allowing an offer or invitation to be made to buy or sell any virtual asset in exchange for any money or any virtual asset (whether of the same or different type), and which comes into custody, control, power or possession of, or over, any money or any virtual asset at any point during its course of business.

Given the limitation of “regulated VA activity” to the business of operating a “VA exchange”, the following activities will not give rise to a licence obligation:

• providing a peer-to-peer trading platform (i.e. a platform that only provides a forum where buyers and sellers of virtual assets can post their bids and offers, with or without automatic matching mechanisms, for the parties themselves to trade at an outside venue), to the extent that the actual transaction is conducted outside the platform and the platform is not involved in the underlying transaction by coming into possession of any money or any virtual asset at any point in time;

• providing virtual asset payment systems as a standalone business;

• providing virtual asset custodian services as a standalone business.

VASPs that are regulated by the SFC under its opt in regime will not need to be separately licensed under the AMLO.

Prohibition on marketing of overseas VA exchanges to Hong Kong public

Similar to the securities licensing regime under the SFO, the Consultation proposes to prohibit any person from actively marketing, whether in Hong Kong or elsewhere, to the public of Hong Kong a regulated VA activity or a similar activity elsewhere (i.e. services associated with a VA exchange), unless the person is properly licensed and regulated by the SFC for the purpose of conducting the regulated VA activity.

Minimum eligibility requirements

An applicant will need to be a Hong Kong incorporated company with a permanent place of business in Hong Kong. That reflects SFC practice for licence applications under the SFO (although in principle a non-Hong Kong company can apply for a licence under the SFO). The SFO also contains provisions that permit the SFC to approve an overseas exchange to provide automated trading services (type 7 regulated activity) in Hong Kong. There is no equivalent provision proposed in the Consultation in relation to overseas VA exchanges.

An applicant will need to satisfy a fit and proper test, which is expected to be similar to the test the SFC applies to applicants for a licence under the SFO.

An applicant will need to have at least two responsible officers, and all executive directors of the applicant will need to be appointed as responsible officers.

Once a VASP licence is granted, it will remain valid until it is revoked by the SFC.

Proposed conduct requirements

The SFC will be empowered to impose (and vary) licensing conditions on licensed VASPs and to impose conduct requirements for licensed VASPs. These conditions and requirements are expected to be similar to the Licensing Conditions and Terms and Conditions for VATP operators issued by the SFC in respect of its opt-in regime, to ensure a level playing field between the two licensing regimes. They include requirements relating to:

• limitation of services to professional investors (as defined in the SFO);

• financial resources;

• knowledge and experience;

• soundness of business;

• risk management;

• segregation and management of client assets;

• virtual asset listing and trading policies, including product due diligence;

• financial reporting and disclosure;

• prevention of market manipulative and abusive activities; and

• prevention of conflicts of interests.

The details of the proposed conditions and conduct requirements will be the subject of a separate SFC consultation at a later stage.

Transitional provisions

Existing operators of VA exchanges will be permitted to continue operating in Hong Kong without a licence for up to 180 days after commencement of the VASP licensing regime. After such period, it will be a criminal offence to operate a VA exchange without a licence.

Given the limited transition period, it will be important that operators of VA exchanges who wish to continue to offer their services in Hong Kong submit an application for a licence as soon as practicable following the commencement of the VASP licensing regime.

What should existing VASPs be thinking about?

It is now a question of when, rather than if, VASPs will need to be licensed in Hong Kong. Existing VASPs should consider whether their activities will give rise to a licence obligation under the VASP licensing regime. If yes, VASPs will need to consider how they would need to change their current operations in order to comply. Changes may include the need to incorporate a Hong Kong company to operate the VA exchange in Hong Kong and, for VASPs that currently market to retail investors in Hong Kong, restricting their services to professional investors only. VASPs should also consider whether they would prefer to apply now to the SFC to be licensed under the existing opt-in regime instead.

What happens next?

The Consultation is open for comment until 31 January 2021.

Assuming the FSTB decides to proceed with the proposals after considering the feedback on the Consultation, it will be followed by further consultations on the specific amendments to the AMLO and on the SFC’s proposed licence conditions and conduct requirements for VASP licensees. The FSTB has indicated it aims to introduce a bill amending the AMLO into the Legislative Council in 2021. Accordingly, it would be prudent for operators of VA exchanges to assume that the new licensing regime will come into operation during the course of 2022.