On May 23, 2023, the Hong Kong Securities and Futures Commission (HKSFC) published its guidelines for SFC-licensing of VASP and VATP Operators (“VA Guidelines”). This regulatory framework is expected to increase opportunities for licensed crypto exchanges, and includes guidelines for retail access.
To get readers up to speed, here is the timeline of events:
October 31, 2022. HKSFC released a policy statement providing additional detail on their plans for developing a Hong Kong regulatory regime for virtual assets. February 20, 2023. HKSFC published a consultation paper inviting public comments on proposed new regulatory requirements for VASPs and VATPs. May 23, 2023. HKSFC published its final VA Guidelines and consultation conclusions. June 1, 2023. VA Guidelines became effective. A compliance transitionary period on the “Travel Rule” (see more below) begins. January 1, 2024. Travel Rule becomes effective, ending the transitionary period. February 29, 2024. All online license applications must be fully completed. May 30, 2024. VASPs operating in Hong Kong must be licensed or in the license application process.
Retail Guidelines for Virtual Asset Trading Platforms
Under the new regulatory regime, SFC-licensed VATPs can now offer services for non-security tokens to retail investors. However, this does not currently include trading derivative products, proprietary trading, algorithm trading, earning, deposit-taking, lending and borrowing. Future guidance is expected in the coming months.
VATPs offering tokens must, without exception, conduct due diligence on each token offering prior to its admission for listing. HK SFC requires non-security tokens to have had at least a 12-month track record prior to listing and that an independent assessor conduct a smart contract audit on any security flaws or vulnerabilities of the smart contract layer of the asset. HK SFC’s non-exhaustive token admission criteria include: the regulatory status of the asset in other jurisdictions; supply, demand, maturity and liquidity of the asset; security infrastructure; marketing materials; prior major incidents; and major risks and the utility of the asset.
Tokens for retail access must be large-cap assets included in at least two acceptable indices issued by two independent index providers. HK SFC will require index providers to comply with the International Organization of Securities Commissions (IOSCO) Principles for Financial Benchmarks and will forgo publishing a whitelist of acceptable tokens or indices. HK SFC is not requiring the submission of legal opinions to confirm that a token for retail access is not a security token but may request legal opinions on specific tokens in light of developments in other jurisdictions.
Stablecoins are not available for retail trading until a more holistic regulatory regime on stablecoins has been implemented by the Hong Kong Monetary Authority (HKMA), which is expected soon. This may coincide with the current pilot programme of e-HKD, with participants including HSBC, Standard Chartered Bank and payment companies.
Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) Measures
Insurance and Compensation Arrangements
At least 98% of client virtual assets must be held in cold storage, with 50% insurance coverage. A maximum of 2% of client virtual assets can be in hot or other storage, but they must have 100% insurance coverage.
Reserve funds can now include virtual assets in addition to funds held in the form of demand deposits or fixed deposits with a maturity of six months or less. Bank guarantees from Hong Kong-based banks may also serve as part of a compensation arrangement.
The SFC will implement a Travel Rule, under which licensed VATPs are required to:
“when acting as the ordering institution, obtain, hold, and submit required information about the originator and recipient to the beneficiary institutionimmediately and securely; and
when acting as the beneficiary institution, obtain from the ordering institution and hold the required information”
Acknowledging that VATPs may require more time to develop systems for the immediate submission of the required information, HK SFC will accept submissions on an “as soon as practicable” basis during a transitionary period from June 1, 2023, until January 1, 2024.
Custody and Security Requirements
All seeds and private keys (and their backups) should be stored securely in Hong Kong with appropriate certification (for example, in an appropriately-certified Hardware Security Module). At this time, the use of 3rd-party custodians is not allowed until regulations for virtual asset custodians are defined.
Summary of Notable Guidelines
Stablecoins are not available for retail trading until further notice from the Hong Kong Monetary Authority.
No proprietary trading, earn/yield, algorithm trading, or lending/borrowing products at this time.
The use of 3rd-party custodians is not allowed until a regime specific to virtual asset custodians has been defined.
Important Considerations for International Exchanges looking to acquire the VATP License
Demonstrate meaningful and substantial presence in Hong Kong by May 31, 2024.
Incorporation in Hong Kong with a physical office and key personnel exercising central management and control over the VATP. Shell operations would not suffice.
Have live operations with independent clients and genuine trading volume in Hong Kong
Have at least two proposed Responsible Officers “RO” in the role of director for supervising the business of the VATP, and be on boarded at the time of submitting the license application and complied with all the RO competence requirements.
Throughout the past few months, CCI has been invited to participate in numerous private roundtables and public industry consultation sessions in the lead-up to the new policy regime, and will continue to provide feedback post policy launch. This will include the sharing of our Global Regulatory Blueprint, along with our upcoming research in illicit finance, stablecoin, and DeFi regulatory frameworks. CCI is also collaborating with Hong Kong-based virtual asset associations as an advisor to ensure international standards and policies are reflected in the next phases of virtual asset policy guidelines and implementations.