Quick review of this week’s key points of Hong Kong’s new crypto policy
Summary of Hong Kong's new crypto policy this week.
1. Allow retail investors to trade qualified virtual currency assets, and there is not only one criterion for inclusion
2. Stablecoin regulation will be implemented in 23/24, and retail trading will not be allowed before that
3. Licensed platforms are not allowed to participate in pledge and other businesses
4. Reiterate and strengthen regulatory restrictions on suspected money laundering
This week, Hong Kong’s actions on crypto-related policy directions were frequent. Not only did the SFC hold a press conference on the 23rd to release a summary of virtual asset-related issues, but it also published multiple guidelines related to cryptocurrencies in the constitutional newspaper yesterday, further elaborating and explaining various aspects such as retail trading, stablecoins, and money laundering. The following is the detailed content summarized by Odaily Planet Daily.
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The SFC mentioned news related to providing services to retail investors on the 23rd. Its response is as follows:
We note the strong support of the respondents for allowing licensed virtual asset trading platforms to provide services to retail investors. We will implement the relevant recommendations on allowing licensed virtual asset trading platforms to provide services to retail investors.
As explained in the consultation paper, the SFC agrees that licensed virtual asset trading platforms should follow a series of proper investor protection measures covering establishing business relationships with customers, governance, disclosure, and token due diligence and inclusion before providing trading services to retail investors. We also believe that retail investors must understand the risks involved in virtual asset investments. Before making any investment decisions, investors should understand the relevant characteristics and risks and be prepared to accept losses. The SFC’s approval of a licensed virtual asset trading platform’s inclusion of a virtual asset for retail buying and selling is not a recommendation or endorsement of the virtual asset, nor a guarantee of its commercial viability or performance. The SFC will continue to work with investors and the Investor Education Council on education about virtual assets and their trading.
At the same time, the SFC also supports licensed trading platforms that open retail businesses to establish business relationships with customers in order to protect general investors. Its specific response is as follows:
This association is pleased to see widespread support for the provision of establishing business relationships with retail customers. Regarding the issue of whether the regulations concerning the establishment of business relationships with clients should be exempted for individual professional investors, it is suggested that the rules applicable to individual professional investors are consistent with existing regulations on derivative knowledge assessments and appropriateness when intermediaries provide services to individual professional investors. As the provision of establishing business relationships with clients follows the spirit of appropriateness, we still believe that individual professional investors should enjoy the same protection as retail investors.
This association has duly considered proposals to relax specific provisions on establishing business relationships with retail customers in certain situations. However, we believe that retail investors are generally unlikely to understand the terms, characteristics, and risks of virtual assets. In addition, as trading on virtual asset trading platforms is automated, even if a transaction is inappropriate, virtual asset trading platforms are unable to intervene, so ensuring appropriateness is extremely important when establishing business relationships with retail customers. Only by fully implementing the proposed regulations for establishing business relationships with clients can this goal be achieved. For example, the proposed regulation to assess a client’s risk tolerance is an important part of existing appropriateness regulations. As most virtual assets are high risk, virtual assets are generally only suitable for clients with a higher risk tolerance. Therefore, even if retail clients have an understanding of virtual assets, virtual asset trading platforms should not be exempted from conducting risk assessments.
As it is necessary to ensure that retail investors have a full understanding of virtual assets before they are allowed to trade them, the SFC believes that platform operators should comprehensively evaluate investors’ understanding of the nature and risks of virtual assets, including evaluating the virtual asset training or courses that the investor has received in the past, the investor’s current or past work experience related to virtual assets, and the investor’s past trading experience related to virtual assets. We have therefore made corresponding revisions to the “Guidelines for Virtual Asset Trading Platforms”. As the knowledge assessment rules apply equally to virtual asset trading platforms and other intermediaries engaged in virtual asset-related activities, we will also make corresponding revisions to ensure that all intermediaries are subject to uniform regulation.
CSRC has been fully aware of the respondents’ request for further guidance on the provisions concerning the establishment of business relationships with customers. We will publish further guidance in the form of FAQs (such as how to assess a customer’s risk appetite and risk-taking ability with respect to virtual assets). Although we understand that the industry may wish to have more specific guidance, such as setting risk limits for investors with different financial conditions and risk tolerance levels, it may not be appropriate for CSRC to provide such guidance, as platform operators (rather than CSRC) are best able to set limits based on the information obtained in the “know your customer” process.
Virtual Assets and Stablecoins
In addition, CSRC has provided relevant opinions on which virtual assets are allowed to be included in retail trading, and has revised the Virtual Asset Trading Platform Guidelines. CSRC’s response to the relevant issues is as follows:
As explained in the consultation paper, in the traditional securities market, investment products offered to retail investors in Hong Kong must comply with the offer document system and the prospectus system. Retail products are generally regulated by CSRC at the product level. The relevant products must have been reviewed by CSRC or have had their offering and promotional documents reviewed before public offering. This regulation does not apply to non-securities tokens; indeed, most (if not all) non-securities tokens are not regulated by any regulatory authority at the product level. This explains why CSRC needs to approve tokens before they can be included in licensed virtual asset trading platforms for retail trading.
Therefore, we recommend that additional minimum criteria be applied to tokens before they can be traded by retail investors. The recommended criteria are based on the following principles: tokens that retail investors can trade should be less susceptible to manipulation by market activity (not only on the platform operated by the platform operator, but also in the overall virtual asset market), as most (if not all) virtual asset trading platforms worldwide are currently unregulated or are regulated only in terms of combating money laundering/terrorist financing. Our proposed regulations therefore require that in order to be eligible for retail trading, tokens must belong to qualified large virtual assets that have been included in at least two accepted indices provided by two independent index providers.
We appreciate the feedback received on the acceptance criteria for, and independence of, index providers. We agree that index providers should be appropriately composed and managed, including ensuring the quality and robustness of the indices. The criteria for determining whether an index is accepted are developed in accordance with relevant principles, and the additional rules for experienced index providers in the context of traditional securities markets are designed to enhance reliability. We also agree, as suggested by some respondents, that the reliability of relevant data and the issue of potential conflicts of interest will be relevant to the robustness of the indices.
Therefore, we consider it appropriate to further specify that experienced index providers publishing indices in the context of traditional securities markets should comply with the Principles for Financial Benchmarks developed by the International Organization of Securities Commissions (IOSCO) to ensure they have appropriate internal arrangements in place to safeguard the robustness and ensure the quality of their indices. In addition to requiring independence between the two index providers, we will also specify that they should be independent of virtual asset issuers and platform operators. We agree that, in the case of virtual assets, a high market capitalization does not necessarily mean high liquidity. The SFC wishes to reiterate that inclusion in the two accepted indices is not the sole criterion for inclusion of a virtual asset. It is in fact a minimum standard, which underscores the importance of due diligence by licensed virtual asset trading platform.
Platform operators should perform further due diligence on tokens for inclusion on the platform, in accordance with the platform’s token admission criteria, and ensure tokens admitted for trading meet relevant criteria for liquidity in the case of tokens admitted for retail trading. Platform operators should also ensure that admitted tokens continue to meet relevant token admission criteria. It would not be appropriate for the SFC to publish lists of qualified virtual assets, accepted indices or index providers, as the acceptability and continuing eligibility of tokens for trading depend on the due diligence performed by platform operators.
With regard to stablecoins, we note that the risks posed by stablecoins have attracted international attention, and there are calls in the market for the regulation of stablecoins to ensure, among other things, that stablecoin reserves are properly managed to maintain price stability and enable investors to exercise their redemption rights. These risks are fundamental to the stability of stablecoins. Stablecoins that cannot maintain their peg or return investor funds upon redemption cannot be called stable. The resulting increased risk of runs can seriously affect the liquidity of stablecoins, making them generally unsuitable for retail investors.
The Hong Kong Monetary Authority (HKMA) has summarized the discussion paper on crypto-assets and stablecoins published in January 2023, and regulatory arrangements for stablecoins are expected to be implemented in 2023/24. Prior to stablecoins being regulated in Hong Kong, we believe they should not be included for retail trading.
Many platforms have recently launched Hong Kong stations/HK version platforms in response to the current situation. The SFC’s response to issues and details related to license applications is as follows:
We have received many requests to clarify various technical issues. For example, some respondents have raised questions about the scope of “providing virtual asset services” defined in the Anti-Money Laundering Ordinance, including whether it covers over-the-counter virtual asset trading activities and virtual asset brokerage activities.
Regarding the dual licensing arrangement, the respondent asked whether it is necessary to obtain licenses under both the Securities and Futures Ordinance and the Anti-Money Laundering Ordinance, particularly because some platform operators may not intend to offer trading in security-type tokens. As non-security-type tokens may evolve into security-type tokens, the respondent also stated that platform operators can terminate trading services for that particular security-type token or only allow customers to reduce their positions in that token, thus no securities and futures licenses are required. Regarding the dual licensing arrangement, the respondent also asked whether virtual asset trading platforms that have obtained dual licenses need to have two or four responsible officers, and whether a pragmatic approach can be adopted in assessing competence (including relevant industry experience of responsible officers) in response to a shortage of talent with experience in both virtual assets and traditional securities.
Regarding the provisions on external assessment reports, the issues raised include whether the commercial name that has drafted policies and procedures for virtual asset trading platform applicants and provided system implementation opinions can serve as an assessment expert in the first and second stage reports; whether the first stage report can be submitted without submitting the license application; whether platform operators interested in applying for a license can submit a declaration of the capabilities of their chosen external assessment experts to the SFC before submitting the external assessment report; and whether virtual asset trading platforms that have been established and are in operation can only submit second stage reports.
Regarding the scope of “providing virtual asset services,” the regime under the Anti-Money Laundering Ordinance will cover central virtual asset trading platforms that operate in a manner similar to automated trading venues licensed under the Securities and Futures Ordinance. Such platforms usually provide virtual asset trading services to customers through automated trading systems that match customer trading instructions and provide ancillary custody services with such trading services. Therefore, those who provide virtual asset services (such as OTC virtual asset trading activities and virtual asset brokerage activities) but do not have automated trading systems and ancillary custody services will not fall within the coverage of the regime under the Anti-Money Laundering Ordinance.
As we explained in the consultation paper, given that the terms and characteristics of virtual assets may evolve over time, the classification of a particular virtual asset as a non-securities token or a securities token (and vice versa) may change. It is prudent for a virtual asset trading platform to apply for approval under both the current regime under the Securities and Futures Ordinance and the regime for virtual asset service providers under the Anti-Money Laundering Ordinance to avoid contravening the licensing regime and ensure the continuity of its business. We note the views that a virtual asset trading platform may only suspend and ultimately revoke the trading services of a particular token that has evolved into a securities token, rather than obtaining a license under the Securities and Futures Ordinance, with concern. Fundamentally, removing a token that has already been admitted for trading may not be in the best interests of customers and should only be used as a last resort. The suggestion that customers are only allowed to reduce their positions in a particular token is also based on a misunderstanding, as any sell order placed by a customer will be matched with a buy order placed by another customer.
We will adopt a streamlined application process such that a dual licence application only needs to submit a single composite application form. On the responsible officer front, the same responsible officer may be approved under both the Securities and Futures Ordinance and the Anti-Money Laundering Ordinance, and hence a virtual asset trading platform with dual licences does not need to have four different responsible officers. For the industry’s possible lack of personnel with both virtual asset and traditional securities experience, we are willing to adopt a pragmatic approach, the details of which will be supplemented through further guidance.
As stated in the consultation document, the provision for external assessment reports is introduced to simplify the application process, particularly for the industry that may not fully understand our regulatory expectations. We expect external assessment experts to substantially assist applicants, for example, by providing opinions or drafting documents on the policies and procedures of applicants, providing opinions on the implementation of systems, and suggesting improvements or corrective measures when deficiencies are found in the design, implementation or effectiveness of policies, procedures, systems and monitoring measures. Therefore, it is an acceptable practice for external assessment experts to participate in the relevant work before and during the first and second stage reports. (The scope of external assessment reports (also attached to the consultation document) and further guidelines will be published on the CSRC website where appropriate.)
As external assessment experts are expected to participate in the early preparation stages of the licensing application and the first stage report is introduced to simplify the application process, the first stage report should be submitted together with the licensing application. In addition, as the industry may not fully understand our regulatory expectations, existing virtual asset trading platform applicants that are already established and in operation are still required to submit the first stage report. We encourage virtual asset trading platforms that are unsure whether the external assessment experts they intend to engage are fully qualified to discuss with the CSRC FinTech Division in advance.
As the range of issues received is broad, we will issue further guidelines on common issues related to the new virtual asset service provider system under the Anti-Money Laundering Regulations in the form of FAQs, circulars and issuance manuals.
The scope of the external assessment report (also included in the appendix to the consultation document) and additional guidelines (if applicable) can be viewed on the CSRC website.
Regarding the relevant business scope of licensed platforms, the CSRC has also provided detailed explanations:
We agree that, like all other intermediaries, platform operators should not provide gifts related to the sale and purchase of specific virtual assets. This principle forms the basis for the requirement that platform operators should not publish any advertisements relating to specific virtual assets. In view of the opinions received, we have now clearly prohibited gifts (except for fees or fee discounts) in the Guidelines for Virtual Asset Trading Platforms. The CSRC would also like to take this opportunity to remind platform operators that they are responsible for ensuring that any materials about specific products they publish, whether on or off the platform, are factual, fair and unbiased.
The Securities and Futures Commission (SFC) does not currently impose a cooling-off period on retail clients of intermediaries who engage in other regulated activities (including providing automated trading services). As suitability must be ensured by a platform operator in establishing a business relationship with a client, any retail client who has already established a business relationship with a platform operator should have been assessed by the platform operator as suitable for trading virtual assets. A cooling-off period after a trade is also not practicable as automated trading services involve matching trades of clients and the cancellation or unwinding of one trade would affect another client of the platform.
In general, the risks associated with holding client virtual assets offline are similar to the custody risks associated with client assets in traditional financial markets (i.e. employee misappropriation and fraud). We note that clients of traditional financial institutions do not have comprehensive insurance coverage for loss of client assets and consider that there is room to lower the safeguard threshold for holding client virtual assets offline, particularly because licensed virtual asset trading platforms are subject to various requirements in the Code of Conduct for Licensed Virtual Asset Trading Platform Operators, including in relation to the management and custody of private keys, aimed at, inter alia, reducing the risk of employee collusion. However, as the risks associated with holding client virtual assets online and in other storage methods (mainly hacking and other cyber security risks) are not risks commonly associated with custody of client assets in traditional financial markets, we still consider that client virtual assets held online and in other storage methods should be fully covered by compensation arrangements of licensed virtual asset trading platforms.
As clients do not have comprehensive insurance coverage for loss of client virtual assets, we consider that there would be a higher safeguard level if most client virtual assets were held offline in storage methods where the risks of hacking and other cyber security risks are usually absent. Accordingly, we propose to lower the safeguard threshold for holding client virtual assets offline to 50% while maintaining that 98% of client virtual assets must continue to be held offline. We note that licensed virtual asset trading platforms may also be inclined to hold less than 2% of client virtual assets online and in other storage methods as the platform operator would need to allocate its own resources to compensate clients when insurance coverage is not available for online and other storage methods.
Regarding the asset types that can form part of a compensation arrangement, we agree that funds held in the form of bank guarantees and funds held in the form of current or fixed-term deposits that will mature within six months are acceptable. As for virtual assets, we believe that holding reserve virtual assets that are the same as those held by customers who need compensation arrangements can reduce market risks caused by the volatility of virtual assets.
We note that respondents have different views on whether placing compensation arrangements under custodial arrangements or allowing licensed virtual asset trading platforms to hold disbursed funds is acceptable. We believe that both arrangements are acceptable on the condition that the disbursed funds are segregated from the assets of the platform operator and its group companies and are disbursed in trust and designated for the relevant purposes. Funds held by the platform operator or its affiliated entities should be held in independent accounts of recognized financial institutions. The “Guideline on Virtual Asset Trading Platform” has been modified accordingly.
We also agree that licensed virtual asset trading platforms should be able to flexibly establish a pool of funds jointly or individually in the form of insurers to provide protection against the loss of their clients’ assets. The “Guideline on Virtual Asset Trading Platform” has made provisions for such flexibility.
Finally, we also agree that virtual assets that form part of a compensation arrangement should be segregated from the virtual assets of the platform operator and its group companies and held offline by its affiliated entities. This is because affiliated entities are limited by multiple provisions on private key management and custody in the “Guideline on Virtual Asset Trading Platform,” but custody standards for third-party custodians may differ significantly or even be insufficient.
We believe that to ensure the safe custody of customer assets, the ratio of offline to online storage should not be reduced, and most customer virtual assets should be held offline in a way that is usually not subject to hacking or other network security risks. We also wish to remind platform operators that they should implement appropriate virtual asset withdrawal procedures and disclose these procedures to their customers. In particular, if a platform operator does not execute a customer’s withdrawal request in real-time, it should specify on its website how long it typically takes to transfer virtual assets to a customer’s private wallet upon receipt of the customer’s withdrawal request.
Regarding proprietary trading, we agree that liquidity on the trading platform is crucial for customers. Therefore, the CSRC allows third-party market makers to engage in market-making activities. However, the current prohibition on proprietary trading is comprehensive and effectively prohibits the group companies of licensed virtual asset trading platforms from holding any virtual asset positions. Therefore, we have revised the provisions in the “Guidelines for Virtual Asset Trading Platforms” to allow related parties to trade through channels other than licensed virtual asset trading platforms.
As for algorithmic trading, the CSRC would like to clarify that although platform operators are prohibited from providing algorithmic trading services to their customers, customers of the platform may use their own algorithmic trading systems for trades conducted through licensed virtual asset trading platforms.
Regarding other common services on the virtual asset market, such as earning interest, depositing, and borrowing, the CSRC does not allow licensed virtual asset trading platforms to provide these services, as covered in Section 7.26 of the “Guidelines for Virtual Asset Trading Platforms.” Ultimately, the main business of licensed virtual asset trading platforms is to act as agents and provide counterparties for their customers’ buy and sell orders. Any other activities may lead to potential conflicts of interest and require additional safeguards, so licensed virtual asset trading platforms are currently not allowed to engage in such activities.
Undoubtedly, the most emphasized and deepest issue in the new regulations is the crackdown on money laundering/terrorist financing. The CSRC has made certain rules for virtual asset transfers in the “Anti-Money Laundering Guidelines for Licensed Corporations and Virtual Asset Service Providers Licensed by the CSRC” and responded to related issues:
The transfer rules are a major measure for virtual asset service providers and financial institutions to combat money laundering/terrorist financing, as the rules provide basic information needed for sanctions screening and transaction monitoring and other risk mitigation measures. This also helps to prevent the processing of virtual asset transfers by criminals and designated persons, and to detect them when such transfers occur.
The Financial Action Task Force (FATF) reiterated that jurisdictions need to implement the transfer rules as soon as possible, as the “sunrise problem” cannot be solved until all virtual asset service providers and financial institutions operating in major jurisdictions comply with the transfer rules.
Other major jurisdictions (such as the United States, Singapore, the United Kingdom and Europe) have implemented or are about to implement transfer rules 9. If the transfer rules are delayed in Hong Kong, the competitiveness of our virtual asset trading platform that we have issued will be affected, as virtual asset service providers and financial institutions operating in other major jurisdictions will not be able or unwilling to trade with them due to risk management concerns.
However, developing a system to facilitate the immediate submission of required information to the receiving institution may take time, even though licensed virtual asset trading platforms have been clearly aware that special organizations have been advocating compliance with transfer rules over the past few years.
Given the positive and rapid development of technology solutions and transfer rule networks in recent years, it has gradually become easier to exchange the required information between institutions, and concerns about immediate submission of information by responders will be resolved over time. In addition, more and more virtual asset service providers and financial institutions operating overseas will be subject to transfer rules.
If the required information cannot be submitted immediately to the receiving institution, the Securities and Futures Commission believes that it is acceptable as a temporary measure to submit the required information as soon as possible within the practical range after the transfer of virtual assets until January 1, 2024, after taking into account the implementation of transfer rules in other major jurisdictions. From June 1, 2023, licensed virtual asset trading platforms should comply with all other transfer rules and related regulations in sections 12.11 to 12.13, including safely submitting the required information to the receiving institution while taking the above temporary measures. Section 12.11 has been revised to reflect the above situation.
Some customers of licensed virtual asset trading platforms can carry out transfer transactions of virtual assets in non-custodial wallets. The reason why this may pose a higher risk of money laundering/terrorist financing is that there is usually no intermediary to enforce anti-money laundering/terrorist financing measures against the owner of the non-custodial wallet.
Therefore, we have listed provisions in section 12.14 to control the transfer of transactions in non-custodial wallets. These provisions are similar to or even stricter than transfer rules. Licensed virtual asset trading platforms should obtain the required information from customers and conduct sanction screening. In addition, licensed virtual asset trading platforms should consider screening related virtual asset transactions and wallet addresses.
Only transfers of virtual assets to and from non-custodial wallets that have been assessed as reliable may be accepted. Please also refer to the discussion in paragraphs 106 to 109 of this summary document.
The transfer rules have been implemented in the United States and Singapore, and will take effect in the United Kingdom on September 1, 2023, and are expected to take effect in Europe in January 2025.
This means that paragraphs 12.11.10 and 12.11.13 will take effect on January 1, 2024. If the required information cannot be immediately submitted to the recipient institution, licensed virtual asset trading platforms should adopt the above temporary measures before January 1, 2024. The SFC will issue frequently asked questions to clarify its regulatory requirements in this regard.
Licensed virtual asset trading platforms should only return virtual assets in appropriate circumstances and without suspicion of money laundering/terrorist financing activities, and after considering the due diligence of the virtual asset transfer counterparty and screening of virtual asset transactions and related wallet addresses. In addition, virtual assets should be returned to the account of the remitting institution, not the remitter’s account. Paragraph 12.11.22 provides additional guidance.
Meanwhile, the Gazette of May 25 has also published guidelines on regulating money laundering/terrorist financing-related activities, details can be found in the Gazette of the Special Administrative Region Government on May 25 .
For the full text of the press conference on May 23, please refer to the following official website link .