FSTB's Public Consultation on Legislative Proposals to Enhance AML and CTF Regulation in Hong Kong
On 3 November 2020, the Financial Services and the Treasury Bureau (“FSTB”) issued the Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (the “Consultation”). Pursuant to the Consultation, the FSTB outlined, among others, its proposed regulatory framework which will have implications for virtual asset services providers (“VASP”), being persons who, as a business, engages in specified activities involving virtual assets (“VA”).
The FSTB proposes that any person seeking to engage in the business of operating a VA exchange will need to obtain a VASP licence from the Securities and Futures Commission (“SFC”). In connection with this proposed licensing regime, the Consultation provides for the following definitions:
1. VA exchange
Any trading platform which is operated for the purpose of allowing an offer or invitation to be made to buy or sell any VA in exchange for any money or any VA (whether of the same or different type), and which comes into custody, control, power or possession of, or over, any money or any VA at any point in time during its course of business.
The Consultation exempts peer-to-peer trading platforms (i.e. platforms that only provide a forum where buyers and sellers of VAs can post their bids and offers, with or without automatic matching mechanisms, for the parties themselves to trade at an outside venue) from the definition of VA exchange.
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 exempts central bank digital currencies, financial assets already regulated by the Securities and Futures Ordinance and closed-loop, limited purpose items that are on-transferable, nonexchangeable and non-fungible from the definition of VA.
In respect of the licensing regime itself, the FSTB has suggested that the SFC act as the regulator for VASPs and holders of the VASP licence will be subject to many of the licensing conditions and regulatory requirements currently applicable to holders of the Types 1 to 9 licences issued by the SFC. Most notably, a holder of a VASP licence must observe, among others, the following:
3. Fit and Proper Test
The responsible officers and ultimate owners of the licensee would need to satisfy the SFC that they are each fit and proper, presumably to a standard that is in line with the SFC’s Fit and Proper Guidelines.
4. Professional investors only
The licensee may only offer services to professional investors. For individuals, being a professional investor generally means having a portfolio of no less than HK$8 million (~US$1 million), and for corporations, a portfolio of no less than HK$8 million (~US$1 million) or total assets of no less than $40 million (~US$5 million).
5. Risk management
The licensee should have in place appropriate risk management policies and procedures for managing money laundering, cybersecurity and other risks arising from a regulated virtual asset activity that are commensurate with the scale and complexity of the business.
6. VA listing and trading policies
The licensee should implement and enforce robust rules for the listing and trading of virtual assets on its platform(s) as well as perform all reasonable due diligence.
7. Prevention of conflicts of interest
The licensee should not engage in proprietary trading or market-making activities on a proprietary basis. Suitable firewalls should also be instituted between the different functions of the corporate structure to avoid conflict of interests.
In our practice, we have come across various business models and assisted our clients in achieving regulatory compliance. While the proposals in the Consultation are subject to change following the public’s comments and the legislative process, we expect there will be profound implications for all types of players in the VA space.
No two client’s business models are exactly the same, but we set out below, on a general basis and based on the text of the Consultation, how we anticipate the main types of Hong Kong-based players in the VA space will be affected:
1. (Centralized) VA exchanges
These are precisely the players that the Consultation seeks to regulate. In our view, VA exchanges have two options once the new licensing regime is passed by the legislature: exit the Hong Kong market entirely or obtain a licence from the SFC. In the event of the former, there will be considerable financial implications, particularly when Hong Kong remains as the gateway into the People’s Republic of China. In respect of the latter, VA exchanges should expect to invest considerable sums in order to comply with the high standards of regulatory compliance expected by the SFC. The SFC may also ultimately require the employees of any VASP licensees to hold the relevant licences, similar to authorized representatives under the current SFC framework for securities and futures contracts.
2. Issuers of VA
Consultation suggests that the proposed licensing regime is meant to regulate VA exchanges only, but the FSTB may expand the scope of the regulatory framework to cover forms of VA activities other than VA exchanges where the need arises in the future. Strictly speaking, issuers of VA do not appear to be captured under the regime proposed by the Consultation. However, the reality is that the position may not be so straightforward. Many of our clients who issue VA also provide a platform whereby such VA may be bought and sold by the users. Such feature could potentially satisfy the definition of VA exchange and transform the issuer into a de facto VA exchange.
3. VA intermediaries
With the term “VA intermediaries”, we refer players such as market makers and managers of funds investing in VA (other than VA constituting “securities” or “futures contracts”). Again, the Consultation does not suggest that VA intermediaries will be subject to the proposed VASP licensing regime. However, such VA intermediaries may need to take the extra step of verifying that any VA exchange that they transaction on/with satisfies the regulatory requirements in Hong Kong (and abroad). There is also a possibility that the FSTB will expand the VASP licensing regime to cover VA intermediaries in the future, mirroring the regulatory regime for securities and futures contracts.
4. VA investors
As for VA investors (i.e. individuals or entities who conduct trading in VA), there are no direct licensing requirements. Individuals or entities meeting the threshold to be considered a professional investor (see above) may continue trading in VA, provided that the VA exchange is appropriately licensed.
However, individuals or entities who are not classified as professional investors may no longer find themselves able to access any VA exchanges, whether such VA exchanges are based in Hong Kong or overseas. It is unclear whether the FSTB is intending the professional investor requirement to form a de facto ban on trading VA on centralized exchanges. Decentralized exchanges may still be an option, as they may not come “into custody, control, power or possession of, or over, any money or any VA at any point in time during its course of business”. However, this area is subject to development, as the Financial Action Task Force’s Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers – which serves as a reference point for the FSTB – suggests that decentralized exchanges may fall under the definition of a VASP.
Should you have any questions on the Consultation will affect you, please contact our Managing Partner, Kristi Swartz at firstname.lastname@example.org or our Associate, Alan Lee at email@example.com.