UPDATE | FSTB's Public Consultation on Legislative Proposals to Enhance AML and CTF Regulation
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”). As part of the Consultation, the FSTB outlined, among others, its proposed regulatory framework which will have implications for virtual asset services providers (“VASPs”), being persons who, as a business, engages in specified activities involving virtual assets (“VA”). Our client update in respect of the Consultation can be viewed here.
Following the receipt of responses from various stakeholders, the FSTB issued its consultation conclusions to the Consultation (the “Consultation Conclusions”) on 21 May 2021. While the Consultation Conclusions set out the FTSB’s views on responses to the proposed regulatory regimes for both VASPs and dealings in precious metals and stones, this client update will focus only on the former.
Scope and Coverage
As proposed in the Consultation, the FSTB wished to designate the business of operating a VA exchange as a “regulated VA activity” under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615). Any person wishing to operate a VA exchange in Hong Kong will therefore need to apply for a licence from the Securities and Futures Commission (“SFC”) as a licensed VASP.
The FSTB noted that a majority of the respondents agreed to the following proposed definitions of “VA exchange” and “VA”:
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, 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. Peer-to-peer trading platforms, 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 VA at any point in time, are not covered under the definition of VA exchange.
VA: a digital representation of value that (i) is expressed as a unit of account or a store of economic value; (ii) 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 (iii) can be transferred, stored or traded electronically. The definition does not cover digital representations of fiat currencies (including digital currencies issued by central banks), financial assets already regulated under the Securities and Futures Ordinance (Cap. 571), as well as certain closed-loop, limited purpose items.
In response to the input received from some respondents on the definition of “VA”, the FSTB clarified that the definition of “VA” (i) will not include stored value facilities which are separately regulated under the Payment Systems and Stored Value Facilities Ordinance (Cap. 584) or non-transferable, non-exchangeable and non-fungible in nature, such as air miles, credit card rewards, gift cards, customer loyalty programmes and gaming coins etc., but (ii) will include “stablecoins”.
Given the fast-evolving nature of the VA industry and the various bells and whistles that VAs can exhibit, the FSTB proposed to bring flexibility to the regulatory framework in two ways. First, the SFC will be empowered to prescribe characteristics that constitute the definition of a VA, so as to provide flexibility and cater for the fast-evolving nature of the VA industry. Second, the Secretary for Financial Services and the Treasury will be empowered to determine whether any digital representation of value is to be regarded as a VA or not.
Summarized below are the key licensing and regulatory requirements proposed by the FSTB:
Eligibility: Following input from respondents, the FSTB will refine the eligibility criteria such that both locally incorporated companies and non-Hong Kong companies registered under the Companies Ordinance (Cap. 622) may apply for a VASP licence.
Fit and Proper Test: Most respondents expressed support for subjecting VASP applications to a fit-and-proper test and the criteria for determining an applicant’s fit-and-properness. In addition, most respondents acknowledged that at least two responsible officers should be appointed.
Professional investors only: Despite views to the contrary, the FSTB maintained that VA exchanges may only offer its services to professional investors only during the initial stage of the licensing regime. Expanding the scope to include retail investors can be considered once the market becomes more mature. Generally speaking, professional investors refer to individuals or corporations with an investment portfolio of not less than HK$8 million.
Other regulatory requirements: In light of individual respondents seeking clarifications on the regulatory expectations on VA exchanges outlined in the Consultation, the FSTB indicated that the SFC will prepare and publish for consultation the detailed regulatory requirements before commencement of the licensing regime.
Open-ended licence: The VASP licence is proposed to be open-ended (i.e. valid until the licensed VASP is revoked by the SFC).
Exemption and Prohibition: Save for any VA exchanges which are already regulated as by the SFC as part of the voluntary opt-in regime launched pursuant to the position paper in November 2019, there will be no exemptions in respect of the VASP licensing requirement and a 180-day transitional period will be proposed. In addition, any unlicensed VASP is prohibited from actively marketing, whether in Hong Kong or elsewhere, to the public of Hong Kong a regulated VA activity or a similar activity elsewhere.
Sanctions: The sanctions for any breaches of the proposed VASP regulatory regime range will include administrative sanctions, fines ranging from HK$1,000,000 to HK$5,000,000 and imprisonment from two to seven years.
As expected by many stakeholders in the VA space, the Consultation Conclusions will have a significant impact on VAs and VASPs in Hong Kong.
With the issuance of the Consultation Conclusions, it has become certain that centralized VA exchanges will need to make the decision to exit the Hong Kong market entirely or obtain a licence from the SFC. This decision, however, is not imminent. The FSTB has indicated that they aim to introduce the bill in respect of the proposed regulatory framework into the Legislative Council in the 2021-22 legislative session. Assuming the bill is passed without substantive debate or changes, there will be a 180-day transitional period for centralized VA exchange to exit Hong Kong or submit a licence application to the SFC. If centralized exchanges opt for the former option, measures to restrict access by ineligible Hong Kong persons should be considered.
The outlook for decentralized VA exchanges is more uncertain. While some respondents took the view that the definition of “VA exchange” should include, among one other, peer-to-peer trading platforms (i.e. decentralized VA exchanges), the FSTB did not address the issue directly. Instead, the FSTB indicated that flexibility will be built in the licensing regime such that it may be expanded to cover forms of VA activities other than VA exchanges where the need arises in future. In our view, this regulatory lacuna may present certain opportunities to decentralized exchanges.
Given the increasing global popularity of VAs as investments by retail investors, fund managers and listed corporations alike, it is unfortunate that the FSTB has maintained its position that licensed VASPs may only offer services to professional investors on the basis that it is necessary to ensure a proper degree of protection for the investing public. Admittedly, VAs are in nature more speculative than traditional assets and carry additional risks. However, it is unclear whether such additional risks justify inconsistent approach to regulation: retail investors can, at the time of publishing and through a licensed corporation, trade in Bitcoin futures contracts and other virtual asset related products (e.g. ETFs, shares in companies in the VA industry) and still have indirect exposure to the risks of the underlying VA assets.
Further, while it is likely that professional investors are more experienced and have higher risk tolerance compared to retail investors, some may argue that the suitability of VAs as an investment should depend on an investor’s understanding of the “tech-savvy” nature of VA activities (as acknowledged in the Consultation Conclusions), rather than the value of one’s portfolio. In any event, the new restrictions will make it significantly more difficult for retail investors to participate in the VA space for the time being.
Should you have any questions on how the Consultation Conclusions will affect you, please contact our Managing Partner, Kristi Swartz at firstname.lastname@example.org, or our Associate, Alan Lee at email@example.com.