10/03/22

HONG KONG: Regulatory regime for cryptoasset marketing and dealing introduced.

As published on step.org/industry-news, Thursday 10 March, 2022.

Hong Kong's Securities and Futures Commission (SFC) and Monetary Authority (HKMA) have announced a comprehensive new licensing regime to regulate virtual asset (VA) marketing and dealing.

Regulations introduced in November 2018 already required licensed VA portfolio managers to ensure that only professional investors invest in their VA funds, and that anyone other than institutional investors and qualified corporate investors would be subject to suitability tests. The following year this was extended to allow trading platforms offering VA securities to opt-in to a licensing regime, offering services only to professional investors where the client's VA knowledge had been assessed. In May 2021, the regulators jointly concluded that a new compulsory licensing regime for VA exchanges was needed, housed in the anti-money laundering legislation, and requiring VA exchanges to offer services to professional investors only. The SFC and HKMA have now issued a joint circular setting out the investor protection measures that intermediaries (licensed corporations and registered institutions) are expected to follow when providing VA-related services.

Licensed intermediaries offering VA services to professional investors will have to comply with a series of safeguards. They will only be allowed to partner with SFC-licensed trading platforms in order to provide VA dealing services, either by introducing clients to the platforms for the client's direct trading or the intermediary establishing an omnibus account with the platforms and trading for the clients. Clients will generally have to be professional investors, with few exceptions, and their knowledge of virtual assets will have to be assessed before they invest in any VA-related products. They will only be allowed to withdraw or deposit fiat currencies.

Even more stringent conditions will be imposed where the intermediary distributes VA-related investment products. But the joint circular no longer takes an overarching 'professional investors (PIs) only' approach to VA activities. Less onerous investor protection measures apply to certain derivative VA-related products traded on a specified exchange, or are funds that are authorised in a designated jurisdiction. These latter products can be sold to retail investors, subject to the usual restrictions in Hong Kong. Aside from that special case, retail investors are generally excluded from the regime.

Intermediaries that already engage in VA-related activities have a six-month transition period until 28 July 2022 to revise their systems and controls to align with the new rules. Intermediaries that do not currently engage in VA-related activities must comply with the requirements before introducing such services.

A further circular issued by the HKMA provides guidance on banks' interaction with VAs and VA service providers (VASPs), either through proprietary investment or provision of banking and investment services to customers. It expects banks to identify and understand associated risks before engaging in VA activities. Banks are not prohibited from incurring financial exposures to VAs, but will need to have adequate risk-management controls and risk-mitigation in place and conduct appropriate due diligence on VAs and VASPs. Banks planning VA products or services should liaise in advance with the HKMA on the adequacy of their risk-management controls, says Hong Kong law firm Slaughter and May.

The Hong Kong Monetary Authority has also issued a discussion paper on further development of the regulatory structure. Stakeholders are invited to submit their views by the end of March.