Virtual Assets In Hong Kong
Hong Kong’s public and private sectors are seeding and supporting a vibrant ecosystem for next generation digital networks, platforms and services. Alongside its initiatives to accelerate the development of the Artificial Intelligence and quantum computing sectors, Hong Kong is also emerging as the global leader in Web3. On June 30, 2023, the government established a Task Force on Promoting Web3 Development comprised of public officials, regulators, academics and business leaders, chaired by Hong Kong’s Financial Secretary, Paul Chan, who has referred to virtual assets as “unstoppable new financial innovations”.
The establishment of the Task Force comes soon after the Securities and Futures Commission’s (SFC) new licensing regime for virtual asset trading platforms, requiring crypto asset exchanges to obtain a license and comply with stringent requirements in asset custody, anti-money laundering (AML), cybersecurity, corporate governance and know-your-client (KYC) standards in order to operate and provide services to retail investors in Hong Kong. The new rules came into effect on June 1.
Virtual asset traders who have already established a platform in the city will have a one year window during which they can maintain their existing operations while preparing a compliance strategy.
The licensing rules, which cover digital assets such as cryptocurrencies and security tokens, require exchanges to weigh a range of factors when offering cryptocurrencies, including average daily trading volume and market capitalization. Furthermore, tokens traded by locally licensed platforms must be included in at least two major cryptocurrency indexes. Trading platforms are also required to screen retail clients for financial literacy in the context of virtual assets (i.e basic familiarity with asset classes and markets) and set account limits in line with individual financial circumstances.
The Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 defines virtual assets as “a cryptographically secured digital representation of value”. NFTs and relatively recent decentralized finance applications (such as GameFi) are not explicitly addressed by the SFC, although it is likely that the majority of virtual assets will fall under the SFC’s purview, with specific exemptions for assets contained within specific platforms (i.e in-game items). The Hong Kong Monetary Authority (HKMA) is expected to implement a separate licensing regime for stablecoins in 2024.
The virtual asset trading platform licensing regime serves to standardize and streamline the governance of the sector, which previously fell outside of Hong Kong’s regulations covering securities, which limited the extent to which exchanges could establish their platforms with local institutions and directly serve retail investors. While the SFC did govern cryptocurrency futures, trade in the currencies themselves was generally unregulated, with the exception of a voluntary licensing scheme enacted in 2019, which allowed exchanges to provide services to professional investors with a minimum of HK$8 million (USD 1 million) in Assets Under Management. Only two exchanges opted for the previous SFC license.
In the wake of 2021’s severe market volatility, there is a growing need for public sector endorsement and oversight of virtual asset trading in order to provide consumer protections in line with traditional investment services, providing a robust foundation for the ongoing innovation and development surrounding the asset class. Hong Kong is uniquely positioned as a vital hub for the sector because of its favorable policy environment, substantially developed regulatory regime and thriving industry ecosystem. The city also has a critical advantage as China’s exclusive jurisdiction for global virtual asset markets, since cryptocurrency transactions remain illegal in Mainland China.
Under the one country, two systems framework, Hong Kong’s vibrant business community, culture of innovation and unparalleled global connectivity enable the city to progressively set international standards for Web3, beginning with virtual assets.
Licensing Rules and Application Procedures
There are four main criteria that applicants must fulfill under the Virtual Asset Trading Platform (VATP) licensing regime.
- Fit-and-proper test
- Responsible Officers
- Financial resources
Applicants should be either locally incorporated with a permanent local office or overseas companies registered under the Companies Ordinance. The SFC will consider the applicant’s background, including financial status, ability to operate Virtual Asset services (i.e expertise, qualifications and experience), as well as their prior record of compliance with regulations. Furthermore, applicants must nominate at least two Responsible Officers (RO) to personally take responsibility for overseeing and executing anti-money laundering controls. Each RO must be approved by the SFC, and at least one of them should be an Executive Director. In order to meet the competence requirement, applicants must demonstrate technical proficiency with virtual assets in addition to rigorous internal controls, efficient operations and prudent risk management.
Furthermore, Virtual Asset Trading Platforms must maintain a minimum share capital of HK$ 5 million all times and minimum liquid capital of HKD 3 million. Applicants for the Virtual Asset trading license must maintain liquid assets (i.e not cryptocurrency equivalent) in cash, deposits or bonds.
There is also an external assessment (EAR) requirement, for which an external auditor must review the applicant’s corporate structure, governance, operations and internal controls. The external assessment involves two phases, in which the auditor will first evaluate the proposed operational structure, and then review the actual implementation in practice. All findings from the external auditor will subsequently be reviewed by the SFC.
The one year transitional period will be permitted for trading platforms that have operated before June 1 2023. However, these platforms must apply for a license before February 29, 2024 or make arrangements to relocate from Hong Kong. Meeting the requirements for the SFC’s license will require substantial reviews and assessments, with a potential necessity to adjust the company’s structure and operations.
We have extensive experience with internal control assessments that meet Hong Kong’s rigorous standards. Drawing on our expertise in business advisory and audit and assurance to work closely with specialist businesses across a range of sectors, we ensure that companies stay ahead of challenges and find the best window of opportunity to flourish.
Hong Kong’s Web3 landscape is now at the beginning of a decisive new phase that will shape the sector’s trajectory. If you are interested in developing a virtual asset trading platform in Hong Kong, you can schedule a free initial consultation with a team of lawyers and auditors at any of our offices.