Republished with the permission from Reuters Limited. This article was first published in Thomson Reuters Regulatory Intelligence, click here for the original article.
Few areas of finance are developing faster than crypto-assets, a category that includes cryptocurrencies, securities tokens and utility tokens, whose common feature is use of distributed ledger technology (DLT). Today there are more than 16,000 individual cryptocurrencies in circulation and daily trading volumes are estimated to be more than $275 billion on more than 400 platforms. Their rise has led to calls for better regulation due to potential investor protection, money laundering and market integrity risks.
- Which body regulates crypto-assets and related services?
- Does any law regulate crypto-assets or crypto-asset service providers such as exchanges?
- Has a national law or regulation defined "crypto-asset" and/or "cryptocurrency"?
- What money laundering regulations, including any due diligence requirements, apply to crypto-assets?
- What rules apply to the promotion of crypto-assets?
- Do different crypto-asset rules apply to wholesale and retail markets, for example, on the sale of derivatives?
- Does any existing or proposed national law impose requirements on issuers of stablecoin?
Which body regulates crypto-assets and related services?
Currently, there is no specific legislative framework in Hong Kong which regulates crypto-assets and therefore no single regulatory body governs such crypto-assets. However, a number of financial regulators have issued guidance relating to crypto-assets, including the Securities and Futures Commission (SFC), the Hong Kong Monetary Authority (HKMA) and the Insurance Authority (IA).
If a crypto-asset has characteristics of a security as defined under the Securities and Futures Ordinance (SFO) then it will be regulated by the SFC as a security in accordance with the SFO and other relevant laws and regulations. Further, the regime governing the offering/marketing of financial products in Hong Kong will be relevant if a crypto-asset qualifies as a security. Crypto-assets that are securities may also be subject to laws concerning regulated activities (which attract licensing and authorisation requirements).
Does any law regulate crypto-assets or crypto-asset service providers such as exchanges?
As explained in Q1, the SFO regulates crypto-assets which have characteristics of a security. Financial regulators such as the HKMA and the SFC have also issued additional regulatory guidance to regulated entities concerning activities involving crypto-assets including:
- the SFC’s regulatory statement and associated licensing terms to Hong Kong licensed asset managers in relation to managing and distributing funds that invest in virtual assets ;
- the HKMA’s guidance to authorized institutions (which includes licensed banks) on the regulatory approaches to authorized institutions’ engagement with crypto-assets and crypto-asset service providers ; and
- the HKMA-SFC joint circular on the distribution of virtual asset-related products and virtual asset related dealing and advisory services .
The regulatory regime in relation to the regulation of virtual assets trading platforms (VATP) currently operates on an "opt-in" basis. A centralised VATP can "opt-in" to regulation by offering to trade at least one token on its platform which qualifies as a security. A VATP which opts-in will need to be licensed by the SFC, and once licensed, a VATP will be required to adhere to licensing conditions (including offering its services to professional investors only) as well as other conduct requirements.
On 3 November 2020, the Financial Services and the Treasury Bureau (FSTB) published a consultation paper on its proposals to amend the Anti-Money Laundering and Counter Terrorist Financing Ordinance (AMLO) to bring exchanges which offer crypto-assets that do not qualify as “securities” within the regulatory oversight of the SFC (VASP regime). The new rules are designed to close the existing regulatory gap and regulate certain providers of non-securities crypto-asset services (also known as virtual assets service providers or VASPs) for the first time. The FSTB published its consultation conclusions on the VASP regime in May 2021 and an amendment bill is expected to be introduced intothe Legislative Council in the second quarter of 2022. The VASP regime will likely come into effect in 2022/2023.
Has a national law or regulation defined "crypto-asset" and/or "cryptocurrency"?
There is no statutory definition of “crypto-asset” or “cryptocurrency” in Hong Kong. However, these terms are often used interchangeably with “virtual assets”. As regards the definition of “virtual asset”, the current proposal, as outlined in the consultation conclusions on the VASP regime, is to introduce a new defined term of “virtual asset” in the amended AMLO to mean 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 is not intended to cover digital representations of fiat currencies (including digital currencies issued by central banks), financial assets already regulated under the SFO as well as certain closed-loop, limited purpose items.
What money laundering regulations, including any due diligence requirements, apply to crypto-assets?
The AMLO is the principal legislation stipulating customer due diligence (CDD) and record-keeping requirements and applies to specified financial institutions registered or licensed in Hong Kong (as well as designated non-financial businesses and professions in Hong Kong). The AMLO does not specifically address requirements as they relate to crypto-assets but the SFC has published licensing conditions applicable to VATPs which include additional AML/CTF guidance and requirements for VATP operators. For example, the licensing conditions specify that a VATP is required to obtain additional customer information to help determine the client’s business and risk profile and conduct ongoing due diligence on the business relationship including, wherever relevant, an IP address with an associated time stamp, geo-location data, device identifiers, virtual asset wallet addresses, and transaction hashes. The SFC also expects a VATP to use appropriate technology and third party services (where appropriate) to identify situations which warrant enhanced CDD e.g. transactions involving tainted wallet addresses such as “darknet”; transactions involving virtual assets with a higher risk or greater anonymity; and transactions involving the use of proxies or any unverifiable or high risk IP geographical locations.
While the VASP regime is not yet in operation, licensed VASPs will also be required to comply with AML/CTF requirements under Schedule 2 to the AMLO which includes CDD and record-keeping requirements. In addition, the SFC will be empowered to supervise the AML/CTF conduct of licensed VASPs and enforce other regulatory requirements in accordance with the AMLO stipulations.
Certain providers of ancillary services may also already be covered under existing regimes requiring CDD measures to be carried out. For example, custody providers that operate under a trust model may require licensing as a trust company service provider and therefore subject the CDD requirements under AMLO.
What rules apply to the promotion of crypto-assets?
There is no specific legislation governing the promotion of crypto-assets in Hong Kong. As mentioned in Q1 above, the regime governing the offering/marketing of financial products in Hong Kong will only be relevant if a crypto-asset qualifies as a security. Please note that the SFC has also issued a warning statement to investors in 2019 regarding virtual assets futures contracts. Given the risks associated with these types of contracts, the SFC has stated that it would not likely grant a licence to any persons intending to carry on a business in such futures contracts. In a similar vein, any offering or marketing of financial products involving crypto-derivatives to retail investors are also unlikely to be approved by the SFC (although per the HKMA-SFC joint circular, the “professional investors only” restriction is not imposed for the distribution of a limited suite products by intermediaries e.g. virtual assets-related derivative products that are traded on regulated exchanges specified by the SFC, or exchange-traded virtual assets derivative funds that are authorised or approved for offering to retail investors by the respective regulator in a designated jurisdiction).
It is also worth noting that when the proposed VASP regime takes effect, it will prohibit any person from actively marketing a regulated virtual assets activity (or services associated with a virtual assets exchange) to the Hong Kong public, unless licensed by the SFC.
Do different crypto-asset rules apply to wholesale and retail markets, for example, on the sale of derivatives?
As mentioned in Q1, there is no specific legislation framework which regulates crypto-assets. Given the risks associated with crypto-assets, there are rules under various regimes which prohibit the relevant licensees from targeting or offering crypto-asset products to retail investors. For example, under the proposed VASP regime, a virtual asset exchange can only provide services to professional investors (i.e. institutional investors or those that meet specified asset threshold tests). The SFC-HKMA joint circular also specifies that, except for a limited suite of products, virtual assets-related products which are considered complex products should only be offered to professional investors (e.g. an overseas virtual assets non-derivative ETF would very likely be considered a complex product and should only be offered to professional investors).
Does any existing or proposed national law impose requirements on issuers of stablecoin?
If a stablecoin fulfils the meaning of a stored-value facility (SVF) in Hong Kong in accordance with the Payment Systems and Stored Value Facilities Ordinance (PSSVFO), it will be subject to a mandatory licensing regime administered by the HKMA. In other words, the issuer of the stablecoin will need to comply with the PSSVFO and other requirements, including guidelines, practice notes and supervisory requirements, issued by the HKMA. However, the definition of an SVF under the PSSVFO may not cover certain types of stablecoins. The HKMA has therefore recently published a Discussion Paper on Crypto-assets and Stablecoins (Stablecoins Paper) in which it outlines its views on how to expand Hong Kong’s regulatory framework for stablecoins. A few of the key messages are outlined below.
Payment related stablecoins
One of the key points made by the HKMA is that it feels that there is a perception that some stablecoins may be developing into a widely acceptable means of payment (i.e., payment-related stablecoins). The HKMA’s concern is that these payment-related stablecoins have a higher potential for being incorporated into the mainstream financial system or even day-to-day commercial and economic activities (by being a means of payment). In light of these concerns, the HKMA is considering expanding the scope of the PSSVFO or introducing new legislation to focus on activities relating to these types of stablecoins.The types of stablecoin-related activities that would fall within regulatory scope include issuing, creating or destroying stablecoins, managing reserve assets to ensure stabilisation of the stablecoin value, and storing the private keys providing access to stablecoins.
Asset-linked stablecoins
The HKMA will also focus on asset-linked stablecoins (e.g., linked to a single fiat currency) rather than algorithm-based stablecoins at this stage, noting that (i) currently, existing stablecoins are mostly asset-linked and predominantly pegged to USD; and (ii) compared to algorithm-based stablecoins, asset-linked stablecoins appear to be more prevalent in the market and more likely to be perceived as having the potential to develop into a widely used and acceptable means of payment.However, the HKMA does not rule out the possibility of regulating other types of stablecoins, including but not limited to algorithm-based ones in the future (e.g., having regard to the risks that they may pose to the monetary and financial stability of Hong Kong).
Regulatory requirements
In terms of the regulatory requirements to be put in place for the stablecoin arrangements, the HKMA states that it proposes a risk based approach on the basis that it is common for multiple entities to be involved in different parts of a stablecoin arrangement. Such entities would be subject to part or all of the requirements. Such requirements include authorisation, maintaining adequate financial resources and liquidity requirements, maintenance and management of reserves of backing assets, and proper implementation of anti-money laundering rules.Importantly, the HKMA states that a foreign company or group cannot carry out, as a business, the proposed regulated activities in Hong Kong or actively market to the public of Hong Kong such activities. Instead, they will need to incorporate a company under Hong Kong law, and the Hong Kong incorporated company would be the entity to apply to the HKMA for a licence and hold that licence if and when granted. A mere Hong Kong branch or office of a foreign corporation will be regarded as not meeting the requirement of being “an entity incorporated in Hong Kong”. This requirement aims to enable the HKMA to exercise effective regulation on the relevant entities.
