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Any person who seeks to carry on a virtual asset service business will soon need to obtain a Virtual Asset Service Provider (“VASP”) licence from the Securities Futures Commission (“SFC”), failing which he commits an offence. Under the current licensing regime, pending implementation of the new rules described below, only two crypto platforms, i.e. OSL Digital Securities Limited and Hash Blockchain Limited, have been licensed as cryptocurrency exchanges in Hong Kong – they will need to transition to the new regulatory regime within the prescribed transition period.
Recent History of the Legislation
The implementing legislation for the VASP scheme, currently in the form of the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance 2022 (the “Ordinance”) specified that the licensing regime for virtual asset services would come into operation on 1 March 2023. After consultation with the regulators in Hong Kong, the Hong Kong government decided to move the effective date of the new law to 1 June 2023. Mr. Joseph Chan, Undersecretary for the Financial Services and Treasury Bureau (“FSTB”) told the South China Morning Post that “after listening to the feedback of the Hong Kong Association of Banks and other regulators, we decide to implement the effective date of the law change for the virtual asset licensing regime to be moved to 1 June 2023. This will allow more time for the industry to have sufficient time to prepare to comply with the new regulatory requirements.”
What are virtual assets?
Virtual assets (“VAs”) under the Ordinance mean cryptographically-secured digital representations of value, expressed as a unit of account or store of economic value and either is used, or is intended to be used, as a medium of exchange accepted by the public, for payment for goods or services, discharge of a debt, or investment; or provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with, or to vote on any change of the terms of any arrangement applicable to, any cryptographically secured digital representation of value; and can be transferred, stored or traded electronically.
The Secretary for Financial Services and the Treasury may also prescribe any digital representation of value as a VA.
Under the proposed new section 53ZRA(2) of the Ordinance, the definition of VA excludes digital representations of fiat currencies issued by central banks or issued by the government; limited purpose digital token; or constitutes securities and a futures contract, etc.
There was much discussion in the industry on the definition of a “limited purpose digital token”. It has been suggested that some non-fungible tokens offered in the current market might be excluded. Upon the gazettal of the Ordinance, s.53ZR clarifies that any digital representation of value that is similar to a customer loyalty or reward point or an in-game asset and it is not intended by the issuer to be convertible into money or another medium of exchange accepted by the public is a “limited purpose digital token”. The Bills Committee notes that “non-fungible tokens” (“NFTs”) in general are unique cryptographic tokens that exist on a blockchain which cannot be replicated, and some NFTs are not intended by the issuer to be convertible into money or another medium of exchange accepted by the public. A NFT that is a digital representation of a collectible is unlikely to qualify as a VA.
What are virtual asset services?
Any person seeking to carry on virtual asset services will be required to obtain a VASP licence from the SFC (s. 53ZRD of the Ordinance). Schedule 3B of the Ordinance sets out the meaning of a VA service. A VA service means operating a VA exchange – that is, providing services through means of electronic facilities where the users will enter into binding transactions for buying or purchasing VAs, and where the users’ money or VAs will directly or indirectly come into possession of the VASP service provider. A person providing such VA services is required to obtain a VASP licence from the SFC.
Requirements for obtaining a VASP licence
An applicant for a VASP licence, its responsible officers, licensed representatives, directors and ultimate owners will be required to satisfy the fit and proper test (see Fit and Proper Guidelines published by the SFC). The VASP applicant is required to appoint at least two responsible officers who will generally be responsible for overseeing the operation of the licensed VASP and ensuring compliance with the legislation and other regulatory requirements. The requirements for the responsible officers of VASPs mirror those for the responsible officers of licensed corporation under the SFO and require that:
- At least one responsible officer must be an executive director of the VASP applicant;
- If the VASP applicant has more than one executive director, they must all be appointed as responsible officers;
- At least one responsible officer must be ordinarily resident in Hong Kong; and
- At least one responsible officer must be available at all times to supervise the business of the VASP service.
Hong Kong-incorporated companies which have a permanent place of business in Hong Kong and non-Hong Kong companies registered under the Companies Ordinance (Cap. 622) will be eligible to be licensed as VASPs. Businesses without a separate legal personality (such as partnerships and sole traders), individuals and overseas companies that are not registered in Hong Kong will not be able to obtain a VASP licence.
Emphasis on Investor Protection
According to the Legislative Council Brief published by the FSTB, VASP licensing applicants will be required to abide by a robust set of regulatory requirements to be imposed as licensing conditions by the SFC. Investor protection will include but not be limited to:
- consideration of VASP licensing applicants’ company and management structure;
- that the business model is sound, with detailed risk management policies and other listing and counter-market manipulation measures in place; and
- VASP licensing applicants must demonstrate that they have adequate financial resources (a minimum amount has not yet been specified). At the initial stage of the licensing regime (unspecified in duration), a licensed VASP may only offer services to professional investors. Imposing this requirement as licensing condition provides flexibility for the SFC to make changes when adjustment is necessary without the need to amend the Ordinance.
In January 2022, the SFC and the Hong Kong Monetary Authority (Hong Kong’s bank regulator) (“HKMA”) published a joint circular on intermediaries’ virtual asset-related activities. The circular demonstrated a differentiated approach to regulating VA related activities by the SFC and the HKMA, and specifies different requirements for the following categories of VA-related activities: product distribution, provision of dealing services, and provision of advisory services.
For example, in relation to product distribution, complex VA products may only be offered to professional investors, and intermediaries are in general required to make an assessment as to whether the client has sufficient knowledge of and experience with VA-related products before trading on their behalf. An exception to this rule is where the client is an institutional professional investor or a qualified corporate professional investor. The circular provided exceptions for exchange-traded VA derivative products that are traded on a specified exchange, and public futures-based VA ETF authorised or approved in a designated jurisdiction for offering to retail investors by the respective regulator and traded on a specified exchange – the professional investors only restriction does not apply to the distribution of these products.
SFC’s supervisory powers and sanctions
The SFC will be granted extensive supervisory and intervention powers including the power to:-
- enter business premises of licensed VASPs and associated entities to conduct routine inspections and request production of documents;
- investigate non-compliance;
- impose administrative sanctions (including reprimands, remedial actions orders, civil penalties and suspension or revocation of licences) in case of non-compliance; and
- impose restrictions and prohibitions against the operation of a licensed VASP and its associated entities where the circumstances so warrant.
Operating a VA exchange in Hong Kong without a licence, or actively marketing (whether in Hong Kong or elsewhere) to the public of Hong Kong the services of an overseas VA exchange that is not licensed in Hong Kong, without a reasonable excuse, will be an offence punishable on conviction on indictment, to a fine of HK$5 million and to imprisonment for seven years and, in the case of a continuing offence, to a further fine of HK$100,000 for every day during which the offence continues. A summary conviction will see fines of HK$500,000 and imprisonment of up to two years, and a further fine of HK$10,000 for every day during which the offence continues.
Implementation timeline
The following is the currently-expected timeline for the new VASP regulatory regime.
What should you start doing now if you want to operate a VASP in Hong Kong?
- Appoint Responsible Officers for AML/CFT compliance, as each VASP applicant is required to have at least two responsible officers to oversee the operation of the licensed VASP and ensure compliance with AML/CTF and other regulatory requirements.
- Develop internal anti-money laundering policies, procedures and controls – including risk assessments, customer due diligence measures (i.e. know your client requirements), ongoing monitoring of customers, suspicious transactions reporting, record keeping, and sufficient staff training on the regulatory requirements.
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