The Hong Kong Securities and Futures Commission (SFC) published its consultation conclusions on regulation of virtual asset trading platforms (Conclusions) on 23 May 2023. In the Conclusions, the SFC confirmed that virtual asset trading platforms licensed by the SFC (VA Platforms) can provide trading services to retail investors and finalised the Guidelines for Virtual Asset Trading Platform Operators (VATP Guidelines), which set out, among other things, standards and requirements expected of VA Platforms on investor protection requirements, safe custody of assets, segregation of client assets, avoidance of conflicts of interest and cybersecurity. The VATP Guidelines came into effect on 1 June 2023.

The virtual asset service provider licensing regime under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Chapter 615 of the Laws of Hong Kong) (AMLO) and the other guidelines and FAQs (set out below) also came into effect on 1 June 2023:

• Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations and SFC-licensed Virtual Asset Service Providers);
• Prevention of Money Laundering and Terrorist Financing Guideline issued by the Securities and Futures Commission for Associated Entities of Licensed Corporations and SFC-licensed Virtual Asset Service Providers;
• FAQs on licensing matters and conduct-related matters; and
• VATP Licensing Handbook.

Four Key Areas

The Conclusions provided clarification in four key areas:

1. Scope of VA platform’s offerings

• The SFC’s view is that a VA Platform’s primary business is to act as an agent and match client orders.
• VA Platforms can offer services to retail investors (however, there are restrictions on offering security tokens¹ to retail investors).
• VA Platforms cannot offer or trade in virtual asset (VA) derivatives – the SFC is aware of the importance of VA derivatives to institutional investors given the large number of comments made on its original consultation in relation to the same. The SFC will conduct a separate review of VA derivatives in due course.
• VA Platforms cannot provide staking, deposit-taking, lending nor borrowing services as these may lead to potential conflicts of interest.
• VA Platforms cannot conduct proprietary trading or algorithmic trading. However, the VA Platform’s clients can use their own algorithmic trading systems in connection with trading via the VA Platform.

2. Listing of tokens

• A VA Platform must conduct due diligence on each token² before the token can be listed on the VA Platform. There are no exemptions from such due diligence requirement even if the token is listed on another licensed VA Platform.
• Token-specific information must be disclosed by the VA Platform and, accordingly, the SFC expects the VA Platform to exercise due skill, care and diligence in selecting VAs to be made available for trading on the VA Platform and in ensuring that the disclosures in relation to each token listed on the VA Platform are not false, biased, misleading or deceptive.
• Non-security tokens need to have at least a 12-month track record prior to listing.
• VA Platforms can rely on smart contract auditing conducted by an independent assessor.
• Tokens to be made available for retail trading must be eligible large market capitalisation token³. The SFC will not publish a whitelist of acceptable tokens or acceptable indices, but will refer to the International Organization of Securities Commission’s (IOSCO) Principles for Financial Benchmarks.
• The SFC does not require a VA Platform to seek and submit to the SFC external legal advice confirming that each token made available for retail trading would not amount to a security token. However, the SFC may request legal opinions in relation to specific tokens taking into account developments in other jurisdictions. VA Platform operators are nonetheless reminded of their obligations and to take reasonable steps to ensure that retail trading of any token they make available will not breach the public offering regimes in Hong Kong.
• Until stablecoin regulatory arrangements have been implemented, stablecoins are not available for retail trading. A more holistic regulatory regime on stablecoins will be announced by Hong Kong Monetary Authority.

3. Insurance and compensation arrangement

• The Conclusions relaxed the insurance/compensation coverage requirements for VAs in cold storage – a minimum 98 percent of client VAs need to be held in cold storage, with 50 percent insurance/compensation coverage. Other compensation mechanisms may also be acceptable.
• A maximum 2 percent of client VAs in hot or other storage, with 100 percent insurance/compensation coverage. This has not changed since the consultation.
• All seeds and private keys need to be securely stored in Hong Kong, with appropriate certification such as Hardware Security Module.

4. Licence related matters

In the Conclusions, the SFC suggests that it would be prudent for VA Platforms to be licensed under each of the respective regimes under the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) (SFO) and the AMLO⁴. The SFC will adopt a streamlined single application process for the dual licensing regime and will allow the proposed responsible officers of a VA Platform to be approved both under the SFO and the AMLO so that it will not be necessary for a dual-licenced VA Platform to maintain four responsible officers.

Conclusion

The VATP Guidelines are a welcome development as they provide clarity on issues that concerned the VA industry. While there are some areas where further development is still needed – for example, VA derivatives – the legal and regulatory framework for VAs in Hong Kong is slowly but surely taking shape.

Footnotes

1) “Security token” means a cryptographically secured digital representation of value which constitutes “securities” as defined in the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong).

2) “Token” means any non-security token and any security token.

3) In the VATP Guidelines, a token available for trading by retail investors must be included in at least two acceptable indices issued by at least two independent index providers (one of which must comply with IOSCO’s Principles for Financial Benchmarks and have experience in publishing indices for the conventional securities market).

For the purposes of the VATP Guidelines, an “acceptable index” means an index that has a clearly defined objective to measure the performance of the largest virtual assets in the global market. Such index must fulfil the following criteria: (a) the constituent virtual assets should sufficient liquid; (b) it should be objectively calculated and rules-based; (c) the index provider should the necessary expertise and technical resources to construct, maintain and review the methodology and rules of the index; and (d) the methodology and rules of the index must be well documented, consistent and transparent.

4) This refers to the licence to conduct Type 1 regulated activity (dealing in securities) and Type 7 regulated activity (providing automated trading services) under the SFO and the licence for virtual asset service provider under the AMLO.