New licensing regime for Virtual Asset Service Providers: The Consultation Conclusions

On 21 May 2021, the Financial Service and the Treasury Bureau (“FSTB”) published the conclusions to the consultation on legislative proposals to enhance anti-money laundering and counter-terrorist financing (“AML/CTF”) regulation in Hong Kong.  We reported on the key points of the consultation for virtual asset services providers (“VASPs”) in our previous article.  Now, we can revisit and look forward with the announcement of the conclusion.  As a brief recap, the FSTB proposed to establish a licensing regime under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”) for VASPs in Hong Kong.  Although the consultation covered AML/CTF issues in other sectors, more than half of the submissions in the consultation period focused solely on the proposed VASP regime.

Definition of Virtual Asset

The proposed definition of virtual asset would be a digital representation of value that:

(a)     is expressed as a unit of account or a store of economic value;

(b)     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

(c)     can be transferred, stored or traded electronically.

However, a virtual asset does not include:

(a)     digital representations of fiat currencies (including digital currencies issued by central banks);

(b)     financial assets already regulated under the Securities and Futures Ordinance (Cap. 571) (“SFO”); or

(c)     certain closed-loop, limited purpose items that are non-transferable, non-exchangeable and non-fungible (such as Asia miles, credit card rewards, gift cards, customer loyalty programmes, or gaming coins).

The majority of the respondents agreed with the proposed definition of virtual asset.  The FSTB further clarified in the conclusions that the proposed definition of virtual asset does not cover stored value facilities, which are separately regulated under the Payment Systems and Stored Value Facilities Ordinance (Cap. 584). The FSTB will provide flexibility in the legislation to cater for the fast-evolving nature of virtual assets by empowering the SFC to prescribe characteristics that constitute the definition of a virtual asset and the Secretary for Financial Services and the Treasury to determine whether any digital representation of value is to be regarded as a virtual asset or not.

Licensing of Virtual Asset Exchanges

Under such regime, the business of operating a virtual asset exchange would be a “regulated virtual asset activity” under the AMLO and require any person seeking to operate a virtual asset exchange in Hong Kong to apply for a licence from the Securities and Futures Commission (“SFC”).

A virtual asset exchange will include any trading platform which:

(a)     is operated for the purpose of allowing an offer or invitation to be made to buy or sell any virtual asset in exchange for any money or any virtual asset; and

(b)     comes into custody, control, power or possession of, or over, any money or any virtual asset at any point in time during its course of business. 

This means that even exchange platforms operating in Hong Kong that only trade in virtual assets would require licensing. So, this would apply, for instance, where the user deposits a virtual asset such as USDT in the platform to buy other virtual assets, such as BTC, ETH or DOGE.

Other forms of virtual asset activities, such as over-the-counter trading or peer-to-peer trading platforms, would not require licensing under the VA regime.  The FSTB’s rationale is that virtual asset exchange within the proposed regulatory perimeter for virtual assets is the most common and developed activity in Hong Kong. Other virtual asset activities outside virtual asset exchanges is scanty and negligible in Hong Kong with fund movements already being traceable where they interface with financial institutions.

Licensing Requirements

The FSTB initially proposed only locally incorporated companies with a permanent place of business in Hong Kong would be considered for granting of a VASP licence.  There was considerable market preference to allow companies incorporated elsewhere but registered in Hong Kong under the Companies Ordinance (Cap. 622) (i.e. non-Hong Kong Company) to apply for a VASP licence.  Accordingly, the FSTB will revise the proposal to permit non-Hong Kong companies that are registered in Hong Kong to apply for VASP licence.

Most respondents supported subjecting VASP applicants to a fit-and-proper test and the criteria for determining an applicant’s fit-and-properness under the AMLO.  Although most respondents acknowledged the need for requiring at least two responsible officers who have to be personally accountable for contravention or non-compliance of the requirements, one respondent raised concern about the cost implication of such a requirement.  As mentioned in our previous article, this cost and burden of regulation may cause some virtual asset exchanges and innovative startups to reconsider their scope of operations in Hong Kong.

Regulatory Requirements

There was general support for licensed VASPs being subject to the AML/CTF requirements (such as customer due diligence and record-keeping requirements) as prescribed in Schedule 2 to the AMLO. 

However, in relation to the proposed condition that licensed VASPs can only offer services to professional investors, over 40% of the submissions consider that retail investors should be allowed to participate in trading activities of a virtual asset exchange.  Nonetheless, the FSTB considers confining the services of virtual asset exchanges to professional investors as necessary to ensure a proper degree of protection for the investing public.  The FSTB believes that the requirement is appropriate at least for the initial stage of the licensing regime.  This is perhaps the most significant impact on the virtual asset sector and is in fact a double-edge sword. 

Virtual asset exchanges operating in Hong Kong will need to decide whether or not to become licensed VASPs.  If they proceed to become licensed, then they give up the retail investor market.  As there would be a prohibition on any person who is not a licensed VASP from actively marketing, whether in Hong Kong or elsewhere, to the public of Hong Kong a regulated virtual asset activity, virtual asset exchanges deciding to exit the Hong Kong market would also not be able to market to the Hong Kong retail investors.

Virtual asset retail investors in Hong Kong would not be able to trade on licensed and regulated VASP platforms in Hong Kong.  As a result, keen virtual asset retail investors may trade on less efficient, unregulated and perhaps riskier alternatives, such as peer-to-peer trading platforms and over-the-counter trading.  This added risk may become counterproductive to FSTB’s intention to “ensure a proper degree of protection for the investing public”.

Powers of the Licensing Authority, Sanctions and Statutory Appeal

There is general support for the SFC supervising the AML/CTF conduct of VASPs and enforcing the regulatory requirements. The proposed criminal and administrative sanctions were uncontroversial and also generally supported by the respondents.  Appeals against future decisions made by the SFC in relation to the VA regime would be to the Anti-Money Laundering and Counter-Terrorist Financing Review Tribunal (rather than the Securities and Futures Appeals Tribunal).  This is the dedicated authority established under the AMLO for reviewing decisions in respect of financial institutions’ compliance with the AMLO requirements.

Transition Period

With the general support from the respondents on the proposal on regulating VASPs via the SFC, the FSTB is targeting to introduce the amendment bill into the Legislative Council in the 2021-22 legislative session (October 2021 to July 2022).  There will be a transition period of 180 days after the start of the licensing regime for interested parties to file the VA licensing applications.

The SFC is also expected to issue consultations before commencing operation of the licensing regime. 

As always, we at Tanner De Witt, are ready to help you with the changes ahead.

River Stone, Pádraig Walsh & Herman Pang

If you would like to discuss any of the matters raised in this article, please contact:

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.