VATP regulation in Hong Kong: The regulatory perimeter

It is possible to apply to the Securities and Futures Commission (SFC) in Hong Kong to obtain a licence to engage in activities relating to virtual assets. However, not all virtual asset services are regulated and require a licence from the SFC. So, the key question is what virtual asset services trigger this licensing requirement. In the second of a series of articles, Pádraig Walsh and Shirley Kong from the Fintech practice group of Tanner De Witt review the regulatory perimeter in Hong Kong that determines whether the provision of virtual asset services must be approved by the SFC.

VASP regulation

Ask a person outside Hong Kong what services are regulated in respect of virtual assets, and the person might propose these five service lines:

1.       exchange between virtual assets and fiat currencies;

2.       exchange between one or more forms of virtual assets;

3.       transfer of virtual assets, that is to say, to conduct a transaction on behalf of another person that moves a virtual asset from one virtual asset address or account to another;

4.       custodian wallet provider; and

5.       participation in, and provision of, financial services related to an issuer’s offer or sale of a virtual asset or both.

These are the services outlined for the regulation of virtual asset service providers (VASP) by the Financial Action Task Force (FATF). [1] These are further expanded to ten possible service lines in the Markets in Crypto-Assets Regulation (MiCA) adopted by the EU. [2]

The position in Hong Kong is different. The key requirement of the VASP regime in Hong Kong is that a person must not carry on a business in Hong Kong of providing a virtual asset service or hold himself out as doing so unless the person holds a licence from the SFC to do so [3]. This restriction will also apply to persons outside Hong Kong that actively market the virtual asset service to the public in Hong Kong. However, the only virtual asset service presently regulated under the VASP regime in Hong Kong is the operation of a centralised virtual asset trading platform (VATP). In Hong Kong, for now, VASP regulation is, in effect, VATP regulation.

What are virtual assets?

A virtual asset is a cryptographically secured digital representation of value, typically in the form of a digital token.

The virtual asset must fulfil three core characteristics to be a virtual asset within the scope of regulation under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) [4]. These characteristics are the virtual asset:

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

(b)     either:

(i)      is used or intended to be used as a medium of exchange accepted by the public for paying for goods or services, discharging of debt or making investments. These are the typical characteristics of payment tokens; or

(ii)     provides rights, eligibility or access to vote on the management, administration or governance of affairs, or the terms, of any arrangements in relation to the virtual asset. These are the typical characteristics of governance tokens; and

(c)     can be transferred, stored or electronically. [5]

The SFC can supplement the characteristics necessary for a regulated virtual asset, and the Secretary for Financial Services and the Treasury can prescribe a particular virtual asset to be a regulated virtual asset.

Carve-outs

A virtual asset will not be regulated under AMLO if the virtual asset is:

(a)     issued by a central bank or government, or its related entity;

(b)     a limited purpose digital token;

(c)     a security or futures contract (which is regulated separately under the Securities and Futures Ordinance [6] ); and

(d)   constitutes a float or stored value facility deposit of a stored value facility (which is regulated separately under Payment Systems and Stored Value Facilities Ordinance [7]). [8]

Again, the SFC can supplement the characteristics necessary to be excluded from the scope of a regulated virtual asset, and the Secretary for Financial Services and the Treasury can expressly exclude a virtual asset from the scope of regulation.

Limited purpose digital tokens

Limited purpose digital tokens are:

(a)     customer loyalty or reward points;

(b)     in-game assets; or

(c)     digital representations of value that are similar to a customer loyalty or reward point or in-game asset, and which are not intended by its issuer to be convertible into money or another medium of exchange accepted by the public. [9]

Customer loyalty or reward points

These are digital representation of value that:

(a)     are not denominated in any currency;

(b)     have as their dominant purpose to promote the purchase of goods or the use of services which are provided by its issuer or any merchant specified by its issuer;

(c)     are issued to a person on the purchase of those goods or the use of those services; and

(d)     may only be used by the person for the payment, part payment or exchange of those goods or services. [10]

Generally, only closed loop customer loyalty and reward points will fall within the scope of the exception. Examples of customer loyalty and reward points are mileage points, credit card reward schemes or reward campaigns in shops and shopping malls.

In-game assets

These are digital representation of value that:

(a)     is purchased or otherwise acquired by a person;

(b)     is not denominated in any currency;

(c)     is issued as part of a game; and

(d)     may only be used by the person to pay or exchange for:

(i)     virtual objects or services in the game;

(ii)     similar things within or in relation to the game; or

(iii)    similar things that is part of the game. [11]

Examples of in-game assets are gaming coins or points for upgrading or entitlement to more resources within the gaming environment.  

Are NFTs considered to be virtual assets?

The issue of whether NFTs are virtual assets regulated under AMLO must be assessed according to the function of the NFT in the context of the definition of a virtual asset in AMLO.

An NFT will be unlikely to fall within the definition of a virtual asset under AMLO if the NFT is merely a genuine digital representation of a collectible. This type of NFT is unlikely to be considered as being a unit of account or a store of economic value, nor to be a medium of exchange accepted by the public or a token that provides holders with rights, eligibility or access to vote. In short, an NFT that is only a digital representation of a collectible (and nothing more) is not a payment token nor a governance token.

Regulated activities

The scope of regulated activities in relation to provision of services of virtual assets under AMLO (VA Service) includes:

(a)     carrying on a business of a VA Service or holding out as such;

(b)     issuing an advertisement relating to an unlicensed person’s provision of VA Services; and

(c)     actively marketing VA Services.

What is a VA Service?

The only VA Service regulated under AMLO presently is the operation of a VA exchange, that is, aVATP.

What is a VATP?

A VATP must fulfil three characteristics, being:

1.       The services must be provided through electronic facilities. The nature of the electronic facilities is not explained further in AMLO.

2.       The services must comprise [12] either:

(a)     regularly making and accepting offers to sell or purchase virtual assets in a way that forms or results in a binding transaction; or

(b)     introducing or identifying persons to each other in order that they may negotiate or conclude sales or purchases of virtual assets in a way that forms or results in a binding transaction.

This language is similar to the language used in the SFO to describe the regulated activity of automated trading services in respect of securities or futures contracts.

3.       In the course of providing the services, the client money or client virtual assets must come into the direct or indirect possession of the operator of the VATP. Client money and client virtual asset [13] is money or virtual assets received or held by the operator on behalf of its client, or in which the client has a legal or equitable interest (or any accretion to those assets). This is a characteristic of a centralised exchange.  

There are certain virtual asset arrangements that do not fall within the regulatory scope of a VATP under AMLO. These include [14]:

(a)     peer-to-peer platforms, as these platforms do not involve a centralised party providing intermediation activities to investors; or

(b)     order routing facilities and simple bulletin boards, as these platforms do not involve the use of automated trading engines.

The licensing requirement

A company or other business entity that carries on a business of operating a VATP that constitutes a VA Service, or holds itself out as such, must have a licence from the SFC permitting it to do so. [15]

An individual that performs any regulated function in relation to a business of operating a VATP that constitutes a VA Service, or holds himself out as such, must have a licence as a licensed representative from the SFC permitting him to do so. [16] A regulated function is generally considered as a function performed for or on behalf of the VATP in relation to the regulated services of the VATP [17], but excludes normal work done by an accountant, clerk or cashier [18].

Actively marketing a regulated activity

Generally, no person may actively market to the public of Hong Kong any services which would constitute a regulated VA Service if provided in Hong Kong, unless that person is licensed by the SFC to do so. Critically, a person who markets a regulated VA Service to the public in Hong Kong, but from a place outside Hong Kong, must still obtain a licence from the SFC in Hong Kong before conducting that active marketing activity. This provision has extra-territorial effect.

Relevant factors that indicate that a person is actively marketing to the public in Hong Kong include whether:

(a)     there is a detailed marketing plan to promote the services;

(b)     the services are extensively advertised via marketing means such as direct mailing, advertisements in local newspapers, broadcasting or other “push” technology over the internet (as opposed to where the services are passively available e.g. on a “take it or leave it” basis);

(c)     the related marketing is conducted in a concerted manner and executed in accordance with a plan or a schedule, which indicates a continuing service rather than an one-off exercise; and

(d)     the services are packaged to target the public of Hong Kong, such as being written in Chinese and with values denominated in Hong Kong dollars.

Advertisements

Unless an exemption applies, a person is not permitted to issue or have in his possession for the purpose of issue:

(a)     an advertisement or a document showing an advertised person holding himself out as being prepared to provide a VA Service. This can be a newspaper, brochure, circular, notice or a prospectus; and

(b)     which the person knows the advertised person is not licensed for the VA Service.[19]

Conclusion

One of the most interesting features of the VASP regulatory regime introduced in Hong Kong is that the regulatory perimeter is quite narrow. The only regulated activity for which a licence is needed from the SFC for virtual assets that are not securities is the operation of a VATP. There is no requirement for a licence to provide a custodian wallet service for virtual assets that are not securities, nor for advice in respect of the offer or sale of such virtual assets.

This unusual feature was addressed by the Financial Services and Treasury Bureau of the Hong Kong government in its consultation conclusions to the changes to AMLO to introduce the VASP regime [20]. A VATP is the most prevalent and developed industry area in Hong Kong in the virtual asset space. Other virtual asset activities noted by FATF are not significant in the Hong Kong market, and their fund movements can be monitored for AML/CTF purposes where they interface with financial institutions. This is an evolving area, and this current form of VASP regulation may be a comma, rather than a full stop. More regulation will follow as the market evolves. There is flexibility in the licensing regime in AMLO for new regulated activities for virtual assets to be supplemented as the need arises in the future.

In Hong Kong, for now, VASP regulation is, in effect, VATP regulation.

Pádraig Walsh and Shirley Kong

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

Pádraig Walsh

Partner | Email

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. This article was last updated on 21 June 2023.

---

[1] See FATF, Updated Guidance for a Risk-Based Approach: Virtual Assets and Virtual Asset Service Providers (2021) [link]

[2] See this link for the text of MiCA adopted by the EU Parliament in April 2023.

[3] Section 53ZRD(1) and (2), AMLO

[4] Cap. 615, Laws of Hong Kong

[5] Section 53ZRA(1), AMLO

[6] Chapter 571, Laws of Hong Kong

[7] Chapter 584, Laws of Hong Kong

[8] Section 53ZRA(2), AMLO

[9] Section 53ZR, AMLO

[10] Section 53ZR, AMLO

[11] Section 53ZR, AMLO

[12] Schedule 3B, AMLO

[13] Section 53ZR, AMLO

[14] See SFC, Consultation Paper on the Proposed Regulatory Requirements for Virtual Asset Trading Platform Operators Licensed by the Securities and Futures Commission (20 February 2023) [Link]

[15] Section 53ZRD(1) and (2), AMLO

[16] Section 53ZRD(3) and (4), AMLO

[17] Section 53ZRB(1)(a), AMLO

[18] Section 53ZRB(1)(b), AMLO

[19] Section 53ZRE(1)(a) and (b), AMLO

[20] See FSTB, Consultation Conclusion: Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (May 2021) [link]