Hong Kong To Bring Virtual Assets Into Line

The government of Hong Kong has this month opened a three month consultation on new AML/CFT regulations for Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs).

• https://www.fstb.gov.hk/fsb/ppr/consult/doc/consult_amlo_e.pdf

The centrepiece of the proposed changes would be the introduction of a licensing system for all VASPs.

Up until now, there has been no mandatory license requirement for VASPs in the jurisdiction, with previous arrangements put in place last year allowing a much looser “opt-in” regulatory framework.

Under the existing regime, only VAs categorized as ‘securities’ – digital representations of ownership of underlying assets or financial rights arising – were covered by AML/CFT regulations.

According to Ashley Alder, head of the Hong Kong Securities and Futures Commission (SFC), this means that

• “if a platform operator is really determined to operate completely off the regulatory radar, it can do so simply by ensuring that its traded crypto assets are not within the legal definition of a security.”
• https://www.regulationasia.com/hong-kong-to-align-crypto-regulatory-framework-with-fatf-standards/

Speaking at the recent Hong Kong Fintech Week, Alder admitted that this had proved “a significant limitation.”

Under the new proposals, all VAs – what are referred to as both ‘Security’ and ‘Non-Security’ tokens – will require licensing and regulation by the SFC.

This will mean that they will only be able to offer services to professional investors (defined by the SFC as an individual or entity with over HK$8 million (US$1.03 million) in assets).

They will need, moreover, to ensure client protections with the proper segregation of assets, effective privacy and security measures around wallet keys, and controls to prevent market manipulation.

Firms will also be required to undertake the full range of AML/CFT obligations around CDD, record keeping and reporting.

The extension of coverage will include both platforms based and operating in Hong Kong itself, but also those based outside the territory and providing services to its residents. Ader commented that “once this new regime is in place all virtual asset trading platforms in Hong Kong would be supervised and monitored,” Alder said.

• “If they’re operating in Hong Kong, or target Hong Kong investors, they would need to apply for an SFC license. Failure to do so would of course be an offence.”

The proposed changes are partly a response to wider global regulatory pressures. As the official announcement of the consultation by Christopher Hui Ching-yu, the Secretary for Financial Services and the Treasury, states openly,

• “the legislative proposals are intended to bring Hong Kong’s regulatory regime…in line with the latest international requirements, as promulgated by the Financial Action Task Force (FATF).”
• As of last June last year, FATF, the international AML/CFT standards organization of which Hong Kong is a member, required jurisdictions to introduce mandatory licenses or registration for VASPs.
• https://www.scmp.com/business/banking-finance/article/3108240/hong-kong-plans-ban-retail-trading-digital-currencies-and

However, the risks are not purely regulatory, and there have also been a number of recent cases of VA abuse linked to the Hong Kong market. BitMEX, one of the world’s leading crypto exchanges, is now under investigation by US authorities for infringement of the Bank Secrecy Act (BSA) and AML/CFT violations.

Although registered in the Seychelles, the firm has been run from Hong Kong, where its recently indicted founder and former CEO, Arthur Hayes, is recorded as a resident.

Another crypto exchange operating in Hong Kong, OKEx, also recently announced it would be suspending all customer cryptocurrency withdrawals, after the exchange’s founder, Xu Mingxing, was reported to be under investigation in mainland China.

According to Secretary Hui, the proposed changes are intended to bring greater certainty and credibility to the Hong Kong VA sector;

• “simply speaking,” he said “we will require all virtual-asset trading platforms to be operating transparently, like working under the sunlight.”

These proposals are therefore a positive development for the jurisdiction, not only as the scope and scale of VA activity grows, but as other competing markets like Singapore and the US, and international organizations such as the EU, try to create their own certainties in the VA sector.

Although lack of regulation and transparency might have been attractive to some in the short term, history suggests that long term growth occurs where trust and accountability are assured.

The full implementation of the proposals, if agreed, is likely to take some time. The consultation remains open for comment until 31 January 2021, with the Hong Kong administration planning to produce a bill before the Legislative Council later in the year. However, currently unregulated VASPs should not see this period of delay as an excuse to wait to make changes, but as an opportunity to get ahead. There is nothing stopping firms thinking through how they should approach these new challenges, and what controls and technology they will need in place.