Hong Kong Crypto Gets Green Light - Brave New Coin

[Gunnar Larson]

https://bravenewcoin.com/insights/hong-kong-crypto-update

Hong Kong Crypto Gets Green Light
Aditya Das 31 Jul 2023, 03:00 UTC
Ethereum NewsBitcoin NewsCrypto ExchangeCryptocurrency News
A crystal clear regulatory framework now gives Hong Kong crypto exchanges
the green light to offer their products to retail investors. This shift has
caught the attention of market observers because of the size of the Hong
Kong market. Is Hong Kong the new crypto hub?

On Thursday, the 1st of June, a much anticipated digital asset regulatory
regime came into effect in the Hong Kong SAR. To appreciate how fast things
have moved in the SAR, the new trading rules and licensing guidelines were
only finalized the week before the rules went live, and just eight months
after the proposed changes were announced in October 2022.

The new exchange regime for crypto in Hong Kong will represent one of the
clearest, most black-and-white structures ever for centralized
cryptocurrency exchanges to operate and offer their products to retail
investors. This rapid and dramatic shift has caught the attention of market
observers because of the size of the Hong Kong financial market.

The Hong Kong public equity market is the 7th largest stock exchange in the
world by market capitalization and beats out the national stock markets of
India and the UK. Hong Kong has been a global financial center for decades.
It has utilized a low tax regime and incredible local human capital, to
become a de-facto hub between China and the West. Hong Kong is the
historical center of ‘East meets West’ business and financial activity.

What the new Hong Kong crypto laws mean
The legislation that came into play on June 1st is a licensing regime for
virtual asset trading platforms (“VATPs”). Platforms that apply to be a
part of the regime will be regulated by the Hong Kong Securities and
Futures Commission (“SFC”).

The SFC has begun to offer guidance to potential VATPs. The SFC’s
‘Consultation Conclusions on the Proposed Regulatory Requirements for
Virtual Asset Trading Platform Operators Licensed by the Securities and
Futures Commission’ was also released on June 1st. It contains some
practical takeaways and guidance for hopeful VATPs to try to follow when
applying for a license with the SFC. A license will allow successful
applicants to offer virtual assets (that are considered securities by the
SFC) to retail customers. The consultation is a guideline document for
potential Virtual Asset Trading Platform Operators applying for a license
with the SFC.

Key aspects of the consultation —

Platform Operators will only be allowed to provide their services to retail
investors if they comply with a range of robust investor protections that
cover onboarding, governance, disclosures, token due diligence, and
admissions. The SFC says these requirements will broadly be in line with
the requirements applied to traditional licensed corporations.
The SFC notes that it is important for clients of the platform to
understand the features and risks of investing in virtual assets. During
the onboarding process the SFC says platforms will have to assess an
investor’s risk tolerance, conducting an holistic assessment of the
investor’s understanding of the nature and risks of virtual assets amongst
other assessments. This type of onboarding will apply to both retail and
institutional investors.
Operators will be required to set up robust governance procedures that may
include setting up a token admission and review committee that consists of
senior management who are principally responsible for managing the key
business line, compliance, risk management, and information technology
functions.
The tokens must also be incorporated in at least two cryptocurrency indexes
from prominent institutions, one with a background in traditional finance.
Disclosing information surrounding listed Virtual Assets. The SFC notes
that while it understands the potential challenges of obtaining and
verifying information provided by the issuer of a digital asset, it will
still expect a Platform Operator to conduct due diligence on each virtual
asset prior to admission for trading. As such, Platform Operators will
still be expected to obtain information for each listed digital asset,
reliable and sufficient enough, to base a token admission decision on. This
information will need to be disclosed to the SFC.
Custodian insurance for platforms. Platforms are required to have in place
insurance/compensation, approved by the SFC, to cover the risks tied to
being custodians of digital assets. An example of how compensation can be
set-up is in the form of bank guarantees, along with funds held in the form
of demand deposits or fixed deposits with a maturity of six months or less.
The SFC has stated that 98% of client’s assets need to be held in cold
storage.
The consultation document states clearly that platforms must not engage in
proprietary trading activities of virtual assets from their own accounts or
any account connected to the platform.
There is also a stated ban on VATPs offering any kind of virtual asset
derivatives style product. This may include offering, trading, or dealing
in virtual asset future contracts or related derivatives.
The trading of stablecoins is also banned for VATPs. The consultation
explains that stablecoins fall under the jurisdiction of the Hong Kong
Monetary Authority (“HKMA”). The HKMA is expected to launch a more robust
framework around stablecoins in sometime in the next 12 months.
The consultation has also stated that firms applying for VATP licenses with
the SFC should as a matter of prudence, apply for approvals under both the
existing SFC licensing regime and the AMLO licensing regime. AMLO is the
Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO). It
is designed to bring exchanges that offer crypto-assets that do not qualify
as “securities” within the regulatory oversight of the SFC (VATP regime).
The SFC states that both licenses should be applied in the instance that
some asset listed by a VATP may change to become a non-security and would
therefore be regulated under AMLO.
Why Hong Kong is Embracing Digital Assets
It has been reported that the new ‘crypto for retail’ framework by Hong
Kong is part of a wider initiative to help the city reclaim its position as
a leading, cutting-edge financial hub. Some of this sheen has been lost
because of the city's extended isolation during COVID-19 and a period of
social/political unrest before this.

Hong Kong has had crypto regulatory regimes before this latest initiative.
There was previously a voluntary license program in Hong Kong run by the
SFC but there were only two applicants— OSL and the Hashkey Group.
Providers were permitted to offer crypto trading services solely to
professional investors with portfolios of at least HK$8 million ($1
million). Notable crypto exchanges Crypto.com and FTX were also founded in
Hong Kong but both shifted their base away from the country and were not
part of any local licensing regime.

Paul Chan, the Financial Secretary of Hong Kong, has championed digital
assets and Web3 in the past. Speaking in January he said “Hong Kong has
become a quality standing point for digital asset corporates,” and
continued that the city has a robust regulatory framework that matches
international standards. He added that it also prohibits free riders and
described virtual assets as “unstoppable new financial innovations” and
implored that there is a need for Hong Kong to embrace them.

Hong Kong Crypto Licensing Not Without Issues
Likely the biggest issue tied to the new SFC licensing regime for digital
assets is its ambiguity. While it seems clear that the trading of what can
be understood as larger crypto assets like Bitcoin and Ethereum will fall
under the jurisdiction of the SFC, there is no mention of DeFi, NFTs, and
many other key components of the wider digital asset sector. They appear to
fall outside what is regulated — so is it to be assumed that these aspects
of crypto are illegal in Hong Kong? Digital asset derivatives are stated to
be outside the scope of the SFC, does this mean that they are also illegal?

Digital asset firms in Hong Kong need to determine if the products they
offer constitute securities. If they do, then they may need to apply for a
license with the SFC. This will be challenging for firms that operate in
gray areas offering services related to staking, NFTs, or play-to-earn
blockchain products. Companies based in Hong Kong offering these types of
services are still operating in uncertain territory - and will likely have
one eye looking over their shoulder expecting one of Hong Kong's numerous
financial watchdogs to come down on them.

The regime shift nonetheless sparks an opportunity to be a part of one of
the most exciting jurisdictional crypto projects in recent times. The SFC
license program is designed to attract fresh capital and talent to Hong
Kong. It will likely do this. The opportunity to offer digital asset
products to Hong Kong’s immense retail investor base is immense and it is
no surprise that major international crypto firms including Huobi, OKX, and
Amber Group have said they intend to pursue licenses with the SFC.
International crypto exchange BTSE announced in March that it would seek to
apply for a license with the SFC to operate within its planned Virtual
Asset License regime.

This interest comes despite the SFC licensing regime including numerous
requirements which may put off some potential applicants. It has been
reported that companies are wary of the potential costs tied to gaining an
SFC license. Information gathering, reporting obligations and KYC/AML
infrastructure will need to be set up to obtain an SFC license.

This will take investment, time, care, and skill. Hong Kong, however, may
be ahead of the curve. Frameworks like the SFC’s are being implemented, or
at least discussed, in major financial hubs including the US and the EU.
Thus companies that meet the requirements of the SFC license will likely be
well placed to expand and receive licenses in other regions. They will also
be more appealing to investors and traders because of assurances that they
have to meet high standards of security and transparency.

In comments shared with Brave New Coin, Joey Garcia, Director and Head of
Public Affairs, Policy, and Regulation at Xapo Bank notes further
challenges with the HKSFC framework. Garcia is a pioneer in the regulation
of virtual currency and distributed ledger technology (DLT). He co-chaired
the Gibraltar government’s working group on blockchain for three years,
which was established to develop the infrastructure to accommodate a DLT
regulatory framework.

He notes that while there has been a lot of publications advertising how
'retail investors' will now be permitted access to a regulated HK platform.
What is less reported is that the retail investor will still be subject to
'suitability' requirements. These requirements may include asset training,
work experience related to virtual assets, or prior trading experience.

Garcia also notes aspects of the framework that may need adjusting. He
tells Brave New Coin “the SFC will not permit 3rd party custodians anywhere
in the world, as they will require a direct regulatory handle over the
custodians. I see this as quite a negative as there have been years of
developments from the most secure custodian providers to arrive at the very
tried and tested position of security offered by those platforms.”
Specialist custodians will have to register in Hong Kong in order to
provide their services which will likely be unappealing. Therefore,
regulated platforms will have to develop their own systems and
infrastructure.

The China question
On the 1st of July 1997, Hong Kong became a Special Administrative Region
of the People's Republic of China. The city is therefore sometimes referred
to as HK SAR. Chinese national law does not generally apply in the region,
and Hong Kong is treated as a separate jurisdiction. It is allowed to have
its own laws and legal system under the Basic Law, which came into force at
the time of the Handover in 1997. The Basic Law was designed as the SAR’s
Constitution, both to maintain a high degree of continuity from the common
law regime inherited from the UK, and to enable Hong Kong to operate under
the “One Country, Two Systems” model with a considerable level of autonomy.
As such Hong Kong can continue to be open and encouraging toward digital
assets, despite the outright ban on anything related to the industry in
mainland China.

There are, however, systems in place like the Office for Safeguarding
National Security of the CPG in the HK SAR, that are designed to ensure
that Hong Kong remains subordinate to China. While on paper Hong Kong has
jurisdictional independence from China, there have been times in the past
when Chinese courts and national laws have trumped those local to Hong Kong.

This potential roadblock to the emergence of the new ‘crypto for retail’
regime has been raised in Hong Kong. Regulators in the city have pushed
against this assumption stating that the ‘One Country, Two Systems’ model
is still valid and Hong Kong is allowed to have its own financial
regulations. This confidence from Hong Kong regulators has been seen as a
sign that, behind closed doors, China is comfortable with Hong Kong’s
open-for-business attitude with regard to its own digital assets policy.
There have been rumors circulating that Chinese officials have even been
seen at local Hong Kong crypto meetups and have been positive about the
space.

The word ‘testing ground’ for Hong Kong has been thrown around. Will China
embrace crypto if Hong Kong’s plan for a regulated digital asset registry
shows signs of success? Time will tell.

In the early years of Bitcoin, Chinese investors and traders were early
adopters of Bitcoin and Chinese mining pools quickly became some of the
largest in the world. The availability of cheap electricity and hardware
made China an attractive location for Bitcoin mining operations, and the
country became a hub for Bitcoin mining activity. This naturally led to the
development of several major exchanges in the country including Okex (OKX)
and Huobi. Chinese trading hours and trading activity believed to have
originated from China, drove the price activity of BTC.

BTC became popular for wealthy Chinese to escape the country’s strict
capital controls. This, amongst many other factors, led to the outright
banning of anything crypto-related in China.

Hong Kong continues to plow forward with its compliant crypto mission. In a
press release shared with Brave New Coin, the HashKey group announced that
it had just partnered with Quam Securities and Longbridge Whale to complete
the first virtual asset online trade for securities firms in Hong Kong.
Livio Weng, COO of HashKey Group, said: "HashKey Group has always
prioritized the protection of customers' funds and assets and adhered to a
regulatory-first policy.” The move signals that some digital asset entities
in Hong Kong are willing to play ball with the city’s regulators.

Conclusion
The recent introduction of new digital asset regulatory measures by the
Hong Kong Securities and Futures Commission (SFC) marks an important step
forward in the city's efforts to provide a structured, secure, and
sustainable environment for digital asset trading targeted at retail
customers. These measures, which offer clear licensing guidelines and
robust investor protections, align Hong Kong's approach to digital assets
with its well-regulated traditional financial markets.

Will investors be more confident in gaining access to a HK-regulated crypto
market, or investing in that market? Xapo Bank’s Garcia thinks they will,
in the context of knowing that there are not only “high standards being
applied to it, but also serious standards for that platform including
market misconduct and insider trading which are well reported in the crypto
exchange environment.”

There are also a number of unknowns tied to the framework. The potential
influence of mainland China's crypto policies adds another layer of
complexity to the issue. What is the legal status of digital asset
derivatives, stablecoins, and Defi? Additionally, the high information
requirements for retail users will create barriers to entry.

As this landscape unfolds, Hong Kong's regulatory actions will undoubtedly
shape not only its own digital asset markets but potentially, those of
other major financial hubs around the globe. The city is taking an exciting
step that continues its proud trend of being a financial markets innovator.
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