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HK crypto trading regime focuses on investor protection
Multiple safeguards include dual licensing, strict onboarding rules, compensation arrangements
Yuki Li 8 Jun 2023

After Hong Kong’s Securities and Futures Commission (SFC) announced a new regulatory framework for virtual asset trading  platforms (VATPs), which took effect on June 1, several industry players have expressed interest in applying for a licence to conduct business in the city.

The new regime seeks to foster the responsible development of the crypto industry in Hong Kong, with a focus on protecting the interest of retail investors and managing related risks.

Dual licensing regime

Under the Securities and Futures Ordinance (SFO) regime, VATPs offering security token trading services may apply for two types of licences, namely Type 1 for dealing in securities and Type 7 for providing automated trading services.

Those providing non-security token trading services are required to obtain a virtual asset service licence for operating a virtual asset exchange under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (AMLO) regime.

While there are different categories, it is suggested that VATPs apply for licences under both the SFO and AMLO regimes to avoid violating licensing requirements and ensure business continuity. This is because the classification of a virtual asset may change from a non-security token to a security token, or vice versa, over time. To streamline the process, applicants for licences under both regimes can submit a single consolidated application online and indicate that they are applying for both licences simultaneously.

Grace period for incumbents

Pre-existing VATPs, or those providing virtual asset services in Hong Kong before June 1, are eligible for one-year transitional arrangements if they can demonstrate meaningful and substantial presence in the local market, such as a physical office presence, central management and control by Hong Kong staff, genuine trading volume with independent clients in Hong Kong, etc.

Qualified VATPs have nine months to prepare as their application should be submitted online no later than February 28 2024, and they can continue providing virtual asset services in Hong Kong from June 1 2023 to May 31 2024 without violating licensing requirements under the AMLO.

Those not operating in Hong Kong before June 1 are not eligible to conduct VATP activities or actively market their services to Hong Kong investors until they obtain the required licence from the SFC. Engaging in unlicensed activities is considered a criminal offense.

Retail investor protection

Platform operators will be allowed to provide services to retail investors if they comply with a range of robust investor protection measures covering onboarding, governance, disclosure, and token due diligence and admission.

The SFC requires platform operators to meet the full scope of the onboarding requirements, including assessing the investor’s risk tolerance, conducting a holistic assessment of the investor’s understanding of the nature and risks of virtual assets, etc. The assessment made during the onboarding process will also be relevant to comply with the suitability requirements.

In order to mitigate risks, platform operators must conduct due diligence on each virtual asset prior to admission for trading, even if the virtual asset in question has already been admitted for trading on another licensed VATP. A minimum 12-month track record is needed for non-security tokens, which means newly launched virtual assets cannot be admitted for trading.

The SFC is also requiring platform operators to have in place a compensation arrangement to cover the potential loss of 50% of a client’s virtual assets and 100% of a client’s virtual assets held by their custodian.

The arrangement should be made up of third-party insurance, funds (held in a demand deposit or time deposit with less than six months’ maturity), or the platform operator’s virtual assets which are set aside for such purpose, and/or a bank guarantee from an authorized financial institution in Hong Kong.

So far, crypto exchanges OKX and BitMex, state-owned Chinese company Greenland Holdings, and Hong Kong virtual lender ZA Bank are already preparing to apply for VATP licences.

“We see immense potential in Hong Kong, and are committed to investing in talents and working with regulators over the next five years,” comments Lennix Lai, managing director of global institutional at OKX.

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